On 4 November 2014 the Employment Appeal Tribunal (EAT) handed down an important ruling in Bear Scotland and others v Fulton and others. The EAT ruling demonstrates that employers are now required to include most types of overtime payment when calculating holiday pay for salaried workers.
The judgment changes the previous understanding of the law and therefore means that most employers who pay overtime are currently at risk of claims in respect of underpayments of holiday pay.
The Working Time Directive (WTD) required all member states of the EU to create an entitlement, for all workers, to a minimum of 4 weeks’ paid annual leave. The WTD does not specify how to calculate pay during such leave. The UK incorporated these provisions into domestic law using the Working Time Regulations 1998 (WTR) which also gave UK workers an additional 1.6 weeks’ paid leave over and above the WTD minimum entitlement. The mechanism for calculating holiday pay is contained in complicated provisions under the Employment Rights Act 1996.
The mechanisms for calculating holiday pay are different depending on whether or not the worker in question has normal working hours, it is the mechanism for calculation in respect of workers with normal working hours (i.e. fixed contractual hours or salaried) that is called into question.
For workers with normal working hours domestic legislation has been interpreted for many years as requiring holiday pay to be based on basic pay alone (with some exceptions like compulsory and guaranteed overtime). This means that employers have not previously been required to include variable payments such as non-guaranteed overtime, commission or incentive bonuses when calculating holiday pay.
UK Law Incompatible with WTD
Prior to Bear Scotland we were already on notice that the European Court of Justice (ECJ) considered the UK method of calculating holiday pay for workers with normal working hours to be inconsistent with the WTD. This is because to not include all elements of remuneration intrinsically linked to the performance of the job (or part of their normal pay) could have the effect of discouraging workers from taking annual leave. These ECJ decisions specifically dealt with time away pay, flying pay and seniority payments (Williams v British Airways) and commission payments that are regularly received (Lock v British Gas Trading Ltd).
Bear Scotland Ruling
The main point to take from the EAT judgment is that employers are now required to include the following in holiday pay calculations:
• Non-guaranteed overtime (overtime that the employer is not obliged to offer but when offered the employee is required to work);
• Semi-voluntary overtime (overtime that the employer is not obliged to offer but when offered the employee can only refuse on reasonable grounds);
• Pay supplements for anti-social hours or short-notice availability (stand-by or on-call payments).
To properly include the above in holiday pay calculations employers would need to include average overtime payments over the previous 12 week reference period.
As guaranteed and compulsory overtime was already required to be included as part of holiday pay calculations this means that the only form of overtime that is still unclear is genuinely voluntary overtime. It should be noted that comments made in the judgment tend to suggest that voluntary overtime which is worked regularly should also be included but the position will not be clear unless and until a ruling on the specific point.
A particularly important aspect of the Bear Scotland ruling from an employer perspective is that it clear that the judgment only applies to the 4 weeks’ paid annual leave under the WTD and not the additional 1.6 weeks’ under the WTR. Further, claims for unlawful deductions from wages based on historic underpayments will be limited as claims can only go back as far as the start of a series of deductions where the gap between deductions is 3 months or less. Due to the way the EAT construed the difference between the WTD annual leave entitlement and the WTR entitlement this means that claims will very rarely go back beyond the current holiday year.
The parties in Bear Scotland have already been granted leave to appeal to the Court of Appeal, which means that the position is far from settled and may change.
Other Holiday Pay Issues
UK employers are likely to find the holiday pay saga continuing for years to come, there is likely to be considerable further litigation relating to various variable pay elements.
It is very likely that the following types of variable pay would be required to be included when calculating holiday pay for workers with normal working hours:
• Guaranteed, non-guaranteed, semi-voluntary overtime (and possibly voluntary overtime);
• Shift premia;
• Seniority payments (i.e. payments linked to grade/seniority);
• Stand-by payments;
• Incentive bonuses.
The reference period over which to calculate an average overtime for the purposes of holiday pay is the previous 12 weeks but it is possible that a different reference period may apply with respect to other variable pay elements such as commission or bonus. If the reference period remains 12 weeks then many employers will find this unfair due to significant fluctuations in variable pay throughout the year. Workers would find it advantageous to take holiday immediately after a reference period in which high commissions or an annual bonus was awarded as this would greatly increase their holiday pay. Based on the ECJ case of Lock v British Gas Trading Ltd (concerning commission payments) it may be that a 12 month reference period is deemed more appropriate but we will have to await a domestic ruling on this point (currently expected February 2015).
Next Steps for Employers
It is clear that the current law requires employers to include most types of overtime, shift premia and stand-by payments in holiday pay calculations. Other variable pay elements are less clear but most likely will also need to be included if they are intrinsically linked to the work the worker is required to carry out under their contract.
The main question for employers is whether to change the way you calculate holiday pay now or await the outcome of appeals and domestic rulings on specific variable pay elements that affect your business. Beginning to include variable pay elements in holiday pay now will increase operating costs (estimated as 3-5% increase) but has the advantages of ensuring compliance, good employee relations/industrial relations, avoiding adverse publicity and preventing or limiting historic claims. However, while the law is unclear and unsettled you are at significant risk of overpaying or paying in circumstances where it may later be proven is not necessary at all (which you could then be held to continue with).
The second question is if you do decide to include variable pay elements in holiday pay calculations will you limit this change to the strict requirement to include them when calculating the 4 week’ annual leave under the WTD? There is currently no requirement to change the way you calculate holiday pay for the additional 1.6 weeks’ leave under the WTR or any contractual additional entitlement over and above 5.6 weeks. However, consider whether the administrative burden of different methods of calculation for different “types” of holiday is worth the saving in holiday pay. It is unlikely that you specify which “type” of holiday is deemed to be taken first but this is probably a good idea if you intend to calculate holiday pay differently for different types of holiday and more importantly to assist with limiting claims for historic underpayments (to create the 3 month gap between underpayments by specifying that the first 4 weeks’ holiday is the WTD entitlement).
For now, the best advice for any business which is affected by the changes in holiday pay is to conduct a risk analysis of your workforce with a view to identifying variable pay elements and the related additional salary costs if they are included in holiday pay calculations. If you decide not to change your current method of calculating holiday pay consider putting aside a budget to meet the costs of any later claims or settlements.