Holiday Pay - what should be included?
There have been a number of recent cases about how holiday pay should be calculated for those workers with variable pay (for example recruitment consultants who work overtime or receive commissions on their placements).
In this article, we summarise the key developments in this sometimes confusing area of employment law and provide some practical guidance on which steps recruitment businesses might think about taking.
The traditional approach to calculating holiday pay was based on a worker's basic salary. This approach has however been challenged in recent years and has shifted as a result of new concepts developed from a line of European cases.
It is now clear that the law in the UK must be interpreted in accordance with European principles and this has been emphasised again in the most recent decision in the long running case of Lock v British Gas Trading Ltd (see commission section below).
How should we calculate holiday pay now?
The latest European case law has established that holiday pay should be calculated in accordance with normal pay. This includes:
- pay that is 'intrinsically linked' to the performance of tasks under the contract
- pay which relates to a worker's professional and personal status
- pay that is received for a sufficient time period
This new shift has however raised issues where workers receive variable pay, for example where workers receive overtime, sales commission, bonuses and allowances. Other questions have also arisen relating to the correct reference period when calculating holiday pay and whether backdated holiday pay can be claimed.
Commission
In the case of Lock v British Gas Trading Ltd, it was found that as a general rule commission payments should be included in normal pay for the purposes of calculating holiday pay, as commission is normally intrinsically linked to the performance of tasks required under the contract.
In this case, Mr Lock was a sales consultant for British Gas. His average monthly take home pay comprised basic pay (40%) and commission (60%). When Mr Lock took annual leave, he received commission based on past sales he had made, but did not receive any sum to account for the commission he would have earned if he were not on annual leave. His salary was therefore significantly lower in the month following any period of annual leave.
The European Court of Justice (ECJ) found that despite the fact that the commission which Mr Lock received fluctuated from month to month, it was permanent enough to be regarded as part of Mr Lock's normal pay.
Overtime
Recent case law has also established that most types of overtime should be included for the purposes of calculating holiday pay.
In the case of Bear Scotland Ltd v Fulton and another, the Employment Appeal Tribunal (EAT) found that overtime which an employee is required to work if requested by the employer should be included in holiday pay.
The decision applied to compulsory overtime that is worked sufficiently regularly to be included in an employee's normal pay. It is unclear what would be sufficiently regular for these purposes. However there is a clear difference between employees who work in addition to their basic hours every week, which is likely to be sufficiently regular, and those who work the odd extra hour from time to time over the course of a year.
Some uncertainty still remains over whether purely voluntary overtime should be included in holiday pay calculations as this was not specifically dealt with in the Bear Scotland case. It is likely however to come down to whether a sufficiently regular and settled pattern has been established over a period of time.
Allowances
The Bear Scotland case also found that allowances (excluding expenses incurred) which amount to additional taxable remuneration, should be included in a calculation of holiday pay.
Bonuses
It is currently unclear whether bonuses should be factored in to calculations of holiday pay. It is likely to come down to how closely linked the bonuses are to the hours worked by the employee. We expect to see further case law in this area.
How should we actually calculate holiday pay?
In the Lock case, the ECJ found that it was for the UK courts to determine how holiday pay should be calculated and we are awaiting the Employment Tribunal's decision on what is the appropriate reference period for calculating the average commission to be included in holiday pay.
Under the UK's Working Time Regulations, the reference period for calculating pay for workers with variable pay is 12 weeks, but the issue has been raised that such a short period may not achieve a representative average. In Lock the Advocate General (an adviser to the ECJ) stated that a reference period of 12 months would be appropriate.
Is there a risk of backdated holiday pay claims?
There has been considerable concern over the impact on employers, particularly in relation to the possibility for claims in respect of deductions from holiday pay to be backdated.
However, in Bear Scotland, the EAT found that if a series of deductions was interrupted by a gap or gaps of more than three months without deductions, the passage of time will break the series. As a result a claim can only include those deductions that occurred after the most recent period of three months during which no deductions were made.
This is important because it greatly restricts the scope for workers to claim arrears of holiday pay. In relation to claims from July 2015 onwards, the government has passed legislation restricting any claim for backdated holiday to a maximum of two years.
Best Practice
The recent cases in this area are significant for recruitment businesses where employees often receive variable pay as a result of commission payments, overtime, allowances and bonuses.
Whilst there is still some uncertainty in this area, recruitment businesses should be alive to the issues and should be taking steps to understand and mitigate the risks to their business. These include:
- undertaking an analysis of your commission structures to understand whether commission payments should be included in holiday pay calculations
- considering whether commission schemes can be restructured so commission payments are not intrinsically linked to the performance of tasks under the contract
- looking at staff working patterns and payment structures to understand whether staff are earning overtime payments, and whether those payments should be included in holiday pay calculations
- understanding the potential costs of including additional payments in respect of overtime, commission or other payments in holiday pay calculations going forward
- considering what is the most appropriate reference period to provide a representative average of hours worked by any affected employees
- considering whether your payroll system has the capacity to deal with potential changes in calculating holiday pay
- understanding the potential liability for any backdated holiday pay claims and if issues are raised how you might engage with employees to agree a way forward
By taking these initial steps, recruitment businesses will gain a clearer picture of what action they need to take going forward.