Leave Encashment Calculation: Should We Divide Monthly Salary by 30 or 26 Days?

Dear All,

It is not mentioned either in the Factories' Act or in any other Acts regarding the method of calculation of leave encashment. Some hold the view that in the case of monthly rated employees, to arrive at the daily rate, the monthly rate of salary should be divided by 30 days. Others argue that the monthly rate of salary should be divided by 26 days. I kindly request someone to highlight the correct and justifiable procedure.

Thank you.

Laws on Leave Encashments

Actually, there are laws on leave encashments. In every Shops and Establishment Act, there are decided leaves, and there is a provision for carrying forward along with cash payments for them. For example, in the Punjab and Haryana Shops and Establishment Act:

Leave Provisions

See Indian Labour Laws & Shram Suvidha Simplified.

"Every employee who has been in employment for not less than twenty days in a year shall be entitled to one day's earned leave for every such twenty days:

- If an employee is discharged or dismissed from or leaves service during the course of the year, he shall be entitled to leave with wages or wage in lieu of unavailed leave.
- If an employee does not in any one year take the whole of the leave allowed to him under clause (a), any leave not taken by him shall be added to the leave to be allowed to him in the succeeding year: Provided that—
- Subject to any specific agreement between the employer and the employee, the total number of days of leave that may be carried forward to a succeeding year shall not exceed forty in the case of a young person or thirty in any other case;
- The provisions of this section shall not operate to the prejudice of any rights to which an employee may be entitled under any other law or under the terms of any award, agreement, or contract of service;
- Where such award, agreement, or contract of service provides for a longer leave with wages or weekly holidays than those provided under this section, the employee shall be entitled to only such longer leave or weekly holidays as the case may be.
- Leave period in clause (a) shall, when applied for, be granted except for a valid reason to be communicated in writing by the employer to the employee within fifteen days of the application: Provided that the leave so refused shall, if applied for again, be allowed during the year.
- Notwithstanding anything contained in the above clauses, every employee in an establishment shall be allowed with wages seven days casual leave and seven days sick leave in a year."

Now, those covered under this act can follow the same parallel while allotting encashment facilities.

Dear Labour Law Index,

Your reply is certainly useful to me. However, my query pertains to the method of calculation in the case of leave encashment. To determine the daily rate, should the monthly salary be divided by 30 or 26 days? I would appreciate clarification on this matter. Additionally, if there is any supporting document available, it would be even more helpful.

Thank you.

Most Appreciated,

There are two ways we can approach this:

Actuarial Standards in India

They value leave encashment on a 26-day basis. https://www.google.co.in/url?sa=t&am...RrCaMdpp25AI7g

Civil Service Rule 38A

It does take 30 days.

According to me, 26 days is the correct valuation measure.

There is an old case in the Supreme Court that declared for the purpose of gratuity computation, the daily rate from the monthly rate would be obtained by dividing by 26. This rule has been followed by courts since. Even minimum wage regulations and notifications specify dividing by 26 days.

So, you need to divide by 26 days in your case.

Dear Mr. Mohan,

For monthly-rated employees, do you pay salary for 30/31/29/28 days? You pay salary based on the total days in the month. For the purpose of Leave Encashment, you take the total days in the month in which Leave Encashment is paid to determine 1 Day's Salary.

For example, if you are paying Leave Encashment in April 2017, take 30 days. Similarly, if you are paying Leave Encashment in May 2017, take 31 days.

I'll try to give a twist to the question here. What are the Heads of Salary (Basic, DA, HRA, Overtime Allowance, Tiffin Allowance, Conveyance Allowance...) that should be considered when deciding the amount to be paid for Leave Encashment?

Learned friends, may you kindly enlighten others, please.

Soumitra Sengupta

Dear Soumitra,

Please peruse "The Factories Act, 1948" and Shops & Commercial Establishments Act to learn about leave encashment. Fixed salary components of gross salary are considered for leave encashment. Extra time allowance/overtime, tiffin allowance, etc., cannot be part of fixed salary components. What an employee earns while on leave, the same amount he earns at the time of surrendering leave.

Thank you.

Dear Seniors,

We can calculate the leave encashment in the following manner:

Example:
Monthly Salary - Rs. 10,000
Number of leaves to be encashed = 10
One day salary = Rs. (10,000 x 12) / 365 = Rs. 1,20,000 / 365 = Rs. 328.8 = Rs. 329 (approx)
Total Leave encashment = Rs. 329 x 10 = Rs. 3,290/-

Please correct me if wrong anywhere.

Regards,
Sandip Shaw

Types of Leave Encashment

Of all types of leaves, only earned or privilege leave is encashable. Usually, the basic salary and dearness allowance are considered for calculating the amount, but gross salary may also be used (subject to the organization's standing order). Leave encashment applies only to completed years of service. For example, if you have 20 years and 7 months of service, the calculation would be for 20 years only. There is no statutory compulsion to have a Leave Encashment Policy, so your employer may or may not offer leave encashment at their discretion. Government employees can accumulate a maximum of 10 months of leave, which can be encashed.

Legal Provisions for Leave Encashment

In industrial law, provisions for leave encashment are derived from the Factories Act and the Shop and Commercial Establishment Act. As per Section 79 of the Factories Act 1948, the total number of days of leave that may be carried forward to a succeeding year shall not exceed thirty (30) for an adult or forty (40) for a child. However, a recent amendment in 2002 via The Small Enterprises (Employment Relations) Act 2002, applicable to all of India, allows a worker to accumulate leave up to 45 days in addition to the leave entitlement of the current year. This leave can be encashed pro-rata if the worker's services are terminated or if they quit.

Leave Encashment Calculation

Leave encashment is received by the employee at the time of separation or retirement. The maximum leave encashment exemption limit is up to 3 Lakhs. Leave is calculated for the calendar year, January to December.

How to Calculate Leave Pay and Encashment Payment

Annual leave encashment = (leave days x 12) x (Gross Salary x 12 / 365)

Example: A person earns a salary of Rs. 12,000 per month and is allowed 2 leave days per month. Calculate Leave Encashment Payment:

Employee salary = Rs. 12,000
Leave Days Per month = 2
Annual leave encashment = (leave days x 12) x (Gross Salary/Basic+D.A x 12 / 365)
= (2 x 12) x (12,000 x 12 / 365)
= Rs. 9,468.493

Tax on Leave Encashment

The tax on leave encashment depends on whether you are a government or private sector employee and whether you are encashing it at the time of retirement or mid-way.

[A) At the time of Retirement]

- Government Employee: The entire amount received as leave encashment is tax-free.
- Non-Government Employee: The leave encashment for private sector employees is stated in Section 10 (10 AA) and is the minimum of the following four factors:
1. Amount received as leave encashment
2. Maximum cap as stated by the government – Rs 3 Lakhs after 02.04.1998
3. Last 10 months' average basic salary & dearness allowance before leaving the job
4. Cash equivalent of the leave balance, subject to a maximum of 30 days for each completed year of service

For example, a non-government employee receives Rs 6 lakh as leave encashment at retirement. She worked for 25 years and was eligible for 45 earned leaves every year. Below is the calculation:

- No. of earned leaves eligible = 45 x 25 = 1,125 days
- Leaves used = 585 days
- Leaves eligible for encashment = 1,125 - 585 = 540 days (18 months)
- Average last 10 months basic + dearness allowance = Rs 25,000

Tax Calculation:
The tax exemption would be the minimum of the below four points:
1. Amount received as leave encashment – Rs 6 Lakhs
2. Maximum cap as stated by the government – Rs 3 Lakhs
3. Last 10 months' average basic salary & dearness allowance before leaving the job – Rs 2,50,000 (Rs 25,000 x 10)
4. Cash equivalent of the leave balance, subject to a maximum of 30 days for each completed year of service – Rs 1,37,500

- Earned leave eligibility as per above rule = 30 days x 25 = 750 days
- Leaves used = 585 days
- Leaves eligible for encashment (as per above rule) = 750 - 585 = 165 days (5.5 months)
- Cash equivalent = 5.5 x 25,000 = Rs 1,37,500
- Tax exemption = Rs 1,37,500
- Taxable component = Rs 6,00,000 - Rs 1,37,500 = Rs 4,62,500
- Post-tax deduction, the leave encashment would vary from Rs 3.2 lakh (in the 30% tax slab) to Rs 4.15 lakh (in the 10% tax slab)

The leave encashment is tax-free for government employees, and the calculation is the same as above for non-government employees. However, the limit of Rs 3 lakh for non-government employees is for the entire lifetime. If you already received Rs 1 lakh while leaving your job, going forward, you can only have Rs 2 lakhs as tax-exempted leave encashment.

[B) Leave Encashment While in Service]

If you encash leaves partially or fully while in service, the income from encashment is fully taxable for both government and non-government employees.

[C) Leave Encashment on Death]

The leave encashment is tax-free when paid to the nominees or legal heirs upon the death of an employee.

Note: It is not necessary that workers in factories be given only earned leave. Certain factories also design their own leave policies, which include Casual Leave and Sick Leave, thereby extending better welfare facilities to employees.

Regards,
Amit