Every worker has the statutory right to 5.6 weeks' paid holiday a year. Sounds straightforward to calculate? Unfortunately, it has proved to be anything but.

In 2012, the Court of Justice of the European Union (CJEU), in Williams v British Airways plc, confirmed that a worker must be no worse off financially during annual leave than if he/she had continued working. Since then, the tribunals have considered a number of claims concerning whether overtime arrangements, commission and various supplements formed part of 'normal remuneration' for holiday pay purposes.

We now have the highly anticipated judgment of the Employment Appeal Tribunal (EAT) in the combined cases of Bear Scotland Ltd v Fulton & others, Hertel (UK) Ltd v Woods & others and Amec Group Ltd v Law & others confirming what constitutes 'normal remuneration' for holiday pay purposes and, if a worker has been underpaid, how far back they can claim.

And the verdict is...

  • Holiday pay must correspond to normal remuneration, which is what is normally received, including "non-guaranteed" overtime (in relation to the first four weeks of statutory leave).
  • Limited scope for workers to recover underpayments of holiday pay by way of an unlawful deduction from wages claim.

This means employers will face larger holiday pay bills in future. Overtime, including non-guaranteed overtime, commission and other allowances forming a worker's normal pay must be included in holiday pay. Employers can face claims for past underpayments, although the period for which a worker can back-claim is severely restricted by this judgment.

Given the significance of this decision, Business Secretary Vince Cable has this afternoon announced he is setting up a taskforce to assess the possible impact of the judgment.

What does this mean for employers?

Calculating holiday pay - what must be included?

For the purposes of regulation 16 Working Time Regulations 1998 (WTR), a "week's pay" is defined in accordance with the Employment Rights Act 1996, under which only guaranteed overtime is included. However, following the CJEU judgments in Williams v British Airwaysand Lock v British Gas, under the Directive workers are entitled to their "normal remuneration" when on holiday.

In light of the CJEU rulings, the EAT has held that overtime, including non-guaranteed overtime and other allowances "intrinsically linked to the performance of the tasks" (in this case "radius allowances" and "travelling time payments") must be included when calculating holiday pay.

The EAT states that "normal pay is that which is normally received". In cases where the pattern of work is settled, it will be fairly easy to determine the normal pay. Where there is no such "normal", an average should be taken over a reference period. While not specifying a reference period, a 12-week reference period is likely to be considered appropriate to identify the average.

However, this only applies in relation to holiday pay payable in respect of the first four weeks of holiday entitlement, known as "regulation 13 leave", and which derives from the EU Working Time Directive.

Regulation 13 v regulation 13A leave - what is and why does this make a difference?

Under UK law, workers are entitled to 5.6 weeks' annual leave. However, it is only the first four weeks of leave under regulation 13 that derives from the Directive. The additional 1.6 weeks under regulation 13A is a matter of UK law only.

As the WTR must be interpreted so as to give effect to the requirements of the Directive, and the CJEU has given a wider definition to "normal pay" under the Directive, the UK courts are obliged to interpret the WTR accordingly, but only insofar as it relates to rights derived from the Directive. As regulation 13A leave is not derived from the Directive, the wider interpretation of "normal pay" does not apply.

This means workers, as in the cases before the EAT, may be entitled to a higher rate of holiday pay for the first four weeks of annual leave and a lower rate for the remaining 1.6 weeks of statutory leave and any additional contractual entitlement. This has an important impact in relation to potential back claims.

Back claims - how far back can a worker claim?

Under the WTR, a worker can only claim underpayments arising in the three months prior to the presentation of their claim. However, a claim for a series of deductions of wages under the Employment Rights Act (ERA) can lead to a very different result.

Last year in the case of Neal v Freightliner Limited, a tribunal found the worker was able to claim for underpayments going back to 2007 when his employment began. But does underpayment of holiday pay over a number of years constitute an unbroken "series of deductions of wages"?

Significantly, the EAT concluded that the workers could not claim any consequent holiday underpayment as forming part of a series of deductions of wages where more than three months had elapsed between the "deductions". The EAT state "any series punctuated from the next succeeding series by a gap of more than three months is one in respect of which the passage of time has extinguished the jurisdiction to consider a complaint that it was unpaid".

Furthermore, as the employer has (within reasonable bounds and following the procedure laid down in the WTR) the right to direct when holiday should and should not be taken; and the regulation 13A leave is described as "additional leave", the first weeks of holiday leave taken in a holiday year will be the first leave taken.

This part of the judgment is of great significance, limiting the number of years a worker may potentially look back. The chances of a worker having a long (if any) series of untaken regulation 13 leave over a number of years is minimal under the EAT judgment.

What should employers do now?

Going forward, overtime, whether guaranteed contractually or not, must be taken into account in calculating the first four weeks of holiday pay. This will inevitably lead to a considerable rise in holiday pay bills for many employers.

The EAT judgment significantly limits the potential value of backdated claims. However, employers need to be aware that this decision is likely to be the subject of a further appeal to the Court of Appeal. Leave to appeal has been given on all the issues involved in this case.

A successful appeal on the issue of how holiday pay should be calculated seems unlikely, however the prospect of success of an appeal on the "series of deductions" issue is much more difficult to call. As it will be some time before the issues are definitively resolved, employers may want to consider:

  • Carrying out an audit of the different payments (e.g. commission, voluntary overtime, non-voluntary overtime, shift allowances and other premiums in pay) paid to workers in all parts of the business.
  • Reviewing contracts of employment, contracts of engagement and staff handbooks to check that they accurately reflect how holiday pay is currently calculated.
  • Carrying out an audit of the workforce demographic and look at holiday patterns - this will help identify how long potential liabilities might go back for.
  • Remembering that paid holiday leave is important to staff. If you receive a grievance, deal with it appropriately and bear in mind that an individual grievance could easily escalate and in a large workforce, with people piggy-backing on an initial successful grievance, lead to a significant cost.
  • If you receive a claim for back payments seek legal advice. Remember, claims should be limited to four weeks' annual leave and checks made as to when holiday was in fact taken.