Lesson 5 of 8 · Employer-Employee Insurance

Group Leave Encashment — Policy Structure & Tax Treatment

Leave encashment is payment for unused earned leave. This lesson covers how an employer may fund it through a group scheme, the four-limit tax exemption for the employee at retirement, and the rule that the employer deducts it only when paid.

Fact-checked 8 October 20264 practice questions in the game

What leave encashment is

Many employers let employees carry forward unused earned leave and receive money for it at retirement or on leaving. That payment is leave encashment. How much leave can be accumulated and when it can be encashed vary with the employer's policy and the applicable law.

For the employer this is a liability that builds up over the years. For entities that follow Ind AS, IndAS 19 (Employee Benefits) governs how it is recognised, measured and disclosed, along with gratuity, superannuation and other employee benefit obligations. It requires an actuarial valuation of the liability and disclosure in the financial statements.

Funding it through a group scheme

A group leave-encashment scheme is one of the permitted employer-employee group products under IRDAI's Master Circular on Life Insurance Products of 12 June 2024. Through it an employer may choose to fund the liability with a life insurer instead of meeting it from its own cash when employees leave. Funding is the employer's choice, not a requirement.

Tax for the employee

For a non-government employee, leave encashment received at retirement is exempt under section 19 of the Income-tax Act, 2025 (section 10(10AA) of the 1961 Act), up to the least of four amounts: the leave encashment actually received; the leave due valued at average salary; ten months' average salary; and the monetary ceiling of ₹25 lakh.

All four are worked out and the lowest is exempt, so the exempt amount can be well below ₹25 lakh. Older material quotes a ceiling of ₹3 lakh. The ceiling is a notified figure and can be revised. Leave encashment of a government employee at retirement is treated separately.

Leave encashed during service, while the person is still employed, is taxable.

Tax for the employer

The employer may deduct leave encashment only in the year it is actually paid, not when a provision is made in the books. In Union of India v. Exide Industries, decided on 24 April 2020, the Supreme Court upheld this rule, which was clause (f) of section 43B of the 1961 Act.

Rules at a glance

Exemption at retirement, non-government employeeLeast of four amountsIncome-tax Act, 2025 — section 19 (old 10(10AA))

Monetary ceiling₹25 lakhNotified figure; earlier ₹3 lakh

Months of average salary10 monthsOne of the four limits

Encashment during serviceTaxableIncome-tax Act, 2025

Employer's deductionOnly when actually paidOld section 43B(f); upheld in Union of India v. Exide Industries, Supreme Court, 24 April 2020

Accounting standardIndAS 19 (Employee Benefits)Actuarial valuation and disclosure

Worked example

The least-of-four test (assumed figures)

Assume Mohan, a non-government employee, retires and receives ₹9,00,000 as leave encashment. His average monthly salary for this purpose is ₹70,000, and the leave due to him, valued at average salary, comes to ₹8,40,000. These inputs are assumptions of the example.
Limit 1, amount received: ₹9,00,000.
Limit 2, leave due valued at average salary: ₹8,40,000.
Limit 3, ten months' average salary: 10 × ₹70,000 = ₹7,00,000.
Limit 4, monetary ceiling: ₹25,00,000.
The least of the four is ₹7,00,000. Taxable amount: ₹9,00,000 − ₹7,00,000 = ₹2,00,000.

Result. ₹7,00,000 is exempt and ₹2,00,000 is taxable, even though the ceiling is ₹25 lakh.

Key points

Leave encashment is payment for unused earned leave; accumulation and encashment rules vary with the employer's policy and the applicable law.
A group leave-encashment scheme is a permitted group product for funding the liability with a life insurer.
IndAS 19 governs recognition, measurement and disclosure of the liability.
At retirement, a non-government employee's exemption is the least of: amount received, leave due at average salary, ten months' average salary, ₹25 lakh.
The ceiling was earlier ₹3 lakh.
Leave encashed during service is taxable.
The employer's deduction is allowed only on actual payment, as upheld in Union of India v. Exide Industries (2020).

Common misunderstandings

₹25 lakh is not automatically exempt: it is only one of four limits, and the lowest applies.
Encashing leave while in service does not get the retirement exemption: it is taxable.
A provision in the books does not give the employer a deduction: leave encashment is deductible only when actually paid.
The ₹3 lakh ceiling is not current: the ceiling is now ₹25 lakh.

Questions people ask

What did the Supreme Court decide in Union of India v. Exide Industries?

It upheld the rule that an employer may deduct leave encashment only in the year of actual payment.

Is a group leave-encashment scheme mandatory?

No. It is a permitted product that an employer may choose in order to fund the liability.

Which accounting standard covers the liability?

IndAS 19, Employee Benefits.

What this lesson relies on

Income-tax Act, 2025 — section 19 (leave encashment at retirement)
Union of India v. Exide Industries (Supreme Court, 24 April 2020)
IRDAI Master Circular on Life Insurance Products (12 June 2024) — group leave-encashment schemes
IndAS 19 — Employee Benefits

This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.