What's the deal with rolled-up holiday pay?

We’ve covered holiday pay a fair bit in the past year or so after a string of high profile decisions have confirmed that employers should take into account certain commission, overtime and bonuses when calculating how much workers should be paid during annual leave.  But how should employers take those additional payments into account when calculating how much a worker is owed for their holiday?

According to the Working Time Regulations 1998, an employee’s normal remuneration should be calculated by using a 12-week reference period immediately preceding any holiday dates.  This is certainly not the most user-friendly system and can result in quite a complicated mechanism for calculating holiday pay and wide inconsistencies for workers whose pay fluctuates throughout the year (for example, workers in industries in which they are paid overtime during high seasonal demand are incentivised to take holidays in the middle of busy periods). 

Some employers have decided to account for additional remuneration by adding a holiday allowance as a percentage of any additional payments provided to employees (and some add this to basic salaries for irregular workers such as those on zero hours contracts).  Financially, the employee may be no worse off than using the 12-week reference period so there should be no problem, right?  Not necessarily. 

The European Court of Justice ruled in 2006 that rolling-up holiday pay in this way is contrary to the EU Working Time Directive, the EU law on which the Working Time Regulations are based.  The reason for this is that the Working Time Directive is not just about ensuring that employees receive the correct remuneration – the ECJ views the Directive as primarily a health and safety measure to ensure that workers actually take their holiday. 

So does that mean that employees cannot roll up pay?  On first view, yes, because it is unlawful.  However, the ECJ did rule that employers are able to set-off against any claim for holiday pay sums already paid “transparently and comprehensively” which were genuine additions to a worker’s rate.  The effect, therefore, is that workers could bring a claim against an employer who rolled up holiday pay but wouldn’t necessarily get any compensation. 

There are still risks for employers rolling up holiday pay though.  Firstly, the requirement for this set-off is that the payments should be transparent and comprehensive, which means that any rolled-up holiday pay should be in writing, clearly incorporated in workers’ contracts and the actual amount clearly identified.  It should not be confused with workers’ basic pay or used as a reason not to provide a salary increase. 

Secondly, there is a risk that an employee could bring a claim on the basis that they have been financially disadvantaged as a result of rolling up pay.  Take the above example of a worker in an industry with peaks in seasonal demand when they work more overtime.  Such a worker would receive lower pay if their holiday allowance on their overtime was based over an entire year, compared with the 12-week reference period if they took the holiday during peak season after they have worked a lot of overtime. 

Thirdly, rolling up holiday pay does not mean that employees should not take their statutory annual leave and it is arguable that rolled up pay creates a disincentive, and possibly a barrier, to taking such leave.  If a worker brings a claim that they have been prevented from taking holiday, the set off rule would not apply. Any employer considering rolling up holiday pay would be wise to closely monitor workers’ holidays and ensure that appropriate leave is taken. 

Finally, the position under the UK Working Time Regulations could change at any time.  As a result of the 2006 ECJ ruling, the UK government is effectively in contravention of EU law and the ECJ invited it to amend the Working Time Regulations.  Nine years have since passed and the Regulations have not changed, but it may be changed in the future.  Meanwhile, current guidance published by the Department for Business, Industry and Skills does discourage the rolling up of holiday pay.