Leave Rules and Encashment Under India’s Labour Codes: The 180-Day Test and the 30-Day Cap

Most Indian small businesses run leave on a rule of thumb. Twelve days a year, use it or lose it, and whatever is left over quietly disappears on 31 December. It was never quite legal, nobody complained, and it worked.

It stopped working on 21 November 2025. Under Section 32 of the Occupational Safety, Health and Working Conditions Code, 2020, the qualifying threshold for annual leave with wages fell from 240 days of work to 180, unused leave above 30 days can no longer be lapsed, and an employee can ask to encash the excess at the end of the calendar year rather than waiting until they leave. Leave stopped being an HR policy you write and became a liability you carry.

This guide covers the new leave rules end to end: what the 180-day test actually counts, why the widely repeated claim that employees now get more leave is wrong for most of your staff and right for exactly the ones you were not thinking about, how the accrual arithmetic works with the numbers run through, the 30-day carry-forward cap and the annual encashment right, the unresolved collision with your state Shops and Establishments Act, what encashment is computed on after the 50% wage rule, the two exit clocks, and what the whole thing costs a 25-person business.

What Changed in the Leave Rules, and When

Three dates. Getting them confused is the main reason an owner thinks there is still time to prepare.

That third row is the one to put in a calendar. Nothing about leave failed loudly in 2026. Balances have simply been accruing under a rule most employers have not applied, and the first moment that becomes a cash number is the year-end reconciliation.

One scope note before the detail. The OSH Code applies to an establishment with ten or more workers. Below that threshold the Code’s leave chapter does not reach you, but your state Shops and Establishments Act almost certainly does, and it has its own leave entitlement. Small does not mean exempt. It means governed by a different instrument.

The 180-Day Test: What Actually Counts

Under Section 79 of the Factories Act, a worker qualified for annual leave with wages by working 240 days in a calendar year. Section 32 of the OSH Code drops that to 180 days. That is a 25 per cent cut in the qualifying bar and it is the single most consequential line in the leave chapter.

What makes it bigger than it looks is what counts toward the 180. The days do not all have to be days the person was at work:

• Days actually worked, obviously.
• Any period of lay-off. If you stood people down because there was no work, those days still count toward their eligibility.
• Maternity leave, for the full period of leave taken.
• Annual leave taken in the same year. Leave counts toward earning leave.

No leave accrues during those periods. They count for the eligibility test, not for the accrual arithmetic. The distinction matters: a person can cross the 180-day line largely on lay-off days and still earn only a small entitlement, because the entitlement is calculated on days of work performed.

There is also a rule for people who joined part way through the year. An employee who started after 1 January qualifies if they worked at least one quarter of the days remaining in the calendar year from their joining date. Someone who joins on 1 October has roughly 92 days left in the year and needs about 23 of them. In practice that means almost every mid-year joiner qualifies, which reverses the old position where a September starter earned nothing for their first partial year.

The Accrual Rate Did Not Change, and Why That Matters

Here is the part almost every write-up gets wrong. You will read that the Labour Codes give employees more leave. For most of your staff, they do not.

The accrual rate is one day of leave for every twenty days of work. That was the rate under Section 79 of the Factories Act and it is the rate under Section 32 of the OSH Code. It is unchanged. What changed is who gets through the door.

Run it across the band that actually matters:

Read the bottom rows. For a full-time employee working a normal year, nothing moved. The entire cost of the change lands on the 180 to 239 day band: seasonal staff, people who joined or left mid-year, staff who were laid off for a stretch, workers returning from long illness, and anyone on a fixed-term contract that ran most but not all of a year.

Which is to say, the change is aimed almost precisely at the workforce shape of an Indian SME. A software company where everyone works 250 days a year absorbed this without noticing. A restaurant, a construction contractor or a retail chain with seasonal peaks just acquired a leave liability for a whole category of staff that previously earned none. If you also run people on fixed-term contracts, the same cohort picked up a gratuity entitlement in the same reform, which we covered in the guide to gratuity for fixed-term employees.

The 30-Day Carry-Forward Cap and the New Right to Encash

The second structural change is at the other end of the year. Under the Code, unused annual leave carries forward into the next calendar year up to a maximum of 30 days. What sits above 30 does not lapse. The worker is entitled to encash the excess.

Separately from that, an employee may ask to encash leave at the end of the calendar year, including balance that would have been within the carry-forward limit anyway. Encashment stopped being a terminal benefit paid on the way out and became an annual right exercisable while still employed.

One further clause quietly removes the oldest trick in the book. If an employee applied for leave and you refused it, the 30-day accumulation ceiling does not apply to that leave. It accumulates without limit. So the informal practice of declining leave through a busy season and letting the balance cap out no longer works. Refusing leave now costs you more than granting it, because refused leave escapes the only ceiling you had.

The Collision With Your State Shops and Establishments Act

This is the part your consultant is probably not raising, because there is no clean answer to give.

The Labour Codes did not repeal the state Shops and Establishments Acts. Those Acts have their own leave chapters, and on carry-forward they are more generous than the Code: Karnataka, Maharashtra, Delhi and Tamil Nadu all permit accumulation up to around 45 days, against the Code’s 30. They are also stricter on encashment. The state model is broadly that leave accumulates to a high ceiling and is cashed out when you leave, or in Maharashtra’s case where leave was applied for and refused. There is generally no free-standing right to encash mid-service on request.

The Code carries the standard more-favourable-benefits protection: where an employee is entitled under some other instrument to something more favourable than the Code gives, they keep it. The Supreme Court has applied the same principle where a state labour statute is more generous than the central one, in Pepsico India Holding Pvt Ltd v. Grocery Market and Shops Board.

The problem is that the test assumes one regime is better. Here they are better in different currencies:

We are not aware of any authority that has resolved this, and honest commentary on it does not pretend otherwise. What is reasonably clear is that an employee cannot take the 45-day ceiling from the state Act and the annual encashment right from the Code and combine them. Courts have consistently refused cherry-picking of the most favourable clause from each of two instruments. The comparison is made between regimes, not clause by clause.

The defensible position for an SME, until something settles it, has three parts. Apply whichever single regime genuinely governs your establishment, and record in writing which one you applied and why. Do not lapse anything under either reading, because both readings agree that lapsing is not available. And where the two produce different money on the same facts, pay the higher, for the same reason it is the right answer on gratuity: an underpayment attracts a claim and interest, an overpayment attracts neither.

What Leave Encashment Is Actually Calculated On

Leave encashment under the Code is computed on wages as defined in the Code on Wages. That is not your payslip Basic, and the difference is money.

The Code caps excluded allowances at half of total remuneration and adds back the excess. So an employee structured the way almost everybody is structured has a statutory wage higher than the number on the Basic line. Take an employee on Rs 30,000 a month:

Now encash 12 days of leave for that person. On the customary 26-day divisor, a day of wages on the payslip Basic is Rs 462, so twelve days is Rs 5,538. On statutory wages it is Rs 577 a day, so twelve days is Rs 6,923. A quarter more, for the same person, the same salary and the same twelve days, purely because the base moved.

Multiply that across a workforce, and across balances that are no longer allowed to lapse, and you have the real shape of this reform. The full mechanics of the add-back, with two complete before-and-after restructures, are in our guide to the new salary structure under the Labour Codes.

The Two Exit Clocks

When employment ends, accrued leave converts to wages. There are two deadlines and they are very far apart:

• Two working days, where the employment ended by resignation, discharge or dismissal. This is the same clock Section 17(2) of the Code on Wages puts on final wages generally, and it is the one employers breach.
• Two months, where the employment ended by superannuation or by the death of the employee. On death the sum is paid to the nominee or the legal heir.

Two working days is not long enough to reconstruct a year of leave from a WhatsApp thread and a register. That is why leave encashment is now an operational problem rather than a payroll one: the arithmetic is trivial, the deadline is not, and the input is a year of records you either kept or did not. We wrote the two-working-day rule up in full in the guide to full and final settlement under Section 17(2).

What This Costs a 25-Person Business

Take a business of the shape this actually bites. 25 people. Statutory wages averaging Rs 18,000, so a day of wages is Rs 692 on the 26-day divisor. Eighteen full-year staff, and seven who work between 180 and 239 days because of seasonality, mid-year joining or a stretch of lay-off.

• The seven who used to earn nothing. At an average of 200 days worked they now accrue 10 days each, worth roughly Rs 48,400 across the group once taken or encashed. Under the old 240-day test this cohort accrued nil.
• The eighteen full-year staff. Their accrual did not change. What changed is that their unused balance no longer lapses. At an average of 4 unused days each, that is about Rs 49,800 of liability that used to be written off every 31 December.
• The base effect. If your payslips run Basic at 40% and the add-back lifts statutory wages by a quarter, every rupee above is understated by roughly a quarter until you restructure.

Call it a little under Rs 1 lakh a year of newly recognised cost, on a payroll of 25. That is not ruinous. What makes it dangerous is the same thing that makes gratuity dangerous: it does not arrive as a bill. It accumulates invisibly across a year, then presents itself as a year-end encashment run and a series of two-working-day settlements, none of which was provisioned for, all of which have to be computed from records.

The Record You Will Be Asked For

Look back at everything above and notice what every single rule depends on. The eligibility test is a count of days worked. The accrual is that count divided by twenty. Lay-off and maternity days have to be counted in for eligibility and out of the accrual. The mid-year joiner rule needs a joining date and a day count from it. The carry-forward cap needs a balance at 31 December. The refused-leave exception needs a record that leave was applied for and declined. The exit payment needs all of it, within two working days.

Not one of those is a policy question. They are all the same question: what does the record say. An employer whose attendance lives in a notebook and whose leave lives in a WhatsApp thread cannot answer any of them, and under the Central Rules the leave balance now has to appear on the wage slip, so the answer is no longer private.

This is the specific gap Shiftelio was built for, so treat what follows as an interested party describing its own product. The mechanics are worth understanding whatever you eventually buy:

• Days worked is a number, not an estimate. Every in and out is a live selfie with GPS geo-fencing, so the 180-day test and the divide-by-twenty accrual are answerable per person for any year, from evidence rather than reconstruction.
• Leave applications leave a trail. A request and its approval or refusal are both recorded with a date, which is the only thing that distinguishes ordinary capped leave from refused leave that accumulates without a ceiling.
• Lay-off and maternity are typed, not guessed. Absence categories stay distinct, so the days that count for eligibility but not for accrual are handled correctly instead of being netted into one number.
• Encashment runs on the Code definition of wages.Payroll totals the excluded components, applies the 50% test and the add-back, so the encashment base is derived rather than remembered, and it does not silently drift when somebody’s special allowance is topped up.
• The balance is on the wage slip. Opening balance, accrued, taken, closing balance, generated with the payslip rather than assembled the week an inspector asks.

All of it sits in the flat annual price, with no per-employee fee. If you just want to work out one person’s exit number right now, our free full and final settlement calculator takes the joining date, last working day, wages and leave balance and shows the whole settlement including leave encashment. No signup, no email.

Frequently Asked Questions

Can I still run a use-it-or-lose-it leave policy?

No. Balance up to 30 days carries forward and balance above 30 is encashable. There is no reading of Section 32 under which unused annual leave simply disappears at year end, and no reading of the state Shops Acts under which it does either. A policy document that says otherwise does not change the entitlement. It just creates evidence that you knew the rule and wrote around it.

Does this mean every employee now gets more leave?

No, and this is the most common misunderstanding. The accrual rate is unchanged at one day per twenty days worked. A person working a normal full year earns exactly what they earned before. The people who gain are those who worked between 180 and 239 days, who previously earned nothing at all.

Do casual leave and sick leave count toward the 30-day cap?

Section 32 governs annual leave with wages, which is earned leave. Casual and sick leave are creatures of your state Shops and Establishments Act, your standing orders or your own policy, and they typically do not carry forward. Keep the three buckets separate in your records. Mixing them is how a 30-day cap quietly turns into a dispute about which 30 days.

My business has eight employees. Does any of this apply?

The OSH Code applies at ten or more workers, so its leave chapter does not reach you at eight. Your state Shops and Establishments Act almost certainly does, and it has its own leave entitlement, its own carry-forward ceiling and its own encashment rules. You are not exempt. You are governed by a different instrument, and you should know which one.

An employee wants to encash leave in the middle of the year. Must I pay?

The encashment right under the Code is expressed at the end of the calendar year, not on demand at any time. A mid-year request is something you may agree to, not something the Code compels. Where an employee is leaving, that is different: accrued leave becomes payable as wages on exit, within two working days for a resignation, discharge or dismissal.

Can I refuse leave to get through a busy season?

You can decline a particular application, but understand the price. Leave that was applied for and refused is not subject to the 30-day accumulation ceiling, so it builds up without limit and lands as a larger encashment later. Refusing leave is now the more expensive option, not the cheaper one.

What rate is leave encashment paid at?

On wages as the Code on Wages defines them, which for most Indian salary structures is higher than the payslip Basic because of the 50% add-back. For a monthly-rated employee the customary daily rate divides monthly wages by 26. Paying encashment on payslip Basic alone is the most common underpayment in this whole area.

Do I have to show the leave balance on the payslip?

The Central Rules notified on 8 May 2026 prescribe the wage slip and the leave register as forms, which in practice means the balance has to be maintained and produced rather than held informally. We went through every register and form an SME now has to keep in the guide to statutory registers and wage slips.

The Bottom Line

Leave used to be the cheapest thing on an Indian payroll, because most of it quietly expired. Three changes ended that at once. The qualifying bar fell to 180 days, which pulled a whole category of seasonal and part-year staff into entitlement for the first time. The balance stopped lapsing, which turned an annual write-off into a carried liability. And the encashment base moved to the Code definition of wages, which made every day of it worth about a quarter more than the payslip suggests.

None of that is expensive on its own. What is expensive is discovering it at a year end, or in the two working days after somebody resigns, with a year of attendance to reconstruct. The work is unglamorous and it is all the same work: count the days properly, record why each absence happened, hold the balance somewhere it can be printed, and compute wages on the Code definition rather than the payslip label. Do those four and the new leave rules are a modest, predictable line item. Skip them and they are a surprise with a two-day deadline attached.

Sources

• Ministry of Labour and Employment, the four Labour Codes
• Ministry of Labour and Employment, FAQs on the Labour Codes
• India Code, the bare text of the Codes and the rules made under them
• Section 79 of the Factories Act, 1948, annual leave with wages, for the position this replaced

This guide is general information for Indian employers, not legal advice. Where your state has notified its own rules under the Codes, or where your state Shops and Establishments Act gives a more favourable entitlement, those govern your establishment. Every worked figure is illustrative.