Everything about Leave Encashment: Meaning, Calculation & Tax Exemption

Have you ever had an employee leave with a chunk of unused annual leave and found yourself wondering how much you actually owe them? The maths looks easy enough until you have to decide which salary figure to use, account for carried-forward leave, and work out whether resignation changes the calculation.

That’s where leave encashment rules can get a little tricky for HR and finance teams. And if you’ve searched for leave encashment tax exemption, you may have already stumbled across advice meant for India. The UAE has no personal income tax, so there’s no equivalent exemption to work out here. For accountants juggling this alongside everything else, having the right spend management for accountants can take one more admin task off the list.

What is leave encashment?

Leave encashment is the payment an employee receives for eligible annual leave they have not used. In the UAE, employees are entitled to annual leave with full wage under Article 29 of Federal Decree-Law No. 33 of 2021. When employment ends, employees are also entitled to payment for their remaining annual leave balance.

It is also worth separating leave encashment from gratuity. They are both part of an employee’s final settlement, but they pay for different things. Leave encashment covers unused annual leave.

When does an employer owe leave encashment?

If employment ends with unused annual leave that is legally due, the employer must pay its cash equivalent, calculated using the employee’s basic salary.

During employment, employees can carry forward up to half of their annual leave to the following year. Alternatively, they can agree with the employer to receive its cash equivalent at the wage applicable when the leave becomes due.

If you’re managing payroll, it helps to keep leave balances and employee records up to date throughout the year. The same principle applies to controlling employee expenses and improving spending management: clear records make it easier to see what has been approved, paid, or is still outstanding.

Here’s how the main situations work:

How to calculate leave encashment in the UAE

For employees covered by the UAE private-sector Labor Law, unused annual leave at the end of employment is calculated using the employee’s basic salary, not their total salary.

Article 29(9) of Federal Decree-Law No. 33 of 2021 sets the entitlement, while Article 19(2) of the Executive Regulation confirms that payment for unused leave is based on basic salary.

Here’s the calculation step by step:

For instance, say your employee’s monthly basic salary is AED 12,000

Say an employee has a basic salary of AED 12,000 and leaves the company with 18 days of unused annual leave.

• Daily basic salary = AED 12,000 ÷ 30 = AED 400
• Unused leave = 18 days
• Leave encashment = AED 400 × 18 = AED 7,200

The employee would therefore be owed AED 7,200 for those 18 days.

Now imagine another employee has a basic salary of AED 8,000 and has 11 unused leave days when their employment ends.

• Daily basic salary = AED 8,000 ÷ 30 = AED 266.67
• Unused leave = 11 days
• Leave encashment = AED 266.67 × 11 = AED 2,933.37

How to calculate accrued leave days

Under Article 29 of the UAE Labor Law, employees are entitled to 30 days of paid annual leave for each completed year of service. If an employee leaves before completing another full year, their annual leave entitlement accrues proportionately for the period worked, provided they have completed at least six months of service.

To calculate the leave days owed, determine the employee’s accrued entitlement up to their last working day, then subtract any leave already taken. The remaining balance is the number of unused leave days to consider when calculating leave encashment.

Carry-forward and forfeiture

Unused leave does not automatically disappear at the end of the year, but there are limits on how much you can carry forward. Under Article 29 of the UAE Labor Law and Article 19 of its Executive Regulation:

• Employees can carry forward up to half of their annual leave entitlement to the following year, subject to applicable rules.
• They can also agree with their employer to receive the cash equivalent of carried-forward leave when it becomes due.
• Employers cannot prevent employees from taking entitled annual leave for more than two years, unless the employee agrees to carry it forward or receive a cash allowance under the applicable rules.
• When employment ends, any legally due unused leave must be paid in cash based on basic salary.

For payroll teams, this means an old leave balance cannot simply be written off. You need to check the applicable carry-forward and payment rules before removing or settling accrued leave.

DIFC and ADGM: the rules are different

If your employee works in the DIFC or ADGM, don’t automatically apply the UAE federal leave rules. Both financial free zones have their own employment legislation, so the calculation and carry-forward rules can differ.

• DIFC: Employees who have completed at least 90 days are entitled to 20 working days of paid annual leave each year. Up to five unused days can generally be carried into the next leave year for 12 months. When employment ends, unused accrued leave is paid using the employee’s Daily Wage, which is generally based on annual wage divided by 260 for a five-day working week.
• ADGM: The ADGM Employment Regulations 2024 apply to ADGM-registered entities and have been in force since 1 April 2025. Employees are entitled to at least 20 working days of vacation leave each year. At least five days of accrued leave can be carried forward for up to 12 months, after which the carried-forward leave expires. When employment ends, accrued but unused leave is paid in lieu.

Getting it right in payroll with Alaan

Leave encashment is easier to manage when you track it throughout the employee’s tenure. Keep records of each employee’s leave entitlement, leave taken, carry-forward balance, and unused leave value. If employees use employee expense cards, keep those spending records separate from payroll records.

Maintain a running leave provision instead of calculating the entire liability when someone leaves. Keep leave records, salary history, approved leave requests, and the final encashment calculation together. This gives you a clear audit trail if the final settlement is ever disputed.

This is where payroll automation software can help. It can take some of the manual work off your plate. And once payroll is sorted, keeping employee spending just as organized matters too. It can help keep those records in one place, instead of leaving finance to piece them together later.

Less time piecing together records. More time actually running finance. See how Alaan can help your team keep spending organized.

FAQs

1. What is leave encashment in the UAE?

Leave encashment is the payment an employee receives for eligible unused annual leave. When employment ends, the employee is generally entitled to receive the cash equivalent of any annual leave balance that is legally due.

2. How is leave encashment calculated in the UAE?

For employees covered by the federal UAE Labour Law, leave encashment is calculated using the employee’s basic salary. Divide the monthly basic salary by 30 to get the daily rate, then multiply it by the number of eligible unused leave days.

3. Is leave encashment owed after resignation in the UAE?

Yes. Resigning does not automatically cancel an employee’s entitlement to unused annual leave. When employment ends, the employee is generally entitled to payment for any legally due unused leave, calculated using their basic salary.

4. Can unused annual leave be carried forward in the UAE?

Yes. Under the federal UAE Labour Law, employees can carry forward up to half of their annual leave entitlement to the following year, subject to the applicable rules. Employees may also agree to receive the cash equivalent of carried-forward leave when it becomes due.

5. Can an employer refuse to pay leave encashment?

An employer generally cannot refuse payment for unused annual leave that an employee is legally entitled to receive when employment ends. The amount must be calculated according to the applicable employment regulations, including the rules governing basic salary and eligible leave days.