UK Holiday Pay Should Include Overtime Payments

The landscape has changed in relation to the calculation of holiday pay in the UK with the November 2014 Employment Appeal Tribunal (“EAT”) decision in Bear Scotland Ltd v Fulton, Hertel (UK) Ltd v Wood and Amec Group Ltd v Law.

The history of the claims

In the UK for many years employers have paid employees with normal working hours their basic pay only in respect of holiday pay and no other payments have been included. However, in the case of Williams v British Airways Plc, the European Court of Justice (‘ECJ’) held that payments ‘intrinsically linked’ to the tasks that an employee carries out under his employment contract must be taken into account in calculating the appropriate rate of holiday pay. The ECJ then held in the case of Lock v British Gas Trading Ltd that commission should be included in holiday pay. Subsequently, various UK Tribunals held at first instance that non-guaranteed overtime (i.e. overtime which the employer does not have to offer but the employee must work if offered) should be included in holiday pay. The employers in these cases appealed to the EAT.

How should holiday pay be calculated in the UK?

It is a matter of principle enshrined in European case law that employees must not suffer a financial disadvantage when they take holiday because, if they do, this will act as a disincentive to taking such holiday. The EAT in the Bear Scotland case held that employees must be paid their ‘normal remuneration’ during the four weeks of annual leave granted by the European Directive (“EU leave”). This is employees’ typical average pay not just their basic pay. It therefore includes commission, non-guaranteed overtime and other payments which are intrinsically linked to the tasks which the employee is required to carry out and which are ‘normally’ paid to the employee.

However, this EAT ruling does not apply to the additional 1.6 weeks of annual leave granted to employees in the UK under the Working Time Regulations 1998 (“WTR”) or any additional contractual leave that employees are entitled to (“additional leave”). Employers in the UK therefore need to decide if they will pay holiday pay including overtime (and other relevant payments) for just EU Leave or for all holiday that the employee is entitled to take. The saving employers will achieve by paying less holiday pay for this additional leave may not be worth the administrative burden of operating two different holiday pay rates. This will depend on how regular overtime is and how many overtime hours an employee typically works.

Grey areas remain

 There are still some grey areas where the EAT did not give a definitive ruling. For instance:-

  • The decision did not deal with purely voluntary overtime (i.e. overtime offered by the employer which the employee can refuse to carry out). It remains to be considered at an appellate level whether purely voluntary overtime should be included in the calculation of holiday pay but it is my view that all overtime is likely to be treated in a similar manner irrespective of how it comes about, and so voluntary overtime is also likely to have to be included in the calculation of holiday pay.
  • No judgment or guidance was given as to how holiday pay should be calculated, except that it must correspond to the normal remuneration received by an employee during the appropriate reference period.
  • The EAT did not specifically rule on the issue of when EU Leave is taken in a holiday year.

What is the correct reference period?

In the UK, in cases where employees do not have normal working hours (or have normal working hours but their pay varies according to the amount of work done or the time of work), average pay is calculated by using the formula set out in the Employment Rights Act 1996 (“ERA”).   The ERA uses a reference period of the last 12 working weeks to calculate pay. It is now not clear if this 12 week period is the appropriate reference period to apply in relation to EU Leave.

To comply with the decisions in Lock and Williams the reference period must be a ‘representative’ period, in other words, it must reflect normal working.   In the absence of further guidance from the ECJ, UK Employment Tribunals will have to approach this question on a case-by-case basis and may choose a different reference period depending on the circumstances. It is arguable that if commission or overtime payments fluctuate widely during the year, a 12 week period may not be representative.

The Advocate General in Lock suggested averaging pay over a reference period of 12 months in relation to commission payments but this was not confirmed by the ECJ. In many businesses there will be peaks and troughs in the levels of overtime worked by employees and therefore averaging overtime over previous weeks or months (as opposed to a 12 month period for example) could result in an obligation to pay sums that are not representative. Employees may also be incentivised to take holiday after periods of high levels of overtime in order to maximise their holiday pay. It is therefore important that an employer uses a reference period that is representative and ensures that the employee receives average remuneration whilst on holiday.

When is EU Leave taken?

Another area of uncertainty relates to EU Leave and when it is taken during the holiday year.   In the Hertel and Amec cases at first instance, the Judge held that it is for the employee to choose which type of leave they are taking at any time (i.e. EU Leave or additional leave). However, the EAT disagreed. It stated that the employer is entitled (within reasonable bounds following the procedure set out in the WTRs) to direct when holiday is taken and the employer therefore has the power to direct when, within the holiday year, EU Leave should be taken. In addition, the WTRs describe the additional 1.6 weeks’ leave granted to UK employees as ‘additional leave’ which, the EAT held, suggests that such leave should be the last taken during the holiday year.

It is therefore arguable that in each holiday year, an employee will take their four weeks of EU Leave first and then later in the holiday year they will take any additional leave to which they are entitled.

Time limit for claims

Claims generally have to be brought within 3 months of the non-payment of holiday pay, which is also a deduction from wages.   The deduction happens on the payment date, not the date of the holiday.

Employers should check whether any claims which may be brought are out of time.   If an employee cannot bring a claim for a recent deduction (i.e. in the previous 3 months) then he or she will not be able to start counting back many months or years.

Backdated holiday pay claims

The UK Government has recently announced that it is intending to limit holiday pay claims to two years before the claim is lodged and make it explicit that the right to paid holiday is not incorporated as a term in all employment contracts. This is intended to limit long term claims for holiday pay both in the UK Employment Tribunal and in the UK civil courts. However, this change will only apply to claims made on or after 1 July 2015. This means that any claims made by employees before then will be subject to the normal limitation rules.

In order for employees to claim unpaid holiday pay going back over a number of years, they will need to prove that there has been a ‘series of deductions’ and bring their claim within three months of the last deduction.

The EAT held that in order for there to be a ‘series of deductions’, there must not be a significant time gap between the deductions. It therefore held that employees cannot make an unlawful deduction from wages claim where, in any case, a period of more than three months has elapsed between the deductions. The EAT ruled that any gap of more than three months has the effect of breaking the series, and therefore limiting the claim to any losses incurred before the series was broken. Unite (the trade union involved in this case) has confirmed that it will not be proceeding with an appeal on behalf of the employees on this point.

It is now the law in the UK, subject to any appeal in a subsequent case, that EU Leave should be paid at a higher rate (including commission, overtime payments etc.) It follows that in the past employers will have made a series of deductions (where the higher rate of holiday pay was not paid) followed by a series of correct holiday payments (i.e. for additional leave where the basic rate was, and still is, appropriate). This period in which holiday pay was paid at the appropriate rate breaks the series of deductions, if it is for a period of more than three months. In practice, it may be the case that there will have been a substantial gap at the end of any given holiday year when employees were taking their additional leave and so no unlawful deductions from wages were made, breaking the ‘series’. Many historic holiday pay claims may therefore be limited to the most recent holiday year.

UK employers should act now

My view is that the basic principle from this EAT case will not be overturned and that employers will be stuck with paying holiday pay for EU Leave to include, for example, overtime.

The prudent employer in my view will therefore begin paying holiday pay that includes overtime and other relevant payments when calculating holiday pay (in respect of EU Leave). The following actions should be considered:

  • Employers will need to choose an appropriate reference period in order to calculate the holiday pay due going forward. They will also need to decide whether they are going to pay the increased rate for EU Leave only or for all holiday entitlement.
  • Any change needs to be communicated clearly to employees and employers should reserve the right to vary or withdraw any additional payments made now if the law changes in the future.
  • Employers should also consider amending the wording of their contracts of employment, staff handbook and relevant policies.
  • Employers should carry out an audit to assess their financial exposure in terms of back pay claims (which will involve individual analysis of all employees and their holiday in recent years to determine if they can find a three month gap in deductions). Employers will then need to assess whether they will address historic liabilities or simply change their practice going forward.

Faced with the prospect of increased wage bills and the administrative burden of calculating how much should be paid in respect of each employee’s holiday, many employers may look to limit pay rises, reduce the availability of overtime where feasible or take on agency staff to cover periods of increased demand rather than offer overtime to their permanent employees. Since approximately 5 million people in the UK regularly work paid overtime, this decision could have far-reaching consequences for many years to come.

Jane Biddlecombe Biddlecombe

Jane Biddlecombe Biddlecombe

Solicitor at Paris Smith LLP

Email: [email protected]
Tel: +44 (0) 2380 482 374

Jane has over 10 years of experience at Paris Smith working on both contentious and non-contentious matters. She works for a broad range of clients in all sectors from small owner managed businesses to large national companies. She provides day-to-day advice in all areas of employment law, including disciplinary issues, performance and absence management and handling grievances. In addition, she advises on the employment implications of business re-organisations and large scale redundancies as well as acting on a range of Employment Tribunal claims.
Jane has an excellent reputation in partnering with her clients to achieve practical solutions to their employee issues.

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About Jane Biddlecombe Biddlecombe

Email: [email protected]
Tel: +44 (0) 2380 482 374
Jane has over 10 years of experience at Paris Smith working on both contentious and non-contentious matters. She works for a broad range of clients in all sectors from small owner managed businesses to large national companies. She provides day-to-day advice in all areas of employment law, including disciplinary issues, performance and absence management and handling grievances. In addition, she advises on the employment implications of business re-organisations and large scale redundancies as well as acting on a range of Employment Tribunal claims. Jane has an excellent reputation in partnering with her clients to achieve practical solutions to their employee issues.