A small business owner’s guide to calculating holiday pay

When you employ staff, you must give them a certain amount of annual leave and pay them during this time.

If your employees work a set number of hours and receive a fixed salary, calculating their annual leave entitlement and holiday pay is straightforward. However, if staff have irregular hours, work overtime, or receive commissions or bonuses, then calculating holiday pay can get quite tricky.

To help new business owners and employers understand the regulations on calculating holiday pay, we asked employment law expert, Peter Done to explain the key points for small businesses;

All employees are entitled to a minimum amount of annual leave

All employees are entitled to annual leave and they gain this entitlement as a ‘day one’ right from the start of their employment as annual leave starts to accrue from the very first working day.

The statutory minimum entitlement is 5.6 working weeks per year and the employee must receive pay for all of it even though they are not working this period.

A week of holiday leave is worked out as the number of days the employee usually works per week, e.g. a full-time employee working 5 days a week will get:

5 days x 5.6 weeks = 28 days annual leave

If they work 3 days a week, 5.6 weeks of annual leave will entitle them to 16.8 days off. However, if they work a 6 day week, the maximum statutory entitlement will remain 28 days and not 33.6 as it may be assumed.

For more in-depth information on annual leave entitlement, for example, how you treat bank holidays, forcing staff to take annual leave at a certain time of year, and when you can refuse employees’ requests to take holiday, read; A Small Business Guide to annual leave entitlement for employees

The Working Time Regulations 1998 set a legal requirement for all annual leave to be paid at the same rate as working time: for example, one week’s pay for one week’s holiday. The law gives guidelines on how a week’s pay is worked out, and recent case law has further developed the holiday pay calculation.

Holiday Pay

It is a statutory requirement that employees receive normal pay for time taken as annual leave. Normal pay means the remuneration they usually receive for a period of work of the same length as a period of annual leave.

For an employee who has set working hours which stay the same each week, then a week’s pay is the remuneration he receives for a week of work.

However, there are employees who do not have a set working time, but work different shifts spread over a number of weeks, resulting in a different number of working hours each week.

This means that they do not have a set ‘normal week’s pay’, so instead their holiday pay is calculated in the following way: their average weekly hours over the previous 12 weeks are multiplied by their average hourly pay for that period to give a week’s holiday pay.

If the worker does not have normal working hours and their pay differs from week to week, then a week’s pay for purposes of holiday pay is the average pay received per week for the 12 weeks immediately before the day the holiday starts.

This means that on each occasion the employee takes time off, their pay has to be calculated using a new pay reference period. The result of this is that the employee may be due a different amount of pay for different periods of annual leave.

Overtime and holiday pay calculations

Although calculating holiday pay may already seem complicated, they are impacted by aspects other than just number of hours worked. Overtime hours can also affect them.

There are three different types of overtime:

1. Guaranteed overtime

Guaranteed overtime where the employer is obliged to offer the extra hours and the employee is obliged to accept them.

2. Non-guaranteed overtime

Non-guaranteed overtime where the employer is not obliged to offer it but when they do, the employee is obliged to accept it, and

3. Voluntary overtime

Voluntary where there is no obligation on neither the employer nor the employee.

Following case law, guaranteed and non-guaranteed overtime must be included in the holiday pay calculation, especially if there is a contractual obligation to work these overtime hours. The tribunal’s judgment stated that if ‘normal non-guaranteed overtime’ makes up a normal part of an employee’s working pattern, then if should be reflected in holiday pay.

The stance with voluntary overtime is not so clear cut. A recent employment tribunal judgment ruled that voluntary overtime should be included in holiday pay as long as it is worked with ‘sufficient regularity’. This is only a first instance tribunal and the decision is not binding on any subsequent claims.

Currently there is no definition of what ‘sufficient regularity’ means and until the decision has been appealed, employers are not under an obligation to factor this type of overtime.

This allows employers to choose whether to change their holiday pay practices early to include voluntary overtime and avoid all possible risk of a claim or to carry on as they do until there is clear guidance.

Commission and holiday pay calculations

Employment Appeal Tribunal rulings have shaped the terms of working out holiday payments for employees who earn commission or undertake overtime shifts.

Although commission is based on the results from someone’s work regardless of the amount of hours they put in and overtime has set hours and rate, recent judgments have set out that both commission and some types of overtime must be included in the calculation.

If the employee receives commission based on their performance or sales they achieve, then the amount they receive for this should be factored into holiday pay. The pay reference period for commission will vary from employer to employer depending on how often commission gets paid.

Pay in lieu of holiday

Sometimes employees may not want to take their holiday entitlement and may prefer to receive the money for it instead. However in normal circumstances, an employer may not lawfully pay an employee in lieu of their holiday entitlement.

If the employee does not take all of their holidays within the relevant leave year, they will simply lose their entitlement. An exception to this rule is when the employment terminates for any reason and the employee has not taken all of the holidays they have accrued.

Employers should keep in mind that if the employee leaves part way during the leave year they will not have accrued a full annual leave entitlement.

If the employee has taken more holiday than they have accrued by the time they leave, then you can deduct the difference from the last salary, providing that you have a contractual right to make deductions.

This guide was written exclusively for ByteStart by Peter Done, Managing Director of Peninsula Business Services – the UK’s leading specialist Employment Law, HR and Health & Safety service