Taxation of encashed leave depends at what time in your career life have you encashed your pending allowed leaves and if this is done during your working life then it is taxed as salary and in a case when the encashment is made after working life by the government employee i.e. while retiring on taxation liability arises on this. But this is as per the prescribed limit in the Income Tax Law.
And for the same, the amount received by way of encashing leave is taxable as salary. This is owing to the fact that Income Tax Act extends the definition of salary to include whatever is received by an employee from an employer in cash, kind or as a facility [perquisite] is considered as salary. Salary comprises wages, any annuity or pension, any gratuity, any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages.
Further, the definition of salary is inclusive of any advance against future salary payment, amount received against leave encashment, 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.
Also, to be noted is any received arrears on salary, which is normally received after a salary is hiked post appraisal season also qualifies for taxation implications.