Holiday pay – what does the future hold?

Holiday entitlement and pay have become particularly complex for employers over recent years. The challenge is that if employers’ holiday processes are wrong or they are not up to speed with the current legal position, it creates legal risks. Workers who are being underpaid holiday pay can bring claims collectively going back up to two years.

With the government estimating that approximately £3bn of holiday pay goes unpaid each year in the UK, it is a sizeable problem. Whilst the government has stepped back from its commitment to enforcing holiday pay under a single enforcement body (much like it does with the National Minimum Wage), it has recently released two separate consultations on the issue. We take a look at those and how they may impact employers.

Why can holiday pay be a complicated for employers?

Holiday pay can be complicated partially because the law derives from Europe, as a consequence of which, there have been many legal cases which have challenged some of the previously well held concepts in the UK. It is also challenging because the calculations set out in the legislation are complicated and practices which have been introduced to simplify them have later been held to be unlawful.

Common issues include:

• Not including paid overtime which is regularly worked into holiday pay calculations.
• Using a 12.07% formula to calculate holiday pay for workers with irregular working hours (bank workers / casual workers).
• Rolling up holiday pay – this is where employers make a holiday pay top up and pay it to the worker instead of allowing them to accrue holiday and take it at a later date.
• Not paying out accrued holiday on the termination of employment.

In an attempt to address some of these issues, the government has proposed several changes within separate consultations.

Government holiday pay consultation

Earlier this year, the government launched a consultation on holiday entitlement and pay for variable hour workers, which closed on 9 March. It followed the recent Supreme Court’s decision in Harpur Trust v Brazel which held that holiday entitlement for part-year workers on permanent contracts (such as term-time only workers) cannot be prorated – meaning they are entitled to the same annual leave as their full-time counterparts and are in a better position than their part-time counterparts. The Supreme Court also decided that holiday pay must be calculated using the method set out in s. 224 of the Employment Rights Act 1996 – emphasising that the commonly used 12.07% method for calculating holiday pay for workers with irregular hours is unlawful.

The judgment in this case caused widespread confusion among businesses, affecting between 320,000 and 500,000 permanent term-time and zero-hours contract workers in the UK.

In its recent consultation, the government sought views on reintroducing the 12.07% method to calculate holiday entitlement and pay for part-year and irregular hour workers so that it is based on the hours actually worked, effectively reversing the Harper Trust v Brazel case. This would make the calculations simpler, but the consultation proposes to implement a 52-week reference period which instead of being taken at the point prior to the worker taking their holiday, would instead be taken from the previous leave year. This would result in payroll having to make changes to their processes to ensure that the calculations were undertaken correctly and will create challenges where the data for employees isn’t available. For example – a representative calculation will be required for employees who were not employed in the previous leave year. 

Merging the separate ‘basic’ and ‘additional’ leave entitlements into one annual leave entitlement 

The government proposes to create a single annual leave entitlement of 5.6 weeks for all workers.

Currently, workers have two separate holiday entitlements set out in the Working Time Regulations 1998 (WTR) - four weeks annual leave derived from the EU’s Working Time Directive (‘EU leave’) and a further 1.6 weeks leave under UK law (‘UK leave’). There are separate rules for calculating holiday pay, depending on whether you are looking at EU leave or UK leave. For example, payments for regular commission, bonuses and overtime should be included in EU leave but not UK leave. This therefore causes complications when calculating holiday pay for workers who are paid a salary but also receive these additional pay components on a regular basis.   

It is hoped that the government’s intention to combine EU leave and UK leave, which will presumably be subject to the same rules, will provide greater simplicity for employers.

Permitting ‘rolled-up’ holiday pay

The government proposes to re-introduce ‘rolled-up’ holiday pay to alleviate issues around holiday pay calculations for atypical workers.

‘Rolled-up’ holiday pay used to be commonly paid to workers with irregular working hours. Employers would ‘roll-up’ holiday pay into a worker’s normal pay – typically an additional 12.07% was applied on top of their normal hourly wage. This meant that, regardless of whether holiday had been taken by the worker in any given week or month, they would receive an additional payment in each pay cheque to cover their holiday pay entitlement.

This practice has been held to be unlawful by EU law, as it could deter workers from taking their holiday pay, and therefore defeats the objective of the Working Time Directive.

The government’s proposal to allow employers to ‘roll-up’ holiday pay is likely to be positive news for many employers engaging casual or zero-hour workers, as it will be easier for them to comply with holiday pay legislation, particularly following the Harpur Trust v Brazel case.

What does this all mean for employers?

Whilst the proposals in some ways are positive for employers, they will still require changes to be made to payroll processes and contracts of employment to ensure compliance.

It may also shine a spotlight on employers who are currently doing the wrong thing which may increase the risk of a collective claim being made against them. Whilst the proposals may lead to changes which result in the employer becoming compliant, they will not be retrospective and the employer will be liable for any unlawful practices that are currently in place.  

Whilst the government had paused its commitment to introduce a single enforcement body which would also cover holiday pay, it is possible these proposals are laying the ground work for such a system of enforcement in the near future.

RSM is a leading provider of audit, tax and consulting services, with around 3,800 partners and staff in the UK. We're working with our tax advisors RSM to help shape government policy on taxation as it affects the sector and to keep housing associations informed of key issues.