Holiday pay should be calculated to include overtime

Holiday pay is provided for under the Working Time Regulations 1998 (‘WTR’), which implements the European Working Time Directive (‘the Directive’).

The WTR provide that a worker is entitled to be paid at the rate of week’s pay for each week of leave taken.

A week’s pay is calculated in accordance with the Employment Rights Act 1996 (‘ERA’) which ‘crudely’ provides that, for workers with normal working hours, ‘a week’s pay … is what they get paid for working those hours for one week’ and, for workers with no normal working hours, ‘a week’s pay … is their average actual weekly remuneration’ averaged over 12 weeks.

‘Normal working hours’ is also calculated in accordance with the ERA. The ERA provides ‘normal working hours’ is the minimum number of hours that the employee must work.  Where overtime is guaranteed (i.e. the employer must provide it and the employee must undertake it) overtime is included within normal working hours. Any overtime that is not guaranteed is not included in normal working hours.

Amec and Hertel: basic working week of 38 hours; obligation on the employee only to work overtime (but not for the employer to provide it) (categorised by the EAT as ‘non-guaranteed overtime’); payment of radius allowance (to compensate for travel time and fares) and travel time payment; and holiday pay calculated based on 38 hours only (overtime, radius allowance and travel time payment not included).

The EAT concluded that:

• under the Directive non-guaranteed overtime (i.e. overtime that the employee must do but which the employer had no obligation to provide) should have been and must be included in the calculation of holiday pay as it is intrinsically linked to the work they are employed to do.
• it is able to interpret the WTR to give effect to its decision that non-guaranteed overtime should and must be included in the calculation of holiday pay.
• the taxable elements of the radius allowance (which compensated for travel time rather than expenses incurred) and the travel time payment should be included in the calculation of holiday pay.
• employees and workers can claim incorrectly paid holiday pay as an unlawful deduction provided the claim is brought within three months of the date of the incorrect payment or the last payment in a series of incorrect payments.
• any series of incorrect payments is, however, broken where more than three months’ has elapsed between incorrect payments.

The EAT has given the parties permission to appeal its judgment. It is therefore possible (and in our view entirely likely) that this is not the end of the holiday pay calculation story.

Employers will need to carefully consider how this decision impacts upon them and, in particular, ensure that they calculate holiday payments correctly going forward. Inevitably, employers will also want to consider potential exposure to claims for back pay. When looking at these issues, employers should take into account that the EAT’s decision:

• relates only to the four weeks’ holiday provided for by the Directive. It does not apply to the additional 1.6 weeks’ holiday that was introduced in October 2007. Employers, in theory at least, can therefore calculate and pay holiday pay including overtime (and other ‘intrinsically linked’ payments) for four weeks of the holiday entitlement and a lesser rate for the balance. This will be administratively burdensome and some employers are likely to discount it as an option (depending on the likely financial savings). Whether this is an option will also depend on the terms of individual contracts of employment and how they say holiday pay should be calculated.
• covers only non-guaranteed overtime. As noted above, guaranteed overtime (i.e. overtime that the employer must provide and the employee must accept) should already be included in the calculation of holiday pay.
• does not specifically deal with truly voluntary overtime payments (i.e. overtime which the employer does not need to provide and which the employee is free to accept or reject). The Neal case which was intended to form part of the cases considered was settled in early summer.  It remains unclear whether such payments should be included in the calculation of holiday pay but in our view this EAT decision and its principles should be considered by employers and potentially apply.
• does not deal with commission payments but this decision and its principles are a strong indication of how the case of Lock is likely to be decided in early 2015 (see below).
• about a series of deductions will undoubtedly be welcomed by all employers as it severely limits the extent to which employees and workers can retrospectively claim correctly calculated holiday pay. After all, in our experience, it is relatively common for there to be gaps of more than three months’ between periods of holiday particularly when taking into account that the decision only applies to the four week entitlement. We expect this point (if nothing else) will be the subject of an appeal to the Court of Appeal.
• leaves open how holiday pay should be calculated when ‘weekly pay’ varies from week to week. Arguably, however, by inference it should be calculated on the basis of an average over the 12 weeks preceding the period in respect of which the payment is due.
• has prompted the Business Secretary, Vince Cable, to announce to a taskforce to consider the impact of the decision and ‘to discuss how we can limit the impact on business’.

If you are struggling to unpick how this decision impacts your organisation, what you need to pay in respect of holiday pay going forward and what you may be liable for in back pay, get in touch with us as soon as possible. One thing we can guarantee is that your employees and workers will be considering how this decision affects them and we will help you keep one step ahead.