UK: The Legality Of Rolled-Up Holiday Pay

Last Updated: 18 January 2008
Article by Daniel Naftalin

Since 01 October 2007, under the Working Time (Amendment) Regulations 2007 (which amended the Working Time Regulations 1998 ("WTR")), all workers (including temporary and those with irregular hours) in the UK have been entitled to 4.8 weeks (24 days) of paid leave every year including bank holidays. This will increase to 5.6 weeks (28 days) from 01 April 2009. The WTR implement the European Working Time Directive ("WTD"). Temporary workers and workers with irregular hours accrue holiday on a pro rata basis.

The WTR state that entitlement to leave may not be replaced by payment in lieu. It is therefore unlawful to pay workers instead of allowing them to take holiday.

Rolled-up holiday pay may be seen as a type of pay in lieu, but technically it is not. Under a rolled-up holiday pay scheme, workers are paid an enhanced hourly rate which incorporates their entitlement to holiday pay, but they do not lose their right to take leave. They accrue holiday in the normal way and are entitled to take it in accordance with the WTR. However, since their normal hourly rate has already compensated them for their entitlement to holiday pay, they are not paid for the leave at the time the leave is taken.

Nevertheless, confusion has arisen in connection with the legality of rolled-up holiday pay. In 2004, this led the British Courts to ask the European Court of Justice if rolled-up holiday pay was lawful. The European Court held that the aim of the WTD was to ensure that workers received their normal remuneration during their annual leave. It concluded that rolled-up holiday pay schemes were contrary to the WTD and therefore unlawful, since workers paid under such schemes receive no pay during their annual leave. The European Court also held that member states should take steps to ensure that any practices contrary to the WTD be discontinued.

Why are employers still using rolled-up holiday pay?

The European Court unequivocally ruled that rolled-up holiday pay was unlawful. However, in the same judgment it stated that sums already paid to workers under a rolled-up holiday pay scheme could be set off against the holiday pay owed to the worker, as long as the scheme was sufficiently transparent.

With this caveat, the European Court has mitigated the effect of its own ruling. If an employer runs a rolled-up holiday pay scheme which is sufficiently transparent, there is little incentive, financial or otherwise, to alter this practice. Even if a ruling was given against an employer, if the scheme is sufficiently transparent the compensation awarded to the worker is likely to be insignificant. This is why many employers are currently continuing with such schemes.

No expiry date was provided for the set-off provision. Therefore there is currently no hurry for employers to change their practices and replace rolled-up holiday pay schemes, as long as the schemes are transparent.

What does "transparent" mean?

No real guidance on transparency has been given by the European Court, but one case in the Employment Appeal Tribunal suggested that indicators of transparency may include whether rolled-up holiday pay has been expressly agreed to by the worker in the contract of employment, whether the amount of holiday pay is clearly marked in the contract and the payslip, whether holiday records have been kept and whether genuine efforts have been made to require workers to take their holiday before the end of the holiday year.

Risks of continuing to pay rolled-up holiday pay

Rolled-up holiday pay schemes are officially unlawful, and therefore any employer that continues with such a scheme is running a risk. If sued by a worker, a court may well find against the employer on the basis that a scheme is not sufficiently transparent, and/or that a worker is not being paid the correct amount of holiday pay. If so, compensation will be awarded to the worker based on the correct amount of holiday pay. If this happens, particularly if the scheme is not considered to be transparent, an employer may find that he has to pay the worker twice for holiday.

It is clear from the decision of the European Court that eventually rolled-up holiday pay schemes will have to be discontinued. This is certainly the opinion of the DTI, whose guidance suggests that the European Court's set off procedures were only provided to give a transitional period for employers.

The DTI's guidance reaffirms the fact that rolled-up holiday pay is unlawful and states that employers should have taken steps to discontinue this practice. Although this guidance is not legally binding, it is a sign of the direction legislation may one day take.

IMPORTANT: This update is only intended as a general statement of the new law and no action should be taken in reliance on it without specific legal advice.

This article is only intended as a general statement and no action should be taken in reliance on it without specific legal advice.

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