Whilst your employees might be counting down the days to
their annual break, if you’re an employer there can be all sorts of reasons to
dread the annual exodus – not least the payroll implications. So, what must we
bear in mind in terms of holiday pay rights and calculations?

Well the first thing to say is this has been a recurring
tribunal topic of recent years so the risks of getting it wrong are significant
in terms of reputational damage. In summary this is because the definition of a
‘week’s pay’ (the Employment Rights Act (ERA) 1996 s16/Employment Rights Order
(ERO) in Northern Ireland) has been the subject of much re-interpretation since it was first
challenged in a case relating to flying allowances paid to pilots covered by the
Civil Aviation Directive but the read across to the Working Time Directive was
key as was the ruling that any payment ‘intrinsically linked to the performance
of the contract and which relates to the worker’s personal and professional
status” must be included in holiday pay – not just basic pay. Since then
successive court cases have ruled that the following pay elements must be included
in holiday pay:

  • Guaranteed overtime (Bamsey v Albon Engineering
    & Manufacturing plc)
  • Compulsory overtime and travel allowances (Bear
    Scotland v Fulton
  • ‍Commission (Lock v British Gas)
  • ‍Regular voluntary overtime*, standby payments,
    call-outs and travel allowances (Willetts V Dudley MBC and Flowers
    v East of England Ambulance Trust

*overtime performed once every four weeks was considered
regular enough to be included

Just to make matters more complex, the Working Time
Directive (WTD) from which the UK’s Working Time Regulations flow, defines the
holiday pay required to be paid for the 20 days’ EU statutory leave as being
based on ‘normal remuneration’, not just pay that is contractual. A number of
holiday cases including have been considered by the European Court of Justice
(ECJ), so we have different definitions for what must be included in holiday
pay for:

  • The first 20 days per year of annual leave – ‘normal remuneration’ (WTD)
  • ‍The next 8 days – ‘a week’s pay’ (ERA/ERO)
  • Any additional contractual holiday over 28 days – definition of pay at the employer’s discretion‍

This brings the thorny question of cost versus complexity.
Does the employer want to have the same generous definition of holiday pay for
all periods of annual leave to simplify systems and processing, or does the
cost overhead mean three different holiday calculations might need to be

Historically, if holiday pay equated to basic pay there was
no need for the payroll or HR teams to know when a salaried employee was on
holiday, the line manger could manage entitlement  and basic salary would be received. Now salaried
staff who have any variable pay elements that fit the ‘intrinsically linked’
definition require annual leave to be reported and a calculation to be
undertaken. But over what period does the variable element need to be averaged?
Some employers have taken the view that as the courts have not determined an
averaging period then there is no action yet needed.  There certainly seems to be no appetite to
give any further direction on this and the cases keep coming to tribunal
(particularly now that fees have been abolished) so what are the options?

  • For employees with variable working patterns or no contractual hours at all the Working Time Regulations look to s224 of ERA and require that pay and hours be averaged over the 12 weeks prior to the holiday period
  • ‍It has been common practice for some employers with  irregularly paid employees to shortcut the 12-week calculation by paying holiday pay at a rate of 12.07% for every hour worked

There has not been any challenge to the first approach even
for salaried staff as it is enshrined in the ERA, it is equally acceptable to
go back further than 12 weeks for example to ‘smooth’ pay peaks such as
quarterly commission. In fact, the Government is consulting on extending the
statutory averaging to 52 weeks. The second approach is more problematic. Lawyers
are split on  the legality of paying holiday
pay each period, even if it is shown transparently as a separate amount. They
point to the Directive requiring four weeks' leave to be taken away from the
workplace and the government’s statement therefore that any form of rolled up
holiday pay was in contravention of the Directive, which they have cemented by
rejecting Mathew Taylor's report suggesting it should be an option for gig
economy workers.

Now the 12.07% calculation itself has been questioned in
Court in the case of Brazel
v Harpur Trust
. Ms Brazel as a term-time  worker only worked 32 weeks a year so her
holiday pay as a percentage of the working year was 17.5%, giving a legal
windfall to part-timers unless the 12-week calculation is used for

With all these holiday challenges it's certainly the case
that HR and payroll professionals will value their time away from the