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We owe you how much?!

View profile for Amy Edwards
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In my previous blogs I’ve looked at how much holiday an employee is entitled to and the rules on employees taking holiday, however recent case law has provided employers with an even bigger problem; how to calculate holiday pay.

Until very recently it was a relatively straightforward calculation – a week’s pay for a week’s leave.  The calculation was quite a complex one depending on whether the employee had ‘normal workings hours’ (for example 9am – 5pm Monday to Friday) or ‘no normal working hours’, but the process had been like that for years, and everyone knew how to calculate  it.

That was, until two very important decisions made by the European Courts of Justice (ECJ).  They found that UK domestic legislation (that is, The Working Time Regulations 1998) is incompatible in certain respects with European Legislation (The Working Time Directive) particularly in relation to the requirement that an employee is to receive their ‘normal remuneration’ during periods of holiday (but only for the first four weeks of any holiday).  This means that our tried and trusted method of calculating holiday pay is wrong according to the European Courts and we must therefore start calculating it in a different (and more complex) way.

Nowadays, when calculating holiday pay, employees are not only entitled to their basic salary, but also to remuneration which “is intrinsically linked to the performance of the tasks which the worker is required to carry out under their contract”.  Thanks ECJ, that’s all perfectly clear to everyone and we’ll just get on with it then!

After much discussion in the Courts, we now have (limited) guidance as to what should be included in a week’s holiday pay provided it is intrinsically linked to the performance of the employees’ contractual duties:

•    Commission payments;
•    Incentive bonuses;
•    Overtime that workers are required to perform - regardless of whether it is guaranteed, overtime premiums should be take into account;
•    Payments that relate to the "personal and professional status" of workers, such as those based on seniority, length of service or professional qualifications; 
•    Productivity/performance bonuses; 
•    Shift allowances and premiums (additional rates for working particular shifts, such as "time and a half"); 
•    Standby payments and payments for emergency call-out duties;
•    Travel and other allowances that are treated as taxable remuneration;

However the following should not be included in the calculation:
•    Benefits in kind;
•    Bonuses not linked to workers' performance;
•    Expenses (including travel expenses) which reimburse workers for costs incurred; and
•    One-off bonuses and occasional payments.

Again, in order to calculate a week’s pay you have to take an average rate of pay for the proceeding 12 weeks’ (as if you were calculating the payments where the employee has no normal working hours).

Remember that these rules only apply to the first four weeks of EU statutory holiday entitlement. The remaining 1.6 weeks and any contractual holiday entitlement can be paid under the old regime.

Whilst I understand the academic rationale behind this decision, it is important for a number of reasons that an employee takes holiday, not least because everyone needs a break once in a while! However, in cases where the employee would be at a financial disadvantage for taking holiday, what incentive is there for him to take holiday?

If an employee usually earns £600 per week when working and then £400 per week when on holiday, he is unlikely to take any holiday.  The employee needs to be in exactly the same position financially that he would have been in (when on annual leave) had he not taken the holiday. But where does this leave the employers?  

This decision is likely to have a huge impact on some employers (for others, nothing will change).  They will have some employees who this will apply to, some that it won’t, some will receive a proportion of the above payments and some all of the above payments.

As the new rules only apply to the first four weeks’ leave and based on the previous 12 weeks’ earnings, the calculation will be different for each period of leave an employee takes.  This is likely to  become a huge administrative burden for employers, not to mention the significant cost implications the changes in calculating holiday pay are likely to have, which will not only mean an increase in the payments to employees (along with Employer NICS)  but  also the man hours in  working out the different payments.

If your business is likely to be affected, you need to start thinking about how you are going to deal with this. I admit it’s not likely to be an easy project for you as, at present, most payroll systems cannot do the calculations for you.  If you haven’t received any queries from your employees as of yet, it’s only likely to be a matter of time until word gets around… unless of course you’ve paid them too much!

If you want to know more about dealing with holiday, sign up for our free webinar on Wednesday 23rd September at 12.30pm.