Back to school: holiday pay updates and what employers need to know

Holiday pay continues to confuse. Impacted by UK and EU derived legislation and case law, and recent UK court decisions and government consultations on proposed changes, it remains key for employers to monitor their compliance carefully. With the school holidays at an end, workers returning from holiday – and seasonal work and the Christmas holidays on the horizon – employers should take stock, do some revision, and review how they calculate holiday entitlement and pay. 

Employers should also consider holiday pay compliance as an integral part of their Environmental, Social, and Governance (ESG) strategy. Holiday forms a key part of the employee value proposition as well as an important aspect of health and safety to promote employee wellbeing, so it falls squarely within the ‘S’ for the social aspect, as well as the ‘G’ for the governance aspect of complying with statutory obligations, of the EGS agenda. This underlines the need for employers to remain compliant with their holiday pay obligations and keep abreast of the latest developments. This article outlines key points for employers to bear in mind.

Workers, including part-time workers, have a right to a minimum of 5.6 weeks’ annual leave. Each week must be paid at the rate of a ‘week’s pay’. Broadly, his is calculated as follows:

• If a worker does not have normal working hours, a week’s pay is the worker’s average weekly pay over a 52-week reference period (any weeks in which no remuneration was payable are excluded, and earlier weeks brought into the reference period); and
• For workers with normal working hours, pay is calculated based on normal pay, which can simply mean their usual salary, but can also include elements such as overtime and commission, where paid sufficiently regularly (in which case the 52-week reference period must be used).

Historically, many employers used 12.07% of pay to calculate pro-rated holiday pay for a part year or casual worker. This percentage was intended to ensure that a part year employee received a proportionate amount of holiday pay compared to a full year employee and was typically used as it was seen as a pragmatic and operationally simpler calculation method.

The Supreme Court held in Harpur Trust v Brazel that holiday entitlement calculations for a part-year worker under a permanent contract must not be pro-rated to be proportional to that of a full-time worker. Therefore, part-year workers are not entitled to pro-rated holiday pay calculated by multiplying the pay for their hours worked by 12.07 per cent.

Instead, part-year workers are entitled to holiday pay calculated by the ‘Calendar Week Method’, which involves multiplying their average week’s pay, which must be calculated in line with legislation on a 52-week average ‘look back’ basis, by 5.6.

This could present employers with atypical workers (part-year, term time, casual and/or zero hours workers) with operational and financial challenges to rectify current payment processes, as well as decisions on how and what to change to mitigate the risk of employee claims.

Where the 12.07 per cent method has been used, employers may find themselves facing claims for underpaid holiday.

1. Undoing Harpur Trust?: A government consultation, which closed in March, was in direct response to the Harpur Trust decision.

This sought views on calculating holiday entitlement for part-year and irregular hours workers. Put simply, the aim is for workers to be paid proportionately to their time spent working, calculating holiday pay consistently for all workers. In practice, this means a return to the 12.07 per cent formula. The government hopes that legislation will provide clarity to workers and employers, so that holiday entitlement is calculated consistently.

We do not yet know the outcome of this consultation, but their proposal for reform in this area clearly suggests the government has some misgivings about the implications of the Harpur Trust decision.

2. Simplifying holiday pay: The government launched a further consultation in May which addressed several aspects of EU law, including holiday pay.

The aim of this consultation was to understand if there are ways to simplify holiday pay, including (in summary):

a. removing the distinction between Regulation 13 holiday (4 weeks derived from EU law) and Regulation 13A holiday (the additional 1.6 weeks derived from UK law);

b. permitting employers to choose to operate rolled up holiday pay – where employees can be paid in lieu of taking holiday; and

c. whether holiday pay should continue to be calculated based on ‘normal remuneration’ (potentially including overtime and commission) or if it should be paid only based on basic pay.

Again, the outcome of this consultation isn’t yet known, but it raises the possibility of some significant changes to holiday pay practices on the horizon.

There’s currently considerable uncertainty as to how the law might change, given all the outstanding consultation issues. However, this makes it all the more important to be clear on your current processes and comfortable with how holiday pay is being operated in your business – so you can action plan for the changes to come.

It's also important to remember that proposed changes which might come in don’t change the legal position now (and there is no timetable for implementing any changes), so it remains important to keep an eye on the present, as well as looking to the future.

With this in mind, key steps as we head into autumn are:

1. Review contracts and worker arrangements to identify any risk areas and any gaps – either in terms of the current legal position or the potential new landscape;
2. If you have casual, part-year or term time employees in particular, it’s important to get on top of your holiday pay entitlement calculations in light of the Harpur Trust decision;
3. Consider any historical liability, future fix and develop a strategy (which should be flexible to address potential changes in the law going forward); and
4. Ensure all relevant stakeholders are engaged, and update HR and payroll processes and procedures accordingly.

For more information on how KPMG and our multi-disciplinary team of employment law, employment tax, payroll and reward specialists can support you, please get in touch with Donna Sharp, Eloise Knapton or your regular KPMG contact.