Calculating Holiday Pay
Please note, this blog was updated in July 2019 and the most recent updates can be found at the bottom of this webpage.
Overtime and Commission
Late 2014 brought a seismic shock to employers when a surprise finding by the Employment Appeal Tribunal (EAT) had serious implications on how holiday pay should be calculated. How overtime should be treated is the main issue. It’s impossible to produce any guide on this subject that is ‘law-lite’ or understandable in only a few sentences, but we have done our best to make it as interesting and readable as possible:
In late 2014 the EAT decided that overtime (including non-guaranteed overtime: overtime which the employer does not have to offer, but the employee must work if offered) should be included in holiday pay calculations. At this time, there was no requirement to include voluntary overtime (where the employer could refuse to work it) but see below for more detail on how this developed. The situation with regard to back-payments is considered below.
This decision is on the back of a recent European Court of Justice (“ECJ”) decision that holiday pay cannot be based on basic salary alone where the worker’s remuneration includes commission.
The Working Time Directive guarantees all workers a minimum of 4 weeks’ annual leave. The Directive makes no mention as to how to calculate the leave. It left that for the individual countries within the EU to implement the legislation in their own way. This gives countries the flexibility to make it fit in with its own way of legislating. This sounds good in principle but if the legislation that is introduced is incompatible in any way with the Directive, it can be challenged in the European courts.
The UK implemented the Directive by way of the Working Time Regulations 1998. The Regulations managed to upset just about all employers by being convoluted, very technical and difficult to understand clearly, in some ways being unworkable in practice and by ‘gold-plating’ the Directive. For example, the Directive requires 4 weeks’ paid leave and the UK Regulations introduced 5 weeks (currently 5.6).
The one thing that was made very clear in the Regulations was how a “week’s pay” would be calculated. The Regulations refer to the Employment Rights Act 1996 which says a week’s pay is to be based on ‘normal hours’ worked by the employee not including overtime (the situation is different where irregular hours are worked). This was subsequently clarified in the Employment Tribunal as meaning that overtime was not to be included in the calculation unless it was guaranteed and compulsory i.e. paid regardless of whether actually worked.
There have been several key cases in the last year or so which threw the way in which holiday pay is calculated into chaos:
Lock v British Gas Trading Ltd (2016):
This was a case brought by an employee who was paid 60% of his salary in commission. The ECJ held that if the commission was not included within the calculation he would be reluctant to take holiday and would be disadvantaged when doing so. Therefore commission should be included within holiday pay calculations where it is determined with reference to sales achieved.
So this was the first major case to chip away at the notion that holiday pay should be calculated using basic pay only. The ECJ said it was a matter for the national courts to decide how payments should be calculated. The method of calculating the commission element of holiday pay has yet to be determined by the UK courts, this issue is likely to be determined in the next stage of litigation. However, we are of the view that the method is likely to be a form of averaging of previous months’ commission payments to determine an appropriate level of holiday pay (the Working Time Regulations has a 12 week calculation method). We have produced a calculator that provides the holiday pay calculation based on a 20 week reference period so as to ensure that there are at least 12 full weeks (where the whole week has been worked) used in the calculation.
This was a nice clear cut case for the ECJ. The discussion then spread to overtime payments and a number of claims were lodged.
Bear Scotland Ltd v Fulton and Baxter (2014):
The holiday pay claims in this case arose because of the conflict between UK and European law as to how holiday pay should be calculated. In particular, the claims were concerned with whether additional payments to basic salary, such as overtime, must be included.
The decision of the EAT was that elements of pay which are currently excluded from the holiday pay of many workers must be added to holiday pay, including overtime. The overtime that the case decided should be included is the type that workers are required to carry out if asked (in other words they are not permitted to refuse) whether guaranteed or not. Purely voluntary overtime is currently not included – there was no definitive judgment on this but we suspect it won’t be long before it is made clear that it should be included. Travel time payments, which exceed expenses incurred, and so amount to additional taxable remuneration, should also be included when calculating holiday pay. The question is left open as to whether such payments as shift payments and unsociable hours payments will have to be incorporated into the holiday pay calculation too.
Nevertheless, in short we can say with some degree of confidence that the following should be taken into account in holiday pay calculations:
- Commission payments;
- Compulsory guaranteed and non-guaranteed overtime;
- Incentive bonuses;
- Travel time payments (where they are not expenses but payments for time spent travelling);
- Shift premiums;
- Flying pay or time-away pay;
- Stand-by payments;
- Seniority payments (e.g. payments linked to experience, grades within the business, qualifications).
- Moving forward, the 4 weeks’ leave required by the Directive and the additional 1.6 weeks’ leave provided by the WTR are to be paid at different rates (although employers can choose to pay it all at the higher rate);
The decision of the EAT will lead to higher wage bills for many employers in the future, but there is also the potential for back pay liability:
How far back the employees can claim depends on whether each instance of under-payment forms part of a ‘series of deductions’. It was initially thought possible that the period employees can claim under-paid holiday pay could be as far back as 1998 if they can establish a series of deductions going back that far.
However, the EAT decided that the series is broken if more than three months has elapsed between deductions. In other words, if three months has passed between holidays, the series is broken. They also said that the additional 1.6 weeks’ leave provided by the WTR will be the last leave to be taken in any leave year and this does not have to be paid at the higher rate (i.e. it doesn’t have to include non-guaranteed but compulsory overtime). This means that claims for back pay will stop at the point at which there is more than a three month gap between the leave (and specifically the 4 weeks’ leave required by the Directive). In practice, this is likely to mean that in the majority of cases the claims for back pay will be limited to the current holiday year.
Business Secretary Vince Cable immediately announced he was setting up a new taskforce to “assess the impact of the ruling”. The members of the taskforce consist of seven employers’ organisations but no unions or employee representatives (so we can make an educated guess as to the recommendations it will be making). The matter has not been put out to consultation beyond that. This was not a sudden act of goodwill towards employers by the government. There was a strong possibility that employers might argue that they are not liable for backdated payments, as it is a failure on the part of the UK Government to comply with European law (i.e. implement the Directive properly by way of the Regulations). If the courts say it is impossible to reconcile UK regulations with the ECJ decision, employers could ask the Government to pick up the tab. It goes without saying that the Government is likely to resist this.
In any event, one result has been the quick introduction of new legislation and within 3 weeks it made changes to Employment Rights Act 1996 (ERA) reducing the potential cost to employers. Workers can make claims under the existing legislation (as outlined above) for a transitional period of 6 months. However, after 1st July 2015 all unlawful deductions claims (regardless of whether they are connected to holiday except SSP, SMP and certain guarantee payments) can only go back 2 years. But what about claims brought in the civil courts for breach of contract? Well, the changes to the ERA make it very clear that the right to paid holiday is not incorporated as a term in employment contracts. Therefore, claims are still limited to the 2 year rule.
- Employers need to consider what should be included in the calculation of holiday pay – e.g. a calculation of overtime, commission etc. and whether to include such items as shift allowance at this stage.
- Many employers will need to decide how to deal with existing claims. Unions have already filed a substantial number of claims for under-paid holiday pay, which have been stayed pending the outcome of these cases. The decision of the EAT may provide an incentive to settle claims, as the potential for back pay is now limited.
- Consider minimising holiday pay liability by, for example, offering voluntary overtime (where the employer is not obliged to offer it and the employee is not required to undertake it if offered) instead of non-guaranteed overtime, or using outside staff rather than permanent staff to carry out overtime.
- It is likely that there will be case law in the near future clarifying whether all overtime should be included within the holiday pay calculation (regardless of whether voluntary, guaranteed or not).
- As mentioned above, we have produced a calculator that provides the holiday pay calculation based on the previous 20 weeks where whole weeks have been worked. The reason for selecting a 20 week reference period is that where whole weeks have not been worked they have to be disregarded in the average pay calculation. A 20 week period should therefore include at least 12 weeks in which whole weeks have been worked. This is in accordance with the Working Time Regulations and the ERA. However, from 6 April 2020, the 12-week reference period used to calculate statutory holiday pay for those not working normal weekly hours will be extended to 52 weeks (or the number of complete weeks for which the worker has been employed, if that period is less than 52 weeks). As such, employers might want to consider adopting that approach now.
The Employment Appeal Tribunal has held that when calculating holiday pay (in respect of the minimum four weeks’ holiday required by EU law), employers must include voluntary overtime, voluntary standby and voluntary call-out payments, on the condition that the work has been ‘sufficiently regular’ to become part of the employee’s ‘normal pay’ (Dudley Metropolitan Borough Council v Willets and others).
This is the first binding decision on the point, and illuminates further the issue of the inclusion of voluntary overtime in the four-week minimum statutory holiday pay. A question that arises is when payments become “sufficiently regular” so as to be included. The Employment Appeal Tribunal did not address this directly, other than to say that this is a question of fact and degree in each particular case. Perhaps the key question that should be asked is ‘what would the worker have earned if they had not taken leave?’ It is likely that we will see further developments in this area in the future. Unfortunately, this means continuing uncertainty for employers. Nevertheless, employers must now give serious consideration as to whether they should be including voluntary overtime in their holiday pay calculations.
Over the past few years we have seen numerous developments in the way that holiday pay is treated in the UK. One issue which is of particular importance to employers is the time limit for which employees or workers are required to bring claims for holiday pay. The standard position is that a claim must be brought within three months of the last in a series of deductions.
For example: an employee has only been paid holiday pay over the last 18 months calculated on basic pay. In actual fact, the employee worked 5 hours guaranteed overtime every week and this should have been included in the holiday pay calculations. The employee is potentially able to claim for the whole 18 months he/she was underpaid, provided the claim is brought within three months of the last deduction (i.e. non-payment of holiday pay calculated to include overtime).
However, what is a ‘series of deductions’ and how much of a gap is allowed before there is no longer a series?
This was clarified in a case called Bear Scotland v Fulton, which said that where more than three months has elapsed between unlawful deductions for holiday pay, this breaks the series of deductions and anything before the three month break can no longer be claimed.
At first blush this may not seem like a significant issue, but from an employer’s perspective this restriction on how far back an employee or worker can claim in relation to holiday pay can (in some cases) severely limit its value.
Let’s go back to our example with the employee whose holiday pay was calculated on the basis of basic pay. If in actual fact the employer started including guaranteed overtime at month 14, but on month 18 went back to only including basic pay in its calculations for holiday pay, there has potentially been a break in the series of deductions. This means the employee may not be able to claim for the incorrect holiday pay between month 1-14 because more than three months has elapsed between the unlawful deductions for holiday pay at month 14 and at month 18.
Chief Constable of Northern Ireland Police v Agnew.
This issue again cropped up in the recent decision of Chief Constable of Northern Ireland Police v Agnew.
Nearly 4,000 police offers brought claims in relation to underpayment of holiday pay against the Police Service of Northern Ireland and the Northern Ireland Policing Board. The claims were brought on the basis that their holiday pay had been calculated by reference to basic salary, instead of by reference to normal pay including overtime.
An issue that the Court of Appeal in Northern Ireland had to consider was whether the Employment Appeal Tribunal in the Bear Scotland case (mentioned above) was correct in finding that a gap of over three months, or a lawful payment, breaks a series of deductions.
The Court decided that the Bear Scotland case was wrongly decided and could lead to “arbitrary and unfair results”. It instead found that whether there had been a series of deductions through time was a question of fact (as opposed to there being an arbitrary three-month breaking point).
Therefore, a series of deductions was not broken by a gap of three months or more. Further, lawful payments of correct amounts between the various holiday payments (such as in the example given above) would not necessarily interrupt the series. Each unlawful deduction was factually linked to its predecessor by the fact that holiday pay had been calculated by reference to basic pay rather than normal pay.
As you will no doubt appreciate, this case significantly increases the potential cost of historical holiday pay claims in Northern Ireland as it confirms that neither a three-month gap, nor a correct payment of holiday pay, will necessarily break a series of deductions. Astonishingly, it was estimated that the costs of the employer meeting its historical liabilities would increase by a factor of 100, from £300,000 to £30 million, as a result of losing on what amounts to a series of deductions.
As the case was on Northern Irish Law, it is not strictly binding in Great Britain. Nevertheless, it is very likely that this case may be relied on in the future. Furthermore, if this case is appealed to the Supreme Court (which is very possible, given the sum of money at stake), the outcome would be binding throughout the whole United Kingdom.
Please keep checking our page, as we will endeavour to keep you updated regularly.
N.B THE CONTENTS OF THIS GUIDE ARE INTENDED FOR GUIDANCE FOR READERS. IT CAN BE NO SUBSTITUTE FOR CONSIDERED ADVICE ON SPECIFIC PROBLEMS. CONSEQUENTLY, WE CANNOT ACCEPT RESPONSIBILITY FOR THIS INFORMATION, ERRORS, OR MATTERS AFFECTED BY SUBSEQUENT LEGISLATION.