Three construction industry cases hit the headlines earlier this month as the effect of the decision in these cases will change the way in which employers are required to calculate holiday pay.  Estimates suggest that up to five million employees may be entitled to some form of back payments and, going forward, higher rates of holiday pay. Recognising the potential impact of the ruling and concerned about the potential cost to business, the government immediately announced a new task force to assess its impact.

Until now, many employers, relying on the UK rules, have limited holiday pay to basic salary (excluding overtime, commission and other allowances). Earlier this month the UK Employment Appeal Tribunal (EAT) issued its decision in Bear Scotland & others v Fulton & others (heard jointly with Hertel (UK) Ltd v Wood & others and Amec Group Ltd v Law & others.

What did the EAT decide?

  • Non-guaranteed overtime, where it is nevertheless regularly required by the employer, amounts to "normal remuneration" and should be included in holiday pay. There was no scope for uncertainty and so the EAT held that parties will not able to make reference to the European courts. The case is silent on whether truly voluntary overtime, where the employee can choose whether or not to work the additional hours, will fall into this category. 
  • The requirements to include overtime pay and allowances only apply to the mandatory four weeks’ holiday required by the European Working Time Directive (WTD) and not the additional 1.6 weeks’ leave that UK employees are entitled to under the UK Working Time Regulations (WTR). Employers could pay the additional leave under the WTR and any additional contractual holiday, at basic pay rates only.
  • Any claim for unpaid holiday pay must be brought within three months of the last failure to pay the correct amount (or the last in a series of underpayments). Any interval of more than three months between vacation periods will break the chain in any “series” of underpayments and tribunals would not have jurisdiction to hear the claims. Commentators had feared that workers could claim back either up to six years of underpayments, or seek compensation for deductions from the introduction of the WTR rules in 1998.
  • Travel and other taxable allowances (in this case, radius allowances and travelling time payments) paid to workers should also be taken into account when calculating employees’ holiday pay.  In the Hertel and Amec cases the employees had an allowance for travelling time and fares. HMRC treated some of the payment as a reimbursement of travelling costs, but the balance as taxable remuneration. The EAT held that this element was time spent linked to work and the payments were directly linked to work.This approach accords with the European court's decision in Williams v British Airways which established that "normal remuneration" included components of pay which were intrinsically linked to the work done by an employee. There was no discussion about how commission is to be treated and we will have to wait until next year to hear the tribunal's ruling in Lock & British Gas as to whether UK legislation can be interpreted in line with ECJ ruling that statutory holiday pay must also include an amount for commission payments.

What are the possible consequences for employers, and what should they be doing now?

Given the prime time publicity the press has given to this case, employers are already facing questions from their employees, while themselves considering their strategy on how to respond to the issues raised.

Non-guaranteed overtime

Going forward non-guaranteed overtime should be included in basic pay for holiday calculations. The EAT clearly indicated that in their view a successful appeal against this finding would be unlikely. However the case is silent on whether truly voluntary overtime, where the employee can choose whether or not to work the additional hours, will fall into this category. Employers should check how "voluntary" such a practice is. Where overtime has become a regular part of normal work and it is unusual for employees not to do overtime, this should be included in holiday pay calculations. There is a potential that courts, in time, might be likely to decide to include all overtime, as well as purely voluntary. Unless overtime can truly be defined in this way, it may be safest (and easiest, for calculation purposes) to assume that all overtime should be included.

Limitation to four weeks holiday

Including overtime payments in holiday pay is limited to four weeks holiday, not "additional leave". The EAT said that it is not up to the employee to decide which type of holiday is being taken and indicated that it would be assumed that in any holiday year the first four weeks of WTR leave would be taken before the 1.6 weeks additional leave. This effectively creates a two tier approach to holiday pay and could cause administrative difficulties for employers in deciding, for any particular individual, in determining whether holiday should be paid at basic pay rates only or not. Employers may wish to specify in employment contracts the order in which different types of holiday should be taken.

Reference period of making a calculation

The EAT did not discuss how this would operate, but it is likely that employers would need to look back on a 12 week reference period under the WTR prior to holiday being taken, to determine whether any, and if so how much, overtime has been worked.

Employees may plan holiday to fall after a period of overtime to enhance their holiday pay. Employers may need to amend contracts of employment to mitigate this, especially if there are periods of the year which have peaks of overtime. Some commentators have suggested that the reference period could be longer e.g. twelve months.

No claim for deduction further back than three months

As a result of this decision, employees who have taken holiday within the last three months, may present claims for deductions from holiday pay if they worked overtime prior to taking the holiday. If more than three months have elapsed since their last holiday payment, then their claim would be time barred. This restriction should significantly minimise the value of many employees’ claims. Employers should check their records to assess whether there are any such potential claims and consider paying any additional sums due to break any series of past deductions.

Travel allowances

These also need to be included in the four weeks holiday pay in a similar way to sector pay being included in the Williams case. It is therefore important for employers not only to consider any employees who currently work overtime, but also to review the nature of taxable allowances paid to employees to assess whether they can be regarded as directly linked to the employee's work.

Pension contributions

These may need to include the overtime element of holiday pay, depending on the definition of "pensionable pay" being used for the contribution rate. For automatic enrolment on the statutory basis, the overtime element should certainly be included.  However, if the definition being used is basic pay, it probably does not need to be extended. It is important to remember that this will cover employee as well as employer contributions, so employee deductions will need to be adjusted as well.

What is likely to happen next?

Following the EAT decision, in which it granted permission for the parties to appeal to the Court of Appeal, the government immediately announced its intention to set up a task force to with a view to analysing this case in more detail and limiting its impact on employers on employers. Until any appeal is decided (if brought), particularly on the time period of retrospective liability, the costs of the decision will remain unclear.  In the meantime, any employer who does not already include overtime and allowances which are intrinsically linked to the employee’s duties or status should do so.

In summary

  1. Going forward: Consider current overtime payments and practices. Include both guaranteed and non-guaranteed overtime payments in calculations of holiday pay if earned in the twelve weeks prior to the statutory four week holiday being taken.
  2. No requirement to make additional overtime payments in respect of either the additional 1.6 weeks statutory leave, or any additional contractual holiday entitlement.
  3. Currently no liability and therefore no requirement to settle potential claims, for past failure to account for overtime in holiday pay where more than three months has elapsed from the date of underpayment. Potentially there could be increased scope for historic claims on a successful appeal.
  4. Consider whether any employees could currently potentially bring claims if less than three months have elapsed since date of holiday payment made through payroll and they have carried out overtime in the twelve weeks preceding the holiday start date. If so, either consider making payments, or take a more cautious "wait and see" approach.
  5. Assess travel allowances, sector payments or other additional payments in addition to basic pay and consider whether they should also be included in holiday payments.