The implementation of the four new Labour Codes in India marks a significant shift in how employee benefits are structured, calculated, and disbursed. Among these changes, the provisions surrounding leave encashment have garnered substantial attention from HR professionals and legal consultants. Under the new framework, specifically the Occupational Safety, Health and Working Conditions (OSH) Code, 2020, the rules for accumulating and encashing leave have been standardised to ensure greater liquidity for employees and uniformity across industries.
The new labour codes mandate that if an employee has a leave balance exceeding 30 days at the end of a calendar year, they are entitled to encash the excess leave. This departure from previous regulations, which often restricted encashment to the time of retirement or resignation, requires employers to rethink their leave management policies and financial provisioning.
The Legislative Framework: OSH Code 2020
The primary regulation governing leave entitlement is the Occupational Safety, Health and Working Conditions Code, 2020. This code consolidates and replaces several older statutes, including the Factories Act, 1948, and various state-specific Shops and Establishments Acts.
Section 32 of the OSH Code outlines the “Annual Leave with Wages” provisions. It establishes a uniform eligibility criterion: any worker who has worked for 180 days or more in a calendar year is entitled to leave. The rate of accrual remains largely consistent with prior standards—one day of leave for every 20 days of work. However, the mechanism for handling unused leave is where the new codes introduce a transformative change.
Annual Encashment vs. Accumulation
Under the existing regime, many organisations allowed employees to accumulate leave up to a certain ceiling (often 60 to 90 days), with encashment typically occurring only upon separation from the company. The new labour codes introduce a mandatory “encashment of surplus leave” rule.
According to the OSH Code, an employee can carry forward leave to the succeeding year, but the total number of days that can be carried forward is capped at 30 days. If the leave balance at the end of the year exceeds this 30-day limit, the employee has the right to encash the excess. This effectively means that leave is no longer just a “time-off” benefit but a recurring financial entitlement that can be realised annually.
This provision is particularly relevant when considering gratuity for contract staff as per new labour codes, as the standardisation of benefits aims to provide equitable treatment across different categories of employment.
Impact of the New Definition of “Wages”
The calculation of leave encashment is directly tied to the “Wage” definition provided in the Code on Wages, 2019. Previously, “salary” for the purpose of leave encashment varied by company policy—some used Basic salary, while others used Basic plus Dearness Allowance (DA).
The new codes provide a statutory definition where “Wages” include Basic Pay, DA, and Retaining Allowance. Critically, if the sum of all exclusions (such as HRA, overtime, and bonuses) exceeds 50% of the total remuneration, the excess amount is added back to the “Wage” component. This “50% rule” ensures that the base used for calculating leave encashment is higher than what many employees currently experience, leading to a higher payout for the worker and increased liability for the employer.
Leave Encashment on Separation
The timeline for settling leave encashment dues upon termination, resignation, or retirement has been tightened. Under the new codes, an employer is required to pay the full amount of leave encashment (and other final dues) within two working days of the employee’s last day.
This is a significant shift from the current practice where full and final settlements often take 30 to 45 days. This promptness is part of a broader effort to protect worker rights during transitions, similar to the updated protocols found in retirement benefits in India, which cover PF and pension disbursements.
Comparative Overview: Current vs. New Labour Codes
| Feature | Existing Framework (Factories Act/Shops Act) | New Labour Codes (OSH Code/Wage Code) |
|---|---|---|
| Eligibility | Usually 240 days of work in a year. | Reduced to 180 days of work. |
| Carry Forward Limit | Varies by state (usually 30–60 days). | Uniformly capped at 30 days for carry forward. |
| Annual Encashment | Rarely mandatory; usually at separation. | Mandatory for days exceeding the 30-day cap. |
| Calculation Base | Often Basic salary only. | Basic + DA + Retaining Allowance (Min 50% of CTC). |
| Payment Timeline | No strict national timeline (usually 30+ days). | Within 2 working days of separation. |
Taxation of Leave Encashment
While the Labour Codes change the operational and calculation aspects, the tax treatment is governed by the Income Tax Act. For non-government employees, leave encashment received at the time of retirement or resignation is exempt from tax up to a specified limit.
In the 2023 Union Budget, the limit for tax exemption on leave encashment for non-government salaried employees was increased significantly from ₹3 lakh to ₹25 lakh. This adjustment aligns the tax benefits with the expected increase in encashment values resulting from the new wage definitions in the labour codes. It is important to note that any leave encashment received while the employee is still in service (annual encashment) is fully taxable as “Salary” in the year of receipt.
Compliance Checklist for Employers
To prepare for the full rollout of these codes, organisations must audit their existing leave policies. The following steps are essential for maintaining compliance:
- Audit Leave Balances: Review current employee leave records to identify those who will exceed the 30-day threshold.
- Update Payroll Systems: Ensure the calculation engine for leave encashment follows the new “Wage” definition (Basic + DA + potential excess exclusions).
- Revise HR Policy Manuals: Clearly communicate the 30-day carry-forward limit and the process for annual encashment of surplus days.
- Financial Provisioning: Adjust the balance sheet provisions for leave encashment liabilities, as the higher wage base and annual payout requirement will impact cash flow.
- Settlement Workflow: Establish a streamlined process to ensure that employees leaving the organisation receive their encashment within the mandated 48-hour window.
Common Misconceptions
A frequent point of confusion is whether the 30-day limit applies to all types of leave. The OSH Code specifically addresses “Annual Leave with Wages” (often referred to as Earned Leave or Privilege Leave). It does not explicitly mandate the same encashment rules for Sick Leave or Casual Leave, which are generally governed by company policy or specific state rules. However, for the primary category of earned leave, the 30-day rule is a statutory floor, meaning employers cannot offer less favourable terms.
Another misconception is that employees lose leave if they don’t use it. Under the new codes, the leave is not “lost”; rather, the portion exceeding 30 days is converted into a monetary benefit at the end of the year. This protects the employee’s earned benefit while preventing the indefinite hoarding of leave days that can create massive financial liabilities for companies decades later.
The transition to these new rules represents a move toward a more liquid and transparent benefit structure. By understanding the nuances of the OSH Code and the new wage definitions, both employers and employees can ensure a smooth transition to the updated regulatory environment.
About Author
Related Posts
Gratuity for Contract Staff as per New Labour Codes