It’s a Wonderful Life

(provided you get your holiday pay calculations right)

As the Christmas holiday period approaches, Dorothée Giret and Robert Andrews, Workplace Solutions – Employment, summarise the key issues and recent developments which employers should be aware of to comply with holiday pay obligations.

Case law surrounding holiday pay calculations has continued to develop, and getting it right is key to building and maintaining trust with your workforce. With the end of year holidays fast approaching and seasonal work over the frenetic Christmas period on the near-horizon, employers must seek to understand the current holiday pay entitlement landscape.

If they have not done so already, they should revise and review their holiday entitlement and pay calculations to get in line with changes for atypical workers, as heralded through the recent Supreme Court judgment Harpur Trust v Brazel.

Holiday pay calculations

It has always been simple to deal with holiday pay calculations for permanent employees who work five days a week all year and are paid a consistent salary. Workers, including part-time workers, have a right to a minimum of 5.6 weeks’ annual leave under the Working Time Regulations 1998 (WTR) which are very clear on pro-rating the 5.6 weeks leave for part time workers who work over 52 weeks.

Workers are entitled to be paid at the rate of a week’s pay in respect of each week of leave. For workers that are not fulltime and may have irregular hours, holiday pay has been calculated traditionally via the ‘percentage method’ which is based on 5.6 weeks equating to 12.07 percent of a working year (52 weeks less 5.6 weeks). The idea is that this method pro-rates a worker’s holiday pay based on their actual hours worked to ensure that they are treated in the same way as full-time or part-time workers with consistent hours over the year. The percentage method has been used by many employers rather than the more complicated ‘calendar year method’, particularly by those with large numbers of workers working irregular hours or workers on zero-hour contracts.

Most guides, including the government-funded Advisory, Conciliation and Arbitration Service (ACAS) have historically advised that it was appropriate to pro-rate holiday entitlement for employees who worked for only part of the year such as term time-only workers, although the WTR does not address how to pro-rate the minimum annual leave entitlement for workers who only work for part of the year.

The Harpur Trust v Brazel case

Though the percentage method for calculating holiday pay for atypical workers has been a widely held custom and practice, the Harpur Trust v Brazel ruling means that calculating leave and pay this way is in fact contrary to the WTR.

In that case, the Supreme Court held that holiday pay 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 percent. Instead, part-year workers are entitled to holiday pay calculated by the calendar year method which involves multiplying their average week’s pay, 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, 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 percentage method has been used for atypical workers on permanent contracts, employers may find themselves facing claims for underpaid holiday.

Employer considerations

The changes affect many employers across a range of sectors, including care homes and the NHS, recruiters that use an employment model for temporary workers, and manufacturers who rely on permanent zero hours workers, irregular hours contracts and workers who only work part of the year. The decision is highly significant for the education sector where thousands of school staff are employed on term-time only contracts, such as music or sports teachers with irregular hours.

Employers with atypical workers should review their holiday pay calculation methodology and payroll processes to ensure compliance with the Harpur Trust v Brazel ruling, and consider what steps need to be taken to regularise the position of affected employees.

Increased risks can arise where workers are under contracts for long periods of time while not working, so employers may also review contracting options more generally and move away from ongoing umbrella contracts. Instead, employers could have a system where each engagement terminates at the end of each assignment and they then, as set out in the contract, pay accrued but untaken holiday on termination of each engagement.

The Supreme Court’s ruling comes on the back of a whole body of case law and other developments relating to the impact of other issues on holiday pay, including what pay components are included (e.g., commission and overtime), and what reference period to use for calculations, which many employers will already be familiar with.

Increased risks can arise where workers are under contracts for long periods of time while not working.

ESG considerations

Holiday pay compliance should also be considered against the backdrop of the ESG agenda, the ‘S’ standing for the social aspects of an organisation’s obligations. The concept of ‘holiday’ forms a key part of an employer’s employee value proposition and is an important aspect of health and safety to promote employee wellbeing. It is therefore critical that employers remain compliant with their holiday pay obligations and keep abreast of the latest developments.

Beyond the increased monetary cost of bringing affected workers up to the full 5.6 weeks’ holiday entitlement, it is worth employers considering the possible resentment that may come because of regular hours staff seeing their colleagues get increased holiday pay in periods they are not working. This should be managed with care and tact.

Next steps

To gear up for upcoming seasonal work and busy holiday periods, here are some actions employers should take:

Review contract and worker arrangements to identify any risk areas. Organisations should check how they have been calculating holiday pay for ‘part year’, permanent, and irregular-hour workers to see if corrections need to be made and consider whether they may face employment tribunal claims. They will need to review and, if necessary, amend their contracts of employment and payroll processes. Strategically, employers may want to review whether such workers should be given permanent contracts, depending on how key that individual is for part of a year’s work.

Consider any historic liability, and future-fix by developing a strategy. Businesses need to be aware of the risk of claims if they continue to use the percentage method calculation and be mindful that a ‘series’ of unlawful deductions from wages claim could go back up to two years. Because of a Court of Appeal decision in Smith v Pimlico Plumbers in 2022, employers could also have difficulties in defending a ‘series’ of unlawful deductions claim on the basis that the ‘series’ of underpayment of holiday pay has been broken by a gap of more than three months. In that case, the Court of Appeal expressed the “strong provisional view” that the three-month gap rule was not correct.

Ensure all relevant stakeholders are engaged, and update HR and payroll processes and procedures accordingly.