Calculating holiday pay - don't fall into the trap

Do you know what ‘pay’ is for the purposes of calculating holiday pay? Is it calculated simply by paying basic salary for any time taken as leave? Should overtime rates and premiums, such as additional pay for working unsociable hours, also be included? A recent Tribunal decision explored this issue and concludes that the calculation may not be as straightforward as many employers think.

Under the Working Time Regulations, the purpose behind paying a worker for time whilst on holiday is to ensure that they are not worse off by taking annual leave than they would be if they were working. The historic position had been that:

• a week's pay for workers who have 'normal working hours' is calculated by reference to those hours only. Where such workers are paid for overtime, they are still treated as having ‘normal working hours’ and any pay for overtime is therefore not counted as part of the calculation of a week’s pay, unless the overtime was guaranteed. In addition, any premiums paid were to be ignored;
• for employees with normal working hours whose pay varies according to the amount of work done or the time of work (for example because of a shift premium) a week’s pay was based on their average pay during those normal working hours over the previous 12 working weeks;  and
• for employees with no normal working hours, a week’s pay is calculated as an average of all the sums earned in the previous 12 working weeks.

In the recent case of Neal v Freightliner, however, the Tribunal concluded that a worker’s holiday pay should include any overtime and premiums paid in the 12 weeks preceding the holiday when calculating the amount of basic remuneration (regardless of whether they have normal working hours). The Tribunal suggested that any element of pay linked to the tasks required of the worker under the contract of employment for which payment is received should be included. That means, in short, that  overtime payments, even where that overtime is voluntary and not guaranteed, should be factored into the calculation of a week's pay for holiday purposes. It also means that any additional pay or premiums for working unsociable hours, or pay for being on emergency standby, for example, could all be included in the definition of ‘basic pay’.

The Tribunal decision in Neal itself is not binding on other Courts or Tribunals and it has been appealed, due to be heard at the end of July 2014. However, in our view and based on previous EU case law, the decision is likely to be upheld. This would mean that any employer who has paid a worker overtime or shift premiums, but has not included any such payments made in the 12 weeks prior to the holiday in the calculation of holiday pay, could be exposed to claims for additional holiday pay.

It is possible, however, that the courts may restrict the scope of the decision or give more detailed guidance as to how holiday pay should be calculated. It is also worth noting that the decision only affects the calculation of holiday pay for the four weeks’ annual leave granted to a worker under EU law and not for the additional 1.6 weeks’ granted by UK law. These additional 1.6 weeks can be calculated simply on ‘basic’ pay alone and need not include overtime. This distinction, however, may be more difficult to apply in practice.

In the meantime, organisations should consider their holiday pay arrangements and, if they are not compliant we consider it would be prudent to change the existing method of calculation. The decision could have major implications for the health and social care sector, where overtime, unsociable hours and bank holiday working are the norm. Not only does it potentially increase the costs of holiday pay considerably, it also exposes employers to the risk of claims for unlawful deductions from wages where calculations have not been carried out correctly. Working out what this will amount to may involve complicated calculations for employers. While employers should tread carefully and seek specialist advice on the issue, one piece of good news is that the liability is not open-ended. In most cases, tribunal claims must be brought within three months of the most recent underpayment, unless they are pursued as claims for breach of contract.

Despite the decision, therefore, there is no need for employers to panic. Taking appropriate steps at this stage can reduce the impact of the decision. Our advice is to invest time now and plan to reduce the potential for complex, expensive and time consuming claims from workers, particularly as claims, where founded, can be backdated as far as 1998, or potentially further. We suggest undertaking the following steps in order to check whether your organisation is compliant:

• look at payroll, overtime and holiday records to check how payments have historically been calculated;
• consider your holiday pay arrangements and whether they allow for any overtime or premium payments paid in the 12 weeks prior to holiday to be included in calculations;
• investigate whether existing payroll systems may require changes;
• change your existing method of calculation if necessary (or if you are prepared to take a more risky approach, budget on the basis that you are likely to need to change your existing arrangements)

• consider whether it may be simpler – and not significantly more costly – to calculate all holiday pay at the enhanced rate, rather than just the four weeks’ leave that is affected by the case law;
• consider what, if any, overtime arrangements should be offered to new joiners; and
• look to manage the overtime that workers take in the run up to holiday so that the potential for abuse of process by workers looking to increase their holiday pay entitlements is reduced.

For more information

If you would like to discuss your arrangements or related issues, please contact Kate Watkins on 0121 212 7494 or kate.watkins@anthonycollins.com.