By Karen Bexley, head of employment law at MLP Law

Following the two rulings made by an Employment Tribunal (ET) and the Employment Appeal Tribunal (EAT) recently, there have been several discussions concerning holiday pay and how it should be calculated. The EAT ruled that non-guaranteed overtime should be factored in when calculating the amount of holiday pay that an employee is entitled to and a recent ET announced that commission should also be taken in account. With this in mind, I will take a look at how employers should calculate holiday pay, taking into account a number of different rates of pay.

Prior to the rulings, holiday pay was calculated based on the employee’s basic rate of pay and additional payments such as overtime and commission were not taken into account. Going forward, employers will have to base holiday pay on an employee’s ‘normal pay’ and should now include non-guaranteed overtime and commission, as well as probably other payments such as shift allowances and bonus payments, for example.

‘Normal pay’ is recognised as the amount of salary that a person usually receives, and can include variable amounts such as commission and overtime. Section 221 of the Employment Rights Act 1996 states that when calculating a person’s holiday pay for someone who receives variable pay, reference should be made to the pay that was received during the 12 weeks prior to the holiday. Whilst it’s not clear how holiday pay should be calculated to include overtime, commission etc, we think it’s most likely to be based on the amount that a person would have normally received during the 12 weeks before their holiday.

Perhaps the most important point for business owners is to determine what constitutes ‘normal pay’. The wage that a person usually receives will be made up of different elements and all of these need to be taken into account. In terms of overtime, non-guaranteed overtime – which is overtime the employee is obliged to work if offered but the employer has no obligation to provide – should be included in holiday pay. When it comes to voluntary overtime, this does not apply. Having said this, there is likely to be debate as to whether overtime is considered to be voluntary or not, and it could be the case that regular voluntary overtime is classed as ‘normal pay’.

Further to this, only the first four weeks of holiday that is taken per year will be required to include additional payments such as overtime and commission. Overtime will not be taken into account when calculating the pay for the remaining 1.6 weeks' of holiday (as required by UK law) or any additional contractual holidays.

So what does this actually mean for employers?

As a result of the decisions, many employers will find that they have to pay out more for holidays, but they may also end up having to pay out for any underpayments that were previously made as employees claim backdated pay.

As the past few months have seen news channels and social media sites discussing the announcements, many employees will be aware of these changes and may look to see if they can make a claim for backdated pay.

The amount of claims made could actually be limited. This is because claims cannot be made if there is a gap of three or more months between claims of incorrect holiday pay. It is likely that employees will take the remaining 1.6 weeks’ of annual leave during the last three months of the holiday year. During this time, the employer is not legally required to pay holiday pay based on an increased “normal pay” rather than “basic pay”. Due to this, any claims that are made are likely to only be backdated for the current holiday year, minimising the risk to most small businesses.

So what should businesses do now?

Businesses now need to review how they currently calculate holiday pay to consider whether they may be at risk of claims being made against them. It is advisable to think about additional payments such as commission, overtime (guaranteed and compulsory, and non-guaranteed but compulsory), bonuses for productivity, attendance and performance, standby and call out payments, shift premiums and acting up payments.

Companies need to think about their next steps and whether they will introduce the new changes. They need to decide whether to make any changes at all, or if they are going to make changes, will they include overtime and commission payments in the first four weeks of holiday pay only, or in the full contractual holiday pay entitlement. It may be worth thinking about putting money aside in the budget to cover any valid backdated claims that employees could make.

To minimise the impact of any possible cases, contracts should be amended to clarify how holiday payments will be calculated. Overtime could be specified as voluntary rather than non-guaranteed so that it is not required to include this type of pay in calculations. Any differences in pay for different holiday periods should also be made clear.

This area is likely to see various developments in case law before the exact outcome of the rulings become clear. To ensure that employers are not at risk of liability, it is important for them to keep an eye on any future changes so that they can act quickly and start to budget for any potential claims.