As per labour law, every salaried employee is entitled to a minimum number of paid holidays. Employees do not have to use all their annual leave entitlements. Unused paid leaves can usually be carried forward by employers.

When the employee retires or resigns, he or she will invariably have an unutilised leave balance. Unutilised paid leave must be compensated by the employer. Leave encashment is the term used to describe this concept.

Encashment of accumulated leave during service and retirement or resignation encashment of accumulated leave during service. As part of ‘income from salary’, any leave encashed during service is fully taxable. Relief can be claimed under Section 89, however. In accordance with the category in which an employee falls, leave encashment received at the time of retirement or resignation may be fully or partially exempt. 

Further details have been provided below: Central or State Government employees who retire or resign receive a fully exempt leave encashment. Legal heirs of deceased employees receive a fully exempt leave encashment. Non-Government employees receive leave encashments which are exempt based on the computation under Section 10(10AA)(ii) and any remaining amounts will be taxed as ‘income from salary’.

Employees are eligible for an leave encashment exemption of Rs 3,00,000 irrespective of how frequently they encash their leave. At the time of first resignation, an employee may only use the balance of Rs 1,00,000 in the exemption computation if he has already used Rs 2,00,000. Thus, an employee may only encash leave encashed from all employers for a total of Rs 3,00,000.

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