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Holiday Pay – what are the rules?

The calculation of holiday pay is a notoriously complicated (and ever changing) topic. There are a number of key cases that have, over the past decade, set out what should and should not be included when calculating a worker’s holiday pay. However, many employers remain confused about what the rules actually are and are still calculating a worker’s holiday pay based solely on basic pay, which is not always the correct approach and could lead to costly, lengthy and complicated claims for unlawful deductions from wages.

The law governing this topic is highly complex and, in some places, contradictory. In this article, we seek to provide some clarification on the position and focus on the main rules governing the calculation of holiday pay.

Under the Working Time Regulations 1998, workers are entitled to be paid during statutory annual leave at a rate of a week’s pay for each week of leave. For workers who work fixed hours and receive a fixed basic salary (and no additional payments), the calculation will in most cases be simple. However, complications arise in situations where workers do not have fixed hours, a fixed rate of pay and/or receive payments in addition to their basic salary, such as overtime or commission. In these circumstances we would encourage you to take legal advice as ensuring that the calculation is correct can be complex.

So, how should employers go about calculating an average week’s pay for the purpose of calculating holiday pay?

The Reference Period

Firstly, when using a reference period (e.g. for those with no normal working hours or whose pay varies), the current law requires employers to look back at the 12 working weeks preceding the period of holiday and calculate the average pay over that period of time (the “Reference Period”). However, with effect from 6 April 2020, the reference period will be extended to 52 weeks and so employers will have to take a greater period of time into account when determining average pay.

To complicate matters further, if there is a week within the Reference Period that no remuneration is received by the worker (for example, if a worker is on a zero hours contract and does not work in any given week) then this week is to be discounted from the calculation. When omitting any given week in which no remuneration was paid, you then look back further so that the Reference Period still amounts to 12 (or soon to be 52) weeks. When the Reference Period increases in April, a worker should not look back any further than 104 weeks if there are several weeks in which no remuneration was paid.

Types of Payment

For all workers, even those with normal hours, employers need to consider what payments to consider when looking at holiday pay.

The overarching principle is that holiday must correspond to a worker’s “normal remuneration”. We know that a worker’s basic pay counts as normal remuneration, however, other types of pay can be unclear. We have taken a look some of the different categories of pay that should be taken into account.

Overtime

Following the cases of Bear Scotland v Fulton and Others and East of England Ambulance Service NHS Trust v Flowers, the following categories of overtime should be included when determining a week’s pay:

  • Guaranteed and compulsory overtime (i.e. where an employer is contractually obliged to provide the overtime);
  • Non-guaranteed overtime (i.e. where the employer does not have to provide the overtime, but it is compulsory for the employee to accept it, if required); and
  • Voluntary overtime, provided that it has been paid over a sufficient period of time on a regular and recurring basis and are “intrinsically linked” to the performance of tasks required under the contract.

So, what isn’t included? If a worker carries out overtime on a genuinely occasional and infrequent basis, then it does not need to be included as part of the holiday pay calculation.

Commission/bonuses

In a nutshell, the case of Lock v British Gas determined that holiday pay must include any results-based commission that would ordinarily be paid to the worker. This can become complicated where the commission structure is complex or where there are a number of commission structures applicable to different workers.

In situations such as this, employers should keep track of the commission payments that their workers receive and ensure that these payments are taken into account when calculating holiday pay.

Expenses

These will only be included to the extent that expenses paid include a profit or surplus which will form part of the worker’s remuneration. For example, if a travel allowance is paid not as a reimbursement but as an “perk of the job”, this should be taken into account. A simple reimbursement for a train fare would not be included.

Under the Working Time Regulations 1998, workers are entitled to be paid during statutory annual leave at a rate of a week’s pay for each week of leave.

Pension contributions

Whilst these are not expressly referred to in legislation, case law has held that pension contributions do come within the meaning of “normal remuneration” and therefore should be included when calculating a week’s pay.

Tips, service charges and gratuities

The current position is that payments received by worker within the above categories are not included within the week’s pay calculation.

Whilst case law over the past decade has provided some clarity on the calculation of holiday pay, the area of law as a whole remains complex. If you are unsure or would like some more detailed advice, please do not hesitate to contact a member of our team.

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Disclaimer
This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.

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