As per the Income Tax rules, leave encashment is taxable as a salary if you receive it while in service. If a government employee gets leave encashment at the time of retirement, then s/he doesn't have to pay tax on it. The official Income Tax website says, "It is taxable if received while in service. Leave encashment received at the time of retirement is exempt in the hands of the Government employee. In the hands of non-Government employee leave, encashment will be exempt subject to the limit prescribed in this behalf under the Income-tax Law."
Under Section 17 of the Income-tax Act, the term Salary is defined. It includes:
- any annuity or pension;
- any gratuity;
- any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages;
- any advance of salary;
- any payment received by an employee in respect of any period of leave not availed of by him;
- the annual accretion to the balance at the credit of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under rule 6 of Part A of the Fourth Schedule;
- the aggregate of all sums that are comprised in the transferred balance as referred to in sub-rule (2) of rule 11 of Part A of the Fourth Schedule of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under sub-rule (4) thereof; and
- the contribution made by the Central Government or any other employer in the previous year, to the account of an employee under a pension scheme, referred to in section 80CCD;
In other words, the salary can include everything you receive from the employer, including in cash, kind or as a facility.