HR, payroll & labour
Leave Encashment in 2026: Labour Code Rules, How to Calculate It and the Tax Exemption
Leave encashment in 2026: OSH Code leave and 30-day carry-forward, year-end and exit encashment, the formula, the ₹25 lakh tax exemption and worked ₹ examples.
Edited by Sumeet YadavFounder & editor, MSMETOOLS · fact-checked against official sources
Contents (9)
Leave encashment is the cash an employee receives for earned leave they did not take — at the end of a year, when the balance overflows, or when they leave the job. Since the labour codes took effect, the rules on earning, carrying forward and encashing leave come from one central law, and the exit payment has a two-working-day deadline. This guide is for employers setting a leave policy and for employees checking their payout. You'll get the leave rules under the OSH Code, the main state differences, the formula, the income-tax exemption, and worked ₹ examples for a year-end, an exit and a retirement.
Quick answer
Under section 32 of the OSH Code, in force since 21 November 2025, a worker who works 180 days in a calendar year earns annual leave at 1 day for every 20 days worked. Up to 30 days carries forward; anything above that can be encashed, and the worker can ask for encashment at year-end. Unused leave must be paid on exit before the expiry of the second working day.
Formula: unavailed days × monthly wages ÷ 26 (or ÷ 30, per policy)
Encashment during service is fully taxable
On retirement or resignation, private-sector staff get up to ₹25 lakh tax-free (lifetime), in either tax regime
Government employees: fully exempt on retirement
What leave encashment is
Indian employees usually have three kinds of leave: earned or privilege leave (called "annual leave with wages" in the law), casual leave and sick leave. Only earned leave is normally encashable. Casual and sick leave are meant for short absences and illness, and most laws and policies let them lapse at the end of the year.
Encashment happens in three situations. First, at the end of a calendar year when the employee asks for it or when the balance exceeds the carry-forward limit. Second, when the employee leaves — resignation, termination, retirement or death — and the balance has to be paid out. Third, under company schemes that let staff sell back a set number of days each year, often alongside leave travel. The labour law covers the first two; the third is purely a matter of policy and is fully taxable.
What happens to unused earned leave
Step 1
Leave earned in the calendar year
Step 2
Unused balance on 31 December
Step 3
Up to 30 days
carried forward
Step 4
Excess or on request
encashed
Step 5
On exit
paid within 2 working days
Before the codes, the rules depended on where you worked. The Factories Act governed factories, each state's Shops and Establishments Act governed shops and offices, and most private companies wrote their own policy above those floors. The OSH Code, which commenced on 21 November 2025, replaced the Factories Act and twelve other laws and put annual leave for workers in all establishments it covers into section 32. State Shops Acts still exist and some are more generous, so employers in practice apply whichever rule gives the employee more.
Annual leave under the OSH Code
Section 32(1) sets out the conditions. A worker becomes entitled to leave in a calendar year if they have worked 180 days or more in that year. Leave is earned at 1 day for every 20 days worked; for adolescent workers and those working below ground in a mine, the rate is one day for every 15 days. Days of lay-off, maternity leave and annual leave taken count towards the 180-day threshold, but no leave is earned on them. Holidays falling within a spell of leave are not counted as leave.
Someone who joins after 1 January doesn't wait a whole year. If they work for one-fourth of the remaining days of that calendar year, they earn leave at the same rate for the days they worked. A worker who leaves mid-year — discharged, dismissed, quitting, retiring or dying — is entitled to wages for the leave due even if they hadn't yet reached the 180 days.
The section applies to "workers". The Code's definition covers people doing manual, unskilled, skilled, technical, operational, clerical or supervisory work, but excludes those employed mainly in a managerial or administrative capacity and supervisors drawing wages above ₹18,000 a month. Managers are not left without leave — state Shops Acts generally cover all employees, and almost every company policy extends earned leave to managers — but their encashment rights come from those sources, not section 32.
Employers must keep a leave register. Rule 76 of the OSH (Central) Rules, 2026, notified on 8 May 2026 (G.S.R. 345(E)), requires a record of leave with wages in Form XX, electronically or on paper, to be shared with each employee once a year on request and preserved for five years after the last entry. States have their own rules for establishments in the state sphere, usually with a similar register.
OSH Code annual leave (2026)
180 days
Days worked to qualify
in a calendar year
1 per 20
Days of leave per days worked
1 per 15 for adolescents and underground miners
30 days
Maximum carry-forward
2 working days
Exit payment deadline
2 months on retirement or death
Carry-forward and when encashment is due
If a worker doesn't take all their leave, section 32(1)(vii) adds the unused days to the next year's entitlement, with two qualifications. The total carried forward can't exceed 30 days. But if the worker applied for leave and the employer refused it, the refused leave carries forward without any limit — a protection against employers who deny leave and then let it lapse.
Two encashment rights follow. Under clause (viii), the worker is entitled, on demand, to encashment of leave at the end of the calendar year. Under clause (ix), where the total leave exceeds the 30-day carry-forward limit, the worker is entitled to encash the excess. Put simply, a balance can't silently disappear: it either carries forward up to 30 days, gets encashed, or — if the employer refused it — carries forward in full.
Because the Code counts in calendar years, the leave year runs January to December even though your payroll and tax year runs April to March. Many employers now close the leave ledger on 31 December, pay any encashment in the January payroll, and show it on that month's payslip.
On exit, section 32(1)(vi) requires wages in lieu of the leave due to be paid before the expiry of the second working day after discharge, dismissal or quitting, and within two months after superannuation or death (to the heir or nominee in that case). That matches the two-working-day rule for final wages under the Code on Wages, so leave encashment belongs in the full and final settlement, not in a later payroll run.
State Shops Act rules that still matter
Shops, offices, restaurants and other commercial establishments are also covered by their state's Shops and Establishments Act, and these Acts were not repealed by the labour codes. Where both apply, follow the more generous provision for each point — more days, higher accumulation, earlier payment.
Maharashtra. Section 18 of the Maharashtra Shops and Establishments Act, 2017 gives 8 days of casual leave a year (which lapses if not used) and, for a worker who worked 240 days or more in the year, earned leave at one day for every 20 days in the following year. A worker employed for at least three months gets up to five days for every 60 days worked. Earned leave can be accumulated up to 45 days, and if the employer refuses leave applied for 15 days in advance, the worker can encash leave above 45 days. On discharge, or on quitting through retirement, resignation, death or permanent disability, the employer must pay full wages for the leave due. Leave wages are paid at the daily average of the worker's wages for days actually worked in the preceding three months, excluding overtime.
Tamil Nadu. The Tamil Nadu Shops and Establishments Act gives 12 days of annual leave with wages after 12 months' continuous service, along with separate sick and casual leave, and allows annual leave to accumulate up to 45 days.
Other states have similar provisions with different numbers. The practical rule for an MSME is to set the leave policy at least at the OSH Code floor — including the 30-day carry-forward and the right to encash the excess — and then check your state Act for anything higher, especially accumulation limits and the rate used for leave wages.
How to calculate leave encashment
The basic formula is the same everywhere:
Leave encashment = unavailed earned-leave days × daily rate of wages
The daily rate is where policies differ. Most employers take monthly wages and divide by 26 (working days) or 30 (calendar days); 26 gives a higher figure. Some state Acts, like Maharashtra's, use the average daily wage over the last three months. Whatever you choose, write it in the leave policy and apply it to everyone.
What goes into "wages" also matters. Since the codes, wages means basic pay, dearness allowance and retaining allowance, plus any part of excluded allowances (HRA, conveyance, commission and so on) that exceeds half of total pay. If your policy encashes on basic alone, check it against that definition; an employee whose allowances exceed half of pay will have a higher wage base. Our salary slip guide walks through the 50% test.
Calculate leave encashment in five steps
- 1
Confirm the leave balance
Take the earned-leave balance from the register (Form XX or your state form): opening carry-forward + leave earned this year − leave taken.
- 2
Separate encashable leave
Exclude casual and sick leave unless your policy encashes them. On year-end, only the excess over the carry-forward (or the days the worker asks for) is encashed.
- 3
Work out monthly wages
Basic + DA + retaining allowance, plus the excess of excluded allowances over 50% of total pay.
- 4
Apply your daily rate
Wages ÷ 26 or ÷ 30 as your policy says (or the state Act's average-wage method), then multiply by the days.
- 5
Deduct tax and pay on time
In service: add to salary for TDS. On exit: pay within two working days, applying the retirement exemption for TDS where it applies.
Worked examples in ₹
Year-end encashment. Ravi is a machine operator at a Coimbatore unit with monthly wages of ₹22,000 (basic + DA; no add-back). On 1 January 2026 he carried forward 24 days. In 2026 he works 288 days, earning 288 ÷ 20 = 14 days (fractions are ignored unless your policy rounds up), and takes 6 days. His balance on 31 December 2026 is 24 + 14 − 6 = 32 days. Only 30 can carry forward, so the 2 excess days must be encashed: 2 × ₹22,000 ÷ 26 = ₹1,692. If Ravi also asks to encash 10 more days under clause (viii), the employer pays another ₹8,462 and he carries 20 days into 2027. Both amounts are taxable salary in January's payroll.
Exit encashment. Fatima, a customer-support lead in Mumbai on monthly wages of ₹36,000 (basic + DA + add-back), resigns with a last working day of 15 October 2026 and 20 days of earned leave in the balance. At ₹36,000 ÷ 26 per day, her leave encashment is 20 × ₹1,384.62 = ₹27,692. It must be paid with her final wages before the end of the second working day after she leaves. Because she is leaving employment, her employer can apply the retirement exemption when working out TDS — see the next section.
Retirement encashment with the tax exemption. Suresh retires from a private company after 30 years. His salary for exemption purposes (basic + DA) has been ₹80,000 a month for the last ten months. He has 300 days of earned leave and his employer pays 300 × ₹80,000 ÷ 26 = ₹9,23,077. Over his career he was entitled to 45 days a year under policy but had taken leave so that 300 days remain; the tax rule caps entitlement at 30 days per year of service, which allows up to 900 days less leave taken, so all 300 days are within the cap. The exemption is the least of: actual payment ₹9,23,077; ten months' average salary ₹8,00,000; cash value of leave at credit, 300 days × ₹80,000 ÷ 30 = ₹8,00,000; and ₹25 lakh. So ₹8,00,000 is exempt and ₹1,23,077 is taxable as salary.
Income tax on leave encashment
Section 16 of the Income-tax Act, 2025, which applies from 1 April 2026, includes in "salary" any payment for leave not availed of. So leave encashment is taxable unless an exemption applies, and the employer deducts TDS on it like any other salary.
While in service: no exemption. Year-end encashment, sell-back schemes and the excess-over-30 payment are all fully taxable at the employee's slab rate in the month they are paid.
On retirement — central and state government employees: the cash equivalent of leave salary for earned leave at credit on retirement, whether on superannuation or otherwise, is fully exempt (section 19, Table serial number 13).
On retirement — everyone else: serial number 14 of the same table exempts the lowest of four amounts:
Tax-free leave encashment for non-government employees
| Limit | How it is measured |
|---|---|
(a) Cash equivalent of leave at credit | Earned leave at retirement, counting at most 30 days per year of actual service, valued at average salary |
(b) Ten months' average salary | 10 × average monthly salary for the ten months before retirement |
(c) Notified limit | ₹25 lakh — lifetime, across all employers |
(d) Actual amount received | What the employer paid |
(a) Cash equivalent of leave at credit
- How it is measured
Earned leave at retirement, counting at most 30 days per year of actual service, valued at average salary
(b) Ten months' average salary
- How it is measured
10 × average monthly salary for the ten months before retirement
(c) Notified limit
- How it is measured
₹25 lakh — lifetime, across all employers
(d) Actual amount received
- How it is measured
What the employer paid
For this calculation, "salary" means basic pay plus dearness allowance if the terms of employment treat it as part of pay, and excludes other allowances and perquisites. The ₹25 lakh limit was notified by the CBDT in Notification No. 31/2023, raising it from ₹3 lakh with effect from 1 April 2023. Section 536(2)(j) of the 2025 Act keeps notifications issued under the old Act in force under the corresponding new provision, so the same limit applies now. It is a lifetime figure: if you received leave encashment from more than one employer in a year, or claimed the exemption in an earlier year, the remaining limit is reduced accordingly.
Resignation counts. The phrase "retirement whether on superannuation or otherwise" has been read by the Madras High Court (CIT v. R.J. Shahney) and the Bombay High Court (CIT v. D.P. Malhotra) to include leaving by resignation, even when the employee joins another employer. Employers routinely apply the exemption to resignations when computing TDS.
Both regimes. Section 202, which sets out the new tax regime, lists the exemptions and deductions that are not allowed. Section 19's serial numbers 13 and 14 are not on that list, so the leave encashment exemption is available whether the employee chooses the new or old regime. Leave encashment above the exempt limit is added to salary; if a large payment pushes income into a higher slab, relief under section 157 (formerly section 89) may be available for arrears-type receipts — ask a tax adviser. Use our TDS calculator to estimate the tax, and see TDS on salary for deposit and certificate rules.
Common mistakes in leave policies
Letting leave lapse. "Use it or lose it" clauses for earned leave conflict with section 32. Unused leave must carry forward up to 30 days, the excess must be encashable, and refused leave carries forward without limit. Rewrite any lapse clause.
Encashing on basic only. If excluded allowances exceed half of total pay, the add-back increases wages. Leave encashment computed on basic alone may underpay.
Paying exit encashment a month later. The OSH Code and the Code on Wages both put it on a two-working-day clock. Include it in the full and final settlement.
Taxing exit encashment in full. Apply the four-way test before deducting TDS; for most mid-career leavers with modest balances, the whole amount is exempt.
Using the financial year for the leave year. The Code counts in calendar years. If your system runs April to March, map the carry-forward and year-end encashment to 31 December or run both calendars.
No leave register. Without the Form XX (or state form) record, you can't defend a dispute over the balance. Share the record with employees once a year as rule 76 requires.
Leave encashment policy checklist
0/8Official links
What to do next
Check your leave policy against the checklist, fix any lapse clause, and decide on one daily-rate method. When someone leaves, include leave encashment in the full and final settlement alongside gratuity, and estimate the tax with our TDS calculator. Show year-end encashment on that month's payslip with the salary slip generator.
This is general information, not legal or tax advice — confirm on the official source or with a professional.
Frequently asked questions
Section 32 of the OSH Code lets a worker carry unused annual leave into the next calendar year up to 30 days. Leave the worker applied for and was refused can be carried forward without any limit. If the balance goes above 30 days, the worker is entitled to encash the excess. State Shops Acts may allow more — Maharashtra and Tamil Nadu allow accumulation up to 45 days.
Multiply the number of unavailed leave days by the daily rate of wages. Most employers use monthly wages (basic + DA, plus any add-back under the 50% rule) divided by 26 or by 30, as their policy says. Example: 20 days × ₹36,000 ÷ 26 = ₹27,692. Some state Acts use the average daily wage of the last three months instead.
Leave encashed while you are still employed is fully taxable as salary. Leave encashed when you retire or resign is exempt for private-sector employees up to the least of four limits, the last being ₹25 lakh over your lifetime. Central and state government employees get the full amount tax-free on retirement. The exemption is available in both the old and new tax regimes.
Generally yes. The exemption covers leave encashment received on retirement 'whether on superannuation or otherwise', and the Madras and Bombay High Courts have held that resignation counts. The exempt amount is still the lowest of the actual payment, ten months' average salary, the cash value of leave limited to 30 days per year of service, and ₹25 lakh.
Under section 32(1)(vi) of the OSH Code, wages for unavailed leave of a worker who is discharged, dismissed or quits must be paid before the expiry of the second working day after leaving — the same deadline as final wages under the Code on Wages. On retirement or death, the deadline is two months.
Not on exit — unavailed annual leave must be paid when a worker leaves. During employment, the OSH Code gives the worker a right to demand encashment at the end of the calendar year and to encash any balance above the 30-day carry-forward. Casual and sick leave are different: most laws and policies let them lapse without encashment.
Sources & verification
Figures on this page were checked against the sources below when it was last reviewed on 11 October 2026. Each rate and limit is stored once with its own official source and review date, and official update channels are monitored daily so changes are picked up. How we verify
- 1.Occupational Safety, Health and Working Conditions Code, 2020 — sections 2(1)(zzl), 6 and 32 — Directorate General of Mines Safety (text of the Act) · accessed 11 October 2026
- 2.Occupational Safety, Health and Working Conditions (Central) Rules, 2026 — G.S.R. 345(E), 8 May 2026 — Ministry of Labour and Employment (Gazette of India) · accessed 11 October 2026
- 3.The Income-tax Act, 2025 (Act No. 30 of 2025) — Legislative Department (Gazette of India) · accessed 11 October 2026
- 4.Government announces implementation of the four Labour Codes — PIB — Ministry of Labour & Employment · accessed 11 October 2026
- 5.Maharashtra Shops and Establishments (Regulation of Employment and Conditions of Service) Act, 2017 — section 18 — Government of Maharashtra (via PRS Legislative Research) · accessed 11 October 2026
- 6.Tamil Nadu Shops and Establishments Act, 1947 — India Code · accessed 11 October 2026
- 7.Increased limit for tax exemption on leave encashment for non-govt salaried employees to Rs. 25 lakh w.e.f. 01.04.2023 — GConnect (reproduces CBDT press release of 25 May 2023) · accessed 11 October 2026
- 8.Tax benefit of leave encashment is available in case of resignation also — TaxHeal · accessed 11 October 2026
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