Geeta has worked at RetailHub since 2014. Sticky person — never took CL/SL except for the occasional flu. Her earned-leave balance: 142 days accumulated (out of company's 240-day max cap). She's now planning to leave RetailHub to join a competitor.
Last drawn salary (basic + DA): ₹1,80,000/month. Per the company's leave policy, accumulated EL on exit gets encashed at last-drawn basic + DA.
Geeta's gross leave encashment: 142 days × (₹1,80,000 / 30) = ₹8,52,000.
How much of that is tax-free? Her HR's first answer was "₹3 lakh under old rules". Her CA's updated answer: "₹25 lakh post Aug 2023". Both are partly right depending on the underlying section's interpretation. Let's walk through.
- Four leaves in Indian employment: Casual Leave (CL, 7-12 days, use-or-lose), Sick Leave (SL, 7-10 days, sometimes encashable), Earned/Privilege Leave (EL/PL, accruing 1.5-2.5 days/month, generally encashable on exit), Maternity Leave (26 weeks paid, under Maternity Benefit Act 1961 as amended).
- Leave encashment during service (e.g., partial encashment of EL while still employed): fully taxable as salary at slab rate. Sec 17(1).
- Leave encashment on retirement / resignation / superannuation: Sec 10(10AA) exemption. Government employees: fully exempt. Non-government employees: least of four amounts (see below). Cap raised from ₹3 lakh to ₹25 lakh on 25 August 2023.
- Maternity leave under the Maternity Benefit (Amendment) Act 2017: 26 weeks paid (was 12 before 2017). Eligibility: 80 days work in 12 preceding months. Salary continues — no separate tax treatment (it's just paid salary while on leave).
- For employer payroll design: structure exit benefits carefully — gratuity, leave encashment, ESOPs, severance — each has its own exemption section with its own cap. Mixing them up costs the departing employee real money.
The four leaves, defined
Casual Leave (CL)
Use-or-lose
Typically 7-12 days/year, granted in advance. For unforeseen personal needs. Not encashable in most policies. Lapses at year-end if unused. Not carried forward.
Sick Leave (SL)
Use-or-lose
Typically 7-10 days/year. For genuine illness, sometimes requires medical certificate above 3 days. Generally not encashable. Some PSUs / older companies do encash; private sector rarely does.
Earned / Privilege Leave
Accrues + encashable
Accrues at 1.5-2.5 days per month worked (so 18-30 days/year). Usually carried forward up to a cap (180-300 days). Encashable on exit at last-drawn basic + DA, or at company's discretion during service.
Maternity Leave (ML)
Statutory 26 weeks
26 weeks paid leave (was 12 before 2017 amendment) for first two children. 12 weeks for third child onwards. Adoption: 12 weeks for child < 3 months. Commissioning mother (surrogacy): 12 weeks. Full salary continues during ML.
Sec 10(10AA) — the leave encashment exemption math
Section 10(10AA) of the Income Tax Act exempts leave encashment received on retirement / resignation / superannuation from taxable salary. Two-tier rule:
- Government employees: fully exempt, no cap. (Includes central, state, public-sector undertakings of central / state).
- Non-government employees: exempt up to the least of:
- (a) Actual leave encashment received
- (b) Average salary (basic + DA forming part of retirement benefit) of last 10 months × 10 months
- (c) Cash equivalent of leave (capped at 30 days per year of completed service) × salary per day
- (d) ₹25,00,000 overall ceiling (revised from ₹3,00,000 on 25 August 2023 via Notification 31/2023)
The ₹25 lakh ceiling is lifetime — applies across all leave encashments received by an individual from one or more non-government employers, cumulative.
Geeta's actual computation
- Last drawn salary (basic+DA): ₹1,80,000/month. Average of last 10 months ≈ ₹1,75,000.
- Service: 12 completed years.
- Leave balance encashed: 142 days at ₹1,80,000/30 = ₹8,52,000 actual.
- (a) Actual: ₹8,52,000
- (b) 10 × average salary: 10 × ₹1,75,000 = ₹17,50,000
- (c) 30 days × 12 years × salary per day: 360 days × ₹6,000 = ₹21,60,000 (capped at the 360 days even though her actual leave balance is 142 days; cap protects against more-than-30-days-per-year accrual)
- (d) Overall ceiling: ₹25,00,000
- Least of all four: ₹8,52,000 (the actual received). Fully exempt under Sec 10(10AA).
Geeta walks away with the full ₹8.52L of leave encashment as tax-free. Her exit also includes gratuity (separate Sec 10(10) exemption, separate ₹20L cap) — likewise structured.
For 20+ years before August 2023, the Sec 10(10AA) cap for non-government employees was ₹3 lakh — set decades ago and never indexed. With salaries having multiplied 10x in that period, ₹3L often covered only a fraction of senior employees' leave balances. The Aug 2023 revision to ₹25 lakh (notified by CBDT under powers granted by Finance Act 2023) finally aligned the cap with current salary realities. The revision is one of the few inflation-indexed adjustments in the IT Act since 2002.
Maternity leave — the statutory baseline
The Maternity Benefit Act 1961 (as amended in 2017 and 2022 codification under the Social Security Code 2020) provides:
- 26 weeks paid leave for first and second children. (12 weeks for third child onward.)
- Eligibility: woman who has worked at least 80 days in the 12 months preceding expected delivery date.
- Salary continuity: full pay during leave from employer. Calculated at average daily wage of last 3 months.
- Work-from-home option: after the leave, employer must consider WFH if nature of work permits.
- Creche facility: mandatory for establishments with 50+ employees.
- Adoption: 12 weeks if adopting child < 3 months. Commissioning mother (surrogacy): 12 weeks.
- Prohibition on dismissal: cannot dismiss/discharge during pregnancy or maternity leave; deemed termination is voidable.
From a tax perspective: maternity leave is paid leave, treated as salary, fully taxable in normal slab. There's no separate exemption — the benefit IS the paid time off.
FBP — Flexible Benefits Plan design with leave
Many companies offer a Flexible Benefits Plan letting employees structure their CTC. Leave doesn't typically enter the FBP allocation directly (it's a statutory entitlement), but related components do:
- Leave Travel Allowance (LTA): paid for actual travel during EL within India. Tax-exempt under Sec 10(5) twice in a 4-year block. Effective when planning a major holiday around your EL usage.
- Encashment during service: fully taxable; some employees opt to encash a fixed quantum each year as flexible benefit. Useful if leave balance approaches the company cap and will lapse anyway.
- Sabbatical / extended unpaid leave: NOT covered by Sec 10(10AA). It's a contract feature with the employer, not a tax-exempt category.
- Comp-off / time-in-lieu: weekend / holiday work compensated with extra leave. Treated as EL for encashment purposes if so accumulated.
The right time to encash — during service vs at exit
During service
Fully taxable
If you encash leave while still employed, the full amount is salary, taxed at slab rate. No 10(10AA) shelter. Only useful if leave is about to lapse (anyway gone) OR you need the cash and have plenty of slab room.
On exit / retirement
10(10AA) shelter
Sec 10(10AA) shelter activates. Up to ₹25 lakh + other criteria. For an exit-rich balance, much better. Plan resignation timing to land in a low-income FY for any taxable balance over the cap.
The funny historical wrinkle
India's maternity benefit was 12 weeks (84 days) from 1961 to 2017 — among the lowest in middle-income countries. The 2017 amendment doubled it to 26 weeks (182 days) — among the highest globally. The trade-off: small employers (10-49 employees) reported they hesitated to hire women of childbearing age because of the longer paid-leave obligation. Studies in 2019-2021 detected a measurable dip in female hiring at small companies in industries with thin margins. The policy debate is unresolved.
The leave encashment ₹3L → ₹25L jump in August 2023 was similarly long overdue — the ₹3L number had been frozen since 2002. It was one of the most-petitioned-for adjustments in Indian tax law for two decades, finally addressed via CBDT notification 31/2023.
Quick answers
Yes — claim the exemption in your ITR (Schedule S, "exempt allowance"). Difference between TDS deducted and actual tax becomes refundable. File a corrected Form 16 request with employer or just claim in ITR directly.
Cumulative across employers. If first employer gave ₹15L tax-free encashment, only ₹10L remains under the lifetime ₹25L cap for the second employer's encashment. Excess is taxable.
The Maternity Benefit Act 1961 applies to establishments with 10+ employees. Below 10, no statutory entitlement. Some smaller companies offer voluntarily; some don't. Negotiate at offer time.
If your employer chooses to encash SL on exit (some PSUs do): same Sec 10(10AA) treatment as EL encashment. Total combined encashment subject to the same ₹25L lifetime cap.
No — public holidays and weekends are NOT leave. They're separate non-working days. EL/CL/SL are working-day leaves on top of these.
When you might want help
Two situations: (1) Senior employee resigning with significant leave balance — exit-payout structuring (gratuity + leave encashment + ESOP + severance), Sec 10(10AA) and 10(10) optimisation. (2) Employer designing a clean leave + FBP + exit policy — Maternity Benefit Act compliance, EL cap design, encashment formula.
Planning a senior-level exit?
Exit-payout structuring across gratuity + leave encashment + ESOP + severance to minimise tax under all applicable sections. Fixed-scope engagement.
"Geeta" and her numbers are composite illustrations. Your actual encashment math depends on policy, salary structure, and accumulated balance.