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Update: What has to be included in holiday pay?

When an employee takes annual leave, how much should he be paid? You might think that this should be a straightforward question, but it is proving to be one of the trickiest issues employers will have to face this year and one that has generated widespread publicity following the recent decisions on overtime in the cases of Wood and others v Hertel and Fulton and Bear Scotland Limited that were delivered in November last year.

Why is it difficult to calculate holiday pay?

The EU Working Time Directive (from which our Working Time Regulations derive) does not specify which elements of pay should be included when calculating holiday pay. The UK opted to utilise the method of calculating a “week’s pay” included in the Employment Rights Act 1996 which was not originally designed to be used in the context of holiday pay.

It provides that where a worker has “normal working hours” and is on a fixed salary, that weekly pay will form the basis of the assessment. However, if the amount the worker receives varies depending on the amount of work he does, or when he does it, a week’s pay is averaged over the previous 12 weeks.

Guaranteed contractual overtime payments and some commission payments have always been included if they fall within the 12 week period. However, overtime and commission payments that do not fall within these categories have been excluded and a number of cases have been brought which challenge this.

Non-guaranteed overtime

The Hertel case was brought by a number of workers whose employment contracts stated that their normal working hours were 38 hours per week. Their employers were not obliged to provide overtime, but if they did, the workers were contractually obliged to accept it (a practice known as non-guaranteed overtime).

In reality, the workers undertook six hours of overtime each week for which they were paid. The Employment Appeal Tribunal (“EAT”) said that these overtime payments must be included in holiday pay because the overtime was regular and had become part of their normal hours.

They also stated that non-guaranteed overtime that does not follow a regular pattern must also be included. However, this will need to be averaged over a (probable) 12 week reference period although it may be possible for businesses to adjust this reference period if it can show that it is not representative of business practice). This might be the case where there are fluctuations in demand for overtime to meet customer requirements.

Does this decision apply to paid voluntary overtime?

There are no cases about purely voluntary overtime (i.e.; overtime which the workers can genuinely accept or reject) currently before the appeal courts. However, it is likely that voluntary overtime that is regularly worked will have to be included, but not if it is worked on an “ad hoc” basis, or is unpaid.

This was the conclusion reached by a Tribunal in 2012 in the case of Neal v Freightliner but the case was settled before the appeal was heard (which means that its decision is not binding on other Tribunals).

What about productivity, attendance or performance allowances?

The extent to which “allowances” must be included will depend upon whether the payment is intended to cover occasional costs incurred by the worker, such as travel or subsistence expenses, or are linked to productivity or the work in some other way. It seems that only those linked to productivity must be included.

By way of example, the following payments were deemed to be part of the employee’s normal remuneration for the purposes of calculating their holiday pay in Hertel.

A fixed element that simply related to hours worked (but which could be removed in the event of excessive absence, failure to work all agreed shifts in full, or resigning without giving proper notice); and
A performance-based element, paid if the employees reached agreed targets, and provided that they had not taken part in any unofficial or unauthorised industrial action.

Does the requirement to include overtime and allowances apply to all paid holiday the worker takes?

No. The EAT made it clear that overtime and other relevant payments only have to be included for the first 4 weeks holiday taken by the worker as this was the minimum provided under the European Working Time Directive (“Directive Leave”) but not to the additional 1.6 weeks leave that the UK Government gives us under our domestic legislation (“Additional Leave”).

How far back can workers bring claims?

Workers will be able to bring claims in the Employment Tribunal under the Working Time Regulations or as a series of unlawful deductions from wages.

However, both claims have to be brought within three months of the underpayment otherwise they will be brought out of time and the Tribunal will not be able to hear them.

In addition, a worker cannot claim that he has suffered a ‘series’ of deductions (and so potentially go back many years) if there are more than three months between payments where there is a shortfall.

The Government, worried about the potential impact of this on UK businesses, has introduced the Deduction from Wages (Limitation) Regulations 2014 which will:
  • Limit all unlawful deductions claims relating to holiday to two years before the date the employment claim is lodged; and,
  • Explicitly state that the right to paid holiday is not incorporated as a term in employment contracts which means that workers will not be able to pursue a civil claim for underpaid holiday in an attempt to get around the restrictions imposed by the Employment Tribunals.
However, these Regulations only apply to claims presented after 1 July 2015.

Key Contact

Glenn Hayes