A series of cases in the UK courts and the European Court of Justice (ECJ) has challenged the approach UK employers have previously taken when calculating holiday pay; in particular, whether commission and overtime payments should be included in the calculation.

These cases have raised the spectre of businesses facing multiple claims for back-dated holiday pay which may run into many millions of pounds. This could force some employers out of business, whilst for others it would drive up their wage bill and reduce competitiveness.

Holiday pay

The Working Time Regulations (WTR) provide for the right to paid holiday.  The WTR implemented the Working Time Directive (WTD) in the UK.  The WTD requires a minimum of four weeks’ paid holiday. All workers in the UK are entitled to an additional 1.6 weeks’ paid holiday under the WTR, making a total of 5.6 weeks’ paid holiday (or 28 days for a full-time worker).

The method of calculating holiday pay under the WTR is complex, using a 12 week reference period to determine average weekly pay.  Employers in the UK had based holiday pay calculations on basic salary only, believing that payments like commission and non-guaranteed overtime need not be taken into account.

The European challenge

In British Airways v Williams (2012) the claimants, airline pilots, sought to recover holiday pay which included allowances for time spent flying or away from base.  The ECJ held that workers must receive their normal remuneration when on annual leave.  In addition to basic salary, “normal remuneration” included any payments intrinsically linked to tasks the worker was required to perform, such as the allowances claimed.  The ECJ’s judgment suggested that exclusion of overtime and commission when calculating holiday pay under the WTR was incompatible with European law.

Commission payments

Earlier this year, in Lock v British Gas, Mr Lock claimed that his holiday pay should include commission payments on sales he made as well as his basic salary.  The commission payments were paid several weeks after conclusion of a sale and made up approximately 60% of his pay.  Whilst Mr Lock would receive commission for previous sales while he was on holiday, he would then suffer a reduction in pay since no commission was generated while on leave.

The ECJ agreed that holiday pay cannot be calculated based on basic salary alone where a worker’s remuneration includes commission based on sales achieved.  It said there was a direct link between commission earned by Mr Lock and the tasks he was required to carry out under his employment contract.  Accordingly, the commission had to be taken into account when calculating his holiday pay.  To do otherwise would place workers at a financial disadvantage when taking annual leave, thus deterring them from taking annual leave contrary to purpose of the WTD.

Overtime

In order to understand the debate regarding holiday pay and overtime it is helpful to distinguish between:

1.Guaranteed overtime, which the employer is obliged to provide and the employee must work.

2.Non-guaranteed overtime, which the employer is not obliged to provide but the employee must work if it is offered.

3.Voluntary overtime, which the employer is not obliged to provide and the employee can choose whether to work.

In November this year the judgment of the Employment Appeal Tribunal (EAT) in Bear Scotland v Fulton was handed down.  At issue was whether non-guaranteed overtime must be included when calculating holiday pay. The EAT held that it should, since it was directly linked to tasks the claimants were required to carry out under their employment contracts.

The case was to be heard with the appeal of another decision, Neal v Freightliner, in which the Employment Tribunal had decided that voluntary overtime should also be included in holiday pay.  The Tribunal said that the fact Mr Neal had volunteered to work overtime did not mean it was not intrinsically linked to the tasks he was required to perform.  However, this case settled before it reached the EAT and so the position regarding voluntary overtime is not yet clear.

Do the changes apply to the full 5.6 weeks’ holiday under the WTR?

The prevailing view of the courts is that the additional elements need only be included when calculating the first four weeks’ holiday entitlement derived from the WTD, rather than the full 5.6 weeks under the WTR. 

Whilst this represents a saving to businesses, it raises questions as to which part of a worker’s annual leave is the entitlement under the WTD and which is the additional entitlement under the WTR.  Where overtime and commission is not earned evenly through the year this could have financial implications for businesses and workers.  It is also easy to see the increased complexity and payroll costs employers will face.

How far back can claims be brought?

The EAT decision is Fulton has brought some welcome relief to businesses in this respect.  Previously, employers had feared that they may face massive historic liabilities since there did not appear to be any limitation on how far back claims for an unlawful series of deductions from pay could go.  This could leave businesses faces claims going back to October 1998 when the WTR came into force.

However, in Fulton the EAT took a different view.  It concluded that there could not be a break of more than three months between any of the unlawful deductions in a series, otherwise the chain would be broken.  This decision appears to severely limit the scope for workers to bring backdated claims for underpaid holiday.

The future

Unfortunately the position for businesses remains far from certain. Both sides have been permitted to appeal in the Fulton case, so it may be some time before employers know where they stand.  Many now face the difficult decision of whether to change their approach to holiday pay now or await the outcome of the appeal.

Chris Weaver is a solicitor at Payne Hicks Beach