Holiday Pay - how much should employees be paid when they take annual leave?

26 November 2015

26 November 2015 by MHA MacIntyre Hudson

You may think this is quite a straightforward question but it has proved to be one of the biggest employment issues considered over the past two years. What is the problem, you ask? Well, let’s start at the beginning…

What does the legislation say?

Two major pieces of legislation underpin the holidays and holiday pay issues and these are Employment Rights Act and Working Time Regulations (WTR).The statutory entitlement to paid annual leave in the UK is 5.6 weeks; 4 weeks come for the European legislation and 1.6 weeks in additional UK entitlement. For a full time worker this is 28 days per year. The legislation clearly specifies that the holidays need to be paid and claims for unpaid or underpaid holiday pay can be brought as unlawful deduction from wages claim. As long as the employees are paid normally during their holidays everything should be ok but here we get to the controversial question…

What is “normal pay”?

This is precisely the question that has been considered by employment tribunals and courts for quite a while now resulting in media reporting about holiday pay all the time. What do we actually know? The general principle is that employees should not be deterred from taking annual leave due to financial disincentives and should be paid at a rate of pay which is comparable to their regular pay. Any payments intrinsically linked to the performance of the job should be included in the holiday pay calculation.

  • Commission payments: the European Court of Justice ruled that if commission is contractual and determined with reference to sales achieved, then the commission payments have to be taken into account when calculating the holiday pay, otherwise the workers might be deterred from taking annual leave at all. The case is being appealed to the EAT and is expected to be heard on 8 and 9 December 2015.
  • Overtime: the following should be included in the holiday pay calculations - any payment for guaranteed overtime and non-guaranteed overtime as well as any taxable payment that is made for time travelling to work (i.e. travel allowance). Treatment of voluntary overtime was addressed in Northern Ireland where the decision was made that voluntary overtime should also be included. This decision is not binding on Courts and Tribunals in England, Wales and Scotland, however it can be cited as “persuasive” and is therefore no doubt a clear green light for employees seeking success in a similar claim over here.

What are we still waiting for?

We have no clarity on how to deal with bonuses and other specific payments such as acting up allowances, stand-by and call-out payments. We can put our own interpretations on what these payments are and how they should be treated in light of the existing case law, but there is no legislation to lean on.

There is no proper definition of the reference period that should be used for holiday pay purposes. The Employment Rights Act makes a reference to twelve week and the tribunals also seem to be pointing in this direction, but importantly, in many industries, a 12-week average could be entirely unrepresentative of normal pay, depending on when holiday is taken. It could lead to artificially high levels of holiday pay after peak periods and also high demand for holiday after such periods.

All in all, not a lot has been clarified yet and most cases are EU judgements and therefore only apply to the 4 weeks holiday entitlement originating from the EU legislation and not to the full 5.6 weeks under the UK legislation. This raises a question of whether the two types of annual leave could be treated differently when it comes to paying it. This in turn raises the issue of administrative burden of making these calculations (either differently or in the same way for all annual leave) and whether our payroll systems are capable of doing this.

How big is the risk of getting claims from employees?

Unlawful deduction from wages claims can be brought in respect of unpaid or incorrectly paid holidays. Businesses have been concerned about the prospect of such claims going far back but a claim has to be brought within 3 months of the deduction and any previous deductions can only be “linked” in a series of deductions if they occurred no more than 3 months previously. This is where the distinction between 4 weeks holiday under the WTD and the additional 1.6 weeks is important because the EAT has suggested that a series cannot span a gap where holiday pay has been paid correctly – and the 1.6 weeks are still likely to be considered to be paid correctly even if only basic pay is paid.

There could still potentially be cases with claims linking back years, however the introduction of The Deduction from Wages (Limitation) Regulations 2014 means that when making a claim for backdated deductions from wages for holiday pay, a two year cap will be placed on all claims that are brought on or after 1 July 2015. This significantly reduced the potential cost of claims for the employers.

What should you do next?

At the moment we can only rely on the WTR which are quite clearly unfit for purpose in light of the case law. As part of its Modern Workplaces consultation, the government has proposed to amend the WTR to take into account the European Court of Justice’s interpretation of the WTD and we are eagerly awaiting for the changes to be legislated.

More information on this topic can be found on our website: 

  • Holiday pay to include overtime
  • Holiday pay must now include commission


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