Annual Leave Encashment: Is It Calculated on Basic or Gross Salary During Final Settlement?

Hello Everyone, Please let me have clarity on the following: Is Annual Leave Encashment done based on the Basic salary or Gross salary during the Full and Final settlement? Thank you

Leave encashment and its calculation

Leave encashment is not a statutory provision. It is regulated as per the Leave Rules in vogue in the organization or establishment. Now, the question is whether leave encashment is always calculated on the last basic pay drawn plus DA. Gross salary is not considered for leave encashment, which may contain fringe benefits like HRA or other allowances that do not form part of PAY as defined in the FR & SR (Fundamental Rules & Service Rules).

If anyone wishes to have more insight, they may contact via email at [Email Removed For Privacy Reasons].

Regards, AK Jain
Retired Manager (HR)
Coal India Ltd.

Annual Leave Encashment

Annual Leave Encashment is done on the Basic salary only.

Generally, leave encashment is done based on the basic salary. However, organizations can formulate their own rules governing encashment. Leave encashment is not mandated by Indian labor laws. The employer decides whether the unused paid leave can be encashed or carried forward to the next year. Organizations generally provide this facility to address authorized or unauthorized absenteeism.

Hope this piece of information helps.

Referring to Chapter VIII, Clause 78 & 79(3) of the Factories Act, 1948 on leave encashment, there is no mention that the encashment should be done based on basic salary. It should be calculated on the gross salary, as would be the case when an employee takes a leave and is paid in full equivalent to their worked day.

There is no logical reason to pay it based on basic salary. However, it is a common practice, which is incorrect.

Even a newly joined employee is entitled to leave encashment upon termination, resignation, or in the event of death (to their heir), regardless of the condition of having worked for 240 days or before confirmation.

Leave encashment during service and at the end of service

Leave encashment during the service and at the end of the service are two aspects to consider. Since leave encashment is not an emolument like salary (basic + DA), it's not a statutory provision in many private sector units. However, in the government sector, there are provisions governing encashment.

In the private sector, many units implement this payment by allowing the surrender of EL/PL only for encashing those days. Some units allow a few days every year, subject to a maximum number of days, while others permit it not every year but as and when feasible. However, most units allow encashment at the credit as part of the Full and Final settlement upon separation due to superannuation, VRS, termination, death, etc., subject to a maximum of, say, 300 or 240 days, as per their service conditions.

Generally, gross salary is taken for computation. The gross salary might include basic pay, DA, HRA, which are payable to employees when they are on EL/PL. The gross salary at the time of encashment is reckoned. I have not come across any unit paying only basic pay. Some units allow encashment linked with LTA. Leave encashment is taxable like salary.

Leave Encashment Considerations

The basic thing that we have to consider is what will be paid to an employee when they take leave for that day. Will it be just the basic pay alone or the gross salary? Obviously, the employee will earn the gross salary for the days they remain on leave with wages. Ideally, that gross salary should be the base for calculating the leave encashment as well. However, since leave encashment while the employee is in service is an obligation of the employer, it can be considered an employee benefit. Therefore, the employer may have a different formula, typically including only basic and dearness allowances as part of the leave encashment.

Leave Encashment Upon Departure

At the same time, when an employee leaves the organization for any reason, the employer is obligated to pay the cash equivalent for the number of leaves remaining unavailed. This payment should be based on the gross salary. It is a straightforward proposition that when an employee takes leave without pay, their gross salary will be subject to proportionate deductions, not just their basic (plus DA).