UK: Calculating Holiday Pay: Nothing Relaxing About It

Last Updated: 4 November 2013
Article by Fiona Rushforth

A recent tribunal decision Neal v Freightliner Ltd held that overtime pay, whether compulsory or voluntary, must be included when calculating holiday pay under the Working Time Regulations.

Calculating the correct amount of holiday pay owed to an employee under the Working Time Regulations (WTR) has never been plain sailing for employers. Where an employee has "normal working hours" (as opposed to working shifts or contractually variable hours),  his holiday pay is based upon those hours only.  The WTR and the UK case law state that non-contractual hours of work, such as voluntary overtime, should be ignored.   In line with this, most employers calculate holiday pay for employees with "normal working hours" on base salary only.

However, in the 2011 case of Williams v British Airways plc the European Court of Justice construed the Directive as meaning that a worker on holiday is entitled not only to basic salary but also to remuneration which is "intrinsically linked to the performance of the tasks which he is required to carry out under his contract of employment."  Since then, the impact of this judgement has been hotly debated.

The recent decision in Neal v Freightliner Ltd creates turbulence for employers by indicating that UK employers may have to consider even voluntary overtime when calculating holiday pay.

The facts

Mr Neal's employment contract with Freightliner provided for a 35-hour week of seven-hour shifts and stated that he may be required to work overtime when necessary.  In fact, Mr Neal never worked shifts as short as seven hours, instead working 9-12 hour shifts. He received enhanced pay premiums for the additional hours of work.

Mr Neal brought a claim for unlawful deduction of wages arguing that his holiday pay should reflect the actual pay he received, rather than his basic salary alone.

Mr Neal cruised to victory as the Employment Tribunal applied the ECJ's ruling in Williams v British Airways and held that the hours worked by Mr Neal over and above his contractual seven hours, regardless of whether voluntary or not, were "intrinsically linked" to his performance of his role and therefore should be taken into consideration when calculating his holiday pay. It was held that holiday pay should represent what the worker would have received if they had been at work, and that therefore employers should take an all-inclusive approach when calculating holiday pay. The Tribunal's reasoning appears to be that, when an employee works variable hours, they can no longer be considered as having "normal working hours".  This would require the employer to carry out the calculation used for shift workers, where the holiday pay is based on the actual hours worked and pay received over the 12 weeks before the holiday.

As an additional complication, this decision affects holiday pay for only the four weeks' annual leave guaranteed under EU law.  The additional 1.6 weeks granted in UK law need not include any overtime and can be calculated simply on basic salary. 

Implications

This case has potentially serious implications for industries where staff regularly work overtime, such as retail and hospitality and there is concern that the principle could extend to other variable pay such as commission or even some bonuses..  A particular concern is that employees can bring claims backdated to 1998, provided they are brought within 3 months of the most recent underpayment.  

Some employers may even wish to follow the example of John Lewis,  which has concluded that it had been miscalculating employees' holiday pay for at least seven years, and took the decision to pay out a sweltering Ł40 million to staff in back-dated payments.

However, because the Neal decision was made in the Employment Tribunal, it is not binding.  It is currently being appealed and could be overturned or, at least, its scope limited or clarified.  It may therefore be more prudent to wait for the appeal judgement before making a decision about whether to change the way holiday pay is calculated.

In the meantime, employers may want to consider limiting overtime (perhaps specifically in the run-up to a period of annual leave), or reducing pay for enhanced overtime, to reduce the eventual pay-out if the EAT concludes that overtime does have to be included.  They could also consider making overtime fixed and contractual, to avoid having to carry out the 12 week calculation.

Employers who have calculated holiday pay based on basic salary for many years, might even want to consider changing this policy now for future holiday calculations.  The advantage of this would be that, if there is no challenge within three months of making the change, employees will at least have lost their right to bring back-dated claims.  If doing this, employers should make it clear that this change is being made on a temporary basis, pending the outcome of the EAT decision, to avoid creating a precedent if the case is overturned. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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