EMPLOYMENT & PENSIONS E-BULLETIN ARTICLE

Following the various recent European and UK cases on holiday pay, the question as to what should and should not be included in a worker's pay packet for periods of annual leave has become a tricky issue for employers and HR professionals to grapple with.

Despite the focus of much of the publicity and commentary being on overtime and commission, the effect of the recent decisions means that a much wider range of variable payments should now potentially be included when calculating holiday pay. As a result of the developments, old ACAS and government guidance for employers which previously provided some clarity on the issues can no longer be relied upon. Instead, principles from fact specific and lengthy judgments need to be extrapolated and applied to practical situations.

The current case law does not provide any clear, definitive tests to determine which variable payments should and should not be included in holiday pay for workers with normal working hours. However, in order to help businesses operate their payroll systems for periods of annual leave, we have summarised below the guiding principles that we have taken from the recent decisions. We have also set out some useful practical examples.

The key principle that has emerged is that workers should not be at a financial disadvantage as a result of taking their statutory annual leave. This is because it could deter people from taking their holiday entitlements, which would be contrary to the purpose of the European Working Time Directive.

Individuals could suffer a financial disadvantage as a result of taking holiday by, for example:

  1. Receiving less pay during periods of annual leave than they would have done if they had been working (e.g. if they do not get paid for the overtime that they would have otherwise worked) or
  2. Losing the opportunity to earn more as a result of taking holiday (e.g. if they had not taken annual leave they could have exceeded their targets by an even larger margin, thereby earning more commission or a larger bonus)

In determining whether or not pay arrangements do put workers at a financial disadvantage if they take their annual leave entitlements, the cases have highlighted that:

  • Workers should receive their "normal remuneration" whilst on statutory annual leave; and
  • Where there is an intrinsic or direct link between the payment made and the work a worker is required to carry out, such payment should be included for the purposes of calculating holiday pay.

Taking these principles and the comments in the current cases into account we have set out below some practical examples of the types of variable payments that, in addition to basic pay, potentially DO and DO NOT need to be included when calculating holiday pay for the first four weeks of annual leave of a worker who has normal working hours. We have also set out the grey areas that still remain.

PAYMENTS TO BE INCLUDED

The following are variable payments which now SHOULD BE included when calculating holiday pay.

1. Guaranteed overtime: This is where the employer is obliged to offer overtime and the employee is obliged to take it.

Example:

Sunaina is a Technical Engineer for a construction company. Her basic contracted hours are 35 hours a week. Her contract however also states that she must undertake 10 hours of overtime each week which is paid at an enhanced rate.

Such overtime payments at the enhanced rate DO NEED to be included in calculating holiday pay (this is the case for the full 5.6 weeks statutory holiday an employee is entitled to in the UK rather than just the 4 weeks that derive from European law which applies in most other cases referred to below.) 

2. Non-guaranteed overtime: This is where the employer is under no obligation to provide overtime but, if it is offered, the employee must work the overtime if required.

Example:

Laura works as a call handler and is contracted to work 5 x 6 hour shifts per week. Her contract also provides that she may be required to work additional paid overtime by the company where there is a business need and she is given reasonable notice. During busy periods Laura is often required to work additional hours.

Such overtime payments DO NEED to be included in calculating holiday pay. 

3. Commission based on sales by an individual worker

Example:

Ahmed is a sales executive and sells insurance products to business customers. His pay is made up of a basic salary and commission. His commission makes up nearly 50% of his remuneration and is calculated on the number of sales made each month. When Ahmed is on holiday he is unable to make any sales and thus build up further commission. He will therefore receive reduced commission the following month.

Not including such commission payments would act as a disincentive for Ahmed to take holiday. Following the recent Lock decision (please see our article for more information) such commission payments DO NEED to be reflected and included in holiday pay.

4. Allowances for performing the job involved

Example:

Joe is a civil servant working within the housing department. His line manager is on maternity leave so Joe has been asked to "act up" and take on more responsibilities. During the 9 month period, Joe is paid an allowance for acting up. In addition, due to the nature of the role, Joe is also placed on a rota and has to work every other Saturday. Joe gets paid an enhanced shift allowance for working unsociable hours for the hours he works on a Saturday.

It is clear from the case law that payments that relate to professional or personal status (such as payments relating to seniority, length of service and qualifications) should be included for the purposes of calculating holiday pay. Therefore, Joe's allowance for acting up DOES NEED to be included. The shift allowance also DOES NEED to be included when determining holiday pay. It is intrinsically linked to the performance of tasks under the contract and forms part of Joe's "normal" remuneration. Joe would be at a financial disadvantage if it was not included.

5. Standby and emergency call out payments

Example:

Ben is a maintenance worker for a large luxury hotel. He is required to be on standby every other Sunday in the event of an emergency maintenance issue arising in the hotel and he is paid an enhanced rate if he is called out to a job.

Both standby pay and any emergency call out payments DO NEED to be included when determining holiday pay as they are intrinsically linked to the performance of tasks under the contract and Ben would suffer a financial disadvantage if they were not included.

PAYMENTS THAT DO NOT NEED TO BE FACTORED INTO HOLIDAY PAY CALCULATIONS

The following are examples of payments that, based on the current case law, we consider employers may still be able to justify excluding from their holiday pay calculations despite the recent developments.

1. Ancillary costs – travel expenses

Example:

Murat receives a basic salary as a carer but is also paid for his time spent travelling and receives mileage expenses plus a mileage allowance on top of the expenses.

Murat's travel expenses (i.e. mileage) DO NOT NEED to be included in calculations for holiday pay as they are ancillary to the job that he is performing. If he is not working he will not need to drive those miles and so does not need to be paid mileage expenses. However, Murat's holiday pay DOES NEED to include the payments he receives for time travelling as this is intrinsically linked to his job.

Where the mileage allowance is at a higher rate than recognised by HMRC to purely recompense the cost of travel and there is an element of benefit in kind it is potentially part of the 'normal pay' needing to be included in holiday pay calculations.

2. Time Off in lieu

Example:

Peter regularly works overtime as a sales assistant in a supermarket. His employer gives him the equivalent time off in lieu.

Time off in lieu would not be part of "normal remuneration" so DOES NOT NEED to be included in the holiday pay calculation. There is also no financial disadvantage suffered by not including it. 

3. Christmas bonus paid equally to all staff

Example:

Louise is a receptionist at an accounting firm. The whole firm is paid a one off Christmas bonus regardless of performance, attendance, length of service or seniority.

Although the area of bonuses is unclear and has not yet been tested, we consider there is a strong argument that such a bonus DOES NOT NEED to be included when calculating holiday pay. This is on the basis that it is not intrinsically linked to past or future performance so not including it in holiday pay calculations would not act as a disincentive for a worker to take annual leave. Also, in practice, the individual would not be at a financial disadvantage if it was not included in holiday pay as they continue to receive the bonus at the same level whether or not they take annual leave. 

4. Variable pay which has already been factored into holiday pay

Some variable payments may have already been factored into holiday pay calculations by being included in a process of averaging pay over a period to determine remuneration. This may happen automatically with some pay roll structures and software. Clearly, if variable payments have already been taken into account correctly they do not need to be included again. Employers should check their payroll systems to determine what is automatically included in holiday pay calculations to ensure it is not provided for twice.

PAYMENTS WHICH FALL INTO A GREY AREA

There is inevitably a grey area into which some payments fall. The safest approach for risk-averse employers is to include the following payments in calculations of holiday pay until there is further guidance from case law or, possibly, legislation. However, within the grey area there is a spectrum of risk. We have listed the examples below in order: from payments that we consider are more likely to fall in scope towards the types of payments where we consider there are stronger arguments for not including them in holiday pay calculations. We recommend that you seek advice in relation to any of the following and we would be happy to discuss this further.

1. Purely voluntary overtime: This is where the employer is not obliged to offer overtime and the employee is under no obligation to take any overtime offered

Example:

Thea works as a sales assistant in a clothing store and is contracted to work 20 hours a week. The store often needs additional staff to cover busy periods and offers overtime to the staff. Although she is under no obligation to do the overtime, Thea regularly does.

Whilst previously this was a grey area (as voluntary overtime was not specifically addressed in earlier decisions) the tribunal decisions and the direction of travel of the courts' approach to interpreting the Working Time Directive strongly indicated that voluntary overtime payments, particularly where overtime is worked over a regular and settled pattern, did need to be included in calculating holiday pay.  A recent EAT decision has now confirmed that when voluntary overtime is made with sufficient regularity it will be "normal remuneration" and it, and payments such as call-out allowance, standby allowance and associated mileage allowance (see example 1 above) related to it, DO NEED to be included in calculating holiday pay.

2. Bonuses where the taking of holidays have been factored in when assessing performance

Example:

Luka is paid an annual bonus for meeting certain financial performance objectives each year. His annual target is set on the basis of his expected daily performance multiplied by the 232 days his employer expects him to be in the office each year. This 232 figure was arrived at by taking the total number of working days in a year (260) and subtracting the number of days' holiday that Luka is entitled to (28).

The position with bonuses is unclear. There is an argument here that there is no financial disincentive to taking holiday in these circumstances as annual leave has already been factored into target setting. However, conversely, there could also be the argument that Luka gives himself more opportunity to hit his target if he works the extra days instead of taking his holiday. As such, whilst there may be an argument for employers to raise in these circumstances, this has not yet been sufficiently tested in the courts to provide any certainty that such payments can be excluded from holiday pay calculations. 

3. Team bonuses not dependent on individual targets

Example:

Reena is sales manager in a car manufacturing company. She works in a team of 10. Each year she receives an annual bonus if the team achieves sales in excess of £1million. It does not matter if Reena makes personal sales of £70k or £130k. Reena and the rest of the team will all get (or lose) their bonus based on the team's collective performance.

Again, bonuses are a grey area. Although the bonus in the example is intrinsically linked to the worker's tasks under the contract, the fact that it relates to the performance of the whole team could allow room for an argument that there is no disincentive to any particular individual taking holiday (as their colleagues will be providing cover for them during that period). The strength of this argument will likely increase or decrease depending on the size of the relevant team. For example, where there is a very small team there would be a greater link between each individual's performance and the hitting of targets necessary to trigger a bonus payment, therefore creating a stronger disincentive to taking holiday. By contrast, the larger the team the less likely that a single individual's contribution will determine whether or not targets are hit and so, therefore, there will be less incentive for them to forgo holiday in order to try and hit those targets. Again, whilst there may be an argument for employers to raise in these circumstances, this has not yet been sufficiently tested in the courts to provide any certainty that such payments can be excluded from holiday pay calculations. 

4. Bonus where targets are not influenced by presenteeism

Example:

Lee is the head of the front of house team for a group of hotels and is responsible for managing a number of receptionists and concierge staff. He does not perform any public facing role himself. He is paid an annual discretionary bonus determined by reference to the amount of positive Trip Advisor comments made, reviews by "secret shopper" guests at the hotels and 360 degree feedback from his team.

Whilst the bonus is intrinsically linked to the performance of Lee's role, there is an argument that he does not have any financial disincentive to taking his holiday entitlement. Assuming his team is appropriately trained and he has implemented proper procedures for managing any issues that may arise, his absence on annual leave should make no difference to whether he receives the bonus or not. The bonus is not based on "hard" quantitative factors such as hours worked or financial targets being hit, which may be affected by presenteeism, but is instead based on a qualitative assessment of his performance over the year. Consequently, there are reasonably strong arguments here that such a bonus does not need to be included in holiday pay calculations. 

CONCLUSION

The recent case law developments have clearly widened the types of payment that need to be included when determining holiday pay. This has the potential to increase the costs of annual leave for employers going forward as well as increasing the value of any potential exposure for past claims. Whilst we have sought to provide some clarity on which of the most common examples of variable pay should now be included in holiday pay, there remain a number of grey areas. There also remain a number of outstanding questions when calculating holiday pay, for instance, whether the starting point of a 12 week reference period will always be appropriate.

If you would like to discuss whether or not to include certain types of variable pay in your calculations or would like advice on managing these issues in practice; amending the terms of any bonus or commission schemes or help in calculating past exposure or future holiday pay for workers please do not hesitate to contact us.

If you have any questions on this article please contact Benjamin Loxton, senior associate on +44 (0)117 915 4954 or email benjamin.loxton@footanstey.com or Helen Dallimore, senior associate on + 44 (0)1392 685289 or email helen.dallimore@footanstey.com.

This article reflects the position as at 3 August 2017 and has been amended to reflect Dudley Metropolitan Borough Council V Willetts EAT.