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Holiday leave and pay – pitfalls to avoid | Sage | Picture of a person walking over a covered trap
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Holiday leave and pay: Pitfalls and possible reforms

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The calculation of holiday leave and pay entitlements is one of the biggest payroll nightmares experienced by accountants, bookkeepers and their clients. Ian Holloway looks at some of the pitfalls and charts a way through for practices, whilst looking ahead to possible reforms.

15th Aug 2023
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The Working Time Regulations are ripe for reform and simplification as they mention little on how to do the calculations for zero-hour, part-time, variable hours or part-year workers. This is to say nothing of managing the calculation for starters, leavers and the different rules for carrying leave over from one year to the next. Case law seems to be inconsistent at best and confuses the situation further.

This article looks at some of the issues and seeks to clarify them, pointing to the relevant guidance that exists. Yet could there be light at the end of the tunnel of confusion with the government's planned reforms?

The UK leave ‘types’

Undoubtedly, holiday leave and pay calculations are complicated and administratively burdensome, not least because every worker’s leave and pay entitlement is broken into three different blocks:

1 - Euroleave and pay

This is the four weeks (or 20 days for a full-time worker) interpreted into UK domestic legislation and derived as a result of the UK’s previous membership of the European Union (EU).

Euroleave, so called because it is derived from the EU Working Time Directive, ensures:

  • Leave is four weeks on a ‘use it or lose it’ basis meaning if it is not used by the end of the holiday year then it is lost. However, currently, it can be carried forward if the reason for taking it is Covid-related, something a July 2023 consultation proposes to remove
  • Pay is based on the value of ‘normal remuneration’, ie, the pay that a worker would normally expect to receive if they had been working.

It is Euroleave that has been the subject of case law interpretation over the years meaning employers have to include elements such as overtime and commission into the calculation.

2 - Domestic leave and pay

This is the 1.6 weeks (or 8 days for a full-time worker) derived from purely UK domestic legislation in 2007, ensuring:

  • Untaken leave can be carried over to the following leave year if there is an ‘agreement’
  • Pay is calculated as per the ‘week’s pay’ definition in employment legislation 

A week’s pay is not the same as normal remuneration.

3 - Over and above leave and pay

This is a leave entitlement in excess of the above statutory minimum (5.6 weeks / 28 days). This is based on the contract of employment which may define different rules for carrying forward untaken leave and the rate of payment.

But that’s not the only problem

There are two major issues that add to the confusion around UK leave types:

  1. Working time and employment legislation is a devolved issue in the UK. The jurisdiction of Great Britain has different legislation and rules compared to Northern Ireland. 
  2. Guidance frequently refers to a statutory entitlement, not differentiating between the three different types outlined above. So, employers and software act one way for the different components and workers accept it – not everyone is a legislation lover. No organisation keeps records of which ‘type’ of leave a worker took and, therefore, what pay calculations should be performed 

This one way of operation is reflected in the way this article continues.

Issues and reforms?

Employers and workers are entitled to reforms and simplifications, which hopefully should be applicable UK-wide. This year has seen two important consultations that could provide this and we refer to these below, discussing the current issues and, where appropriate, pointing to the latest guidance for employers.

Zero-hour workers / workers with variable hours

If a worker works full-time from Monday to Friday and is never absent from the workplace save for holiday, the leave calculation is simple. This almost never happens in practice though!

To accurately comply with legislation, employers must calculate the weekly pay in the 52-week reference period (though this is still 12 weeks in Northern Ireland). The current guidance states that it’s important to calculate the figure as a weekly amount, as all legislation refers to a week rather than any other pay reference period. Further, the calculation must only consider the weeks in which work was performed, discounting weeks not worked.

In January 2023, the government issued a consultation proposing amending this discount rule, ensuring the 52 weeks included weeks not worked. Plus, the reference period calculation would be fixed at the start of each leave year, based on the work done in the 52 weeks up until the end of the previous holiday leave year. So, the average pay calculation would be performed once annually rather than every time the worker went on leave.

Part-year workers

Readers may recall the Supreme Court ruling in Harpur Trust v Brazel, the music teacher on a permanent part-year worker zero-hours contract. This ruling confirmed the 52-week reference period should be used but also confirmed a part-year worker is entitled to 5.6 weeks leave, although they only work part of the year.

The same consultation proposed changing the legislation so leave entitlement for part-year workers was prorated, mirroring the worker’s prorated working time. 

Simply, the Supreme Court ruled that prorating was against the law as it stands, so the solution is to change the law going forward!

Part-time workers

The underlying message to both employers and workers is that all workers must receive an entitlement of 5.6 weeks per holiday year. It follows, then, a worker who works part of a year should receive a prorated 5.6 weeks entitlement. So, using a simple example, someone who works 3 days per week instead of 5 is entitled as follows:

28 days / 5 x 3 = 16.8, rounded up to 17 days

The then-Department for Business, Energy and Industrial Strategy (BEIS) published guidance in 2019 which is still relevant. This says employers may find it easier to calculate entitlements in hours rather than days.

Of course, the long-standing issue is whether a part-time worker should be paid for Bank Holidays, regardless of whether this is a day they usually work or not. Current legislation is silent on the matter, however, guidance from Acas is good in this respect.

Neither of the two 2023 consultations proposes to solve this issue, so employers need to remember the primary obligation for employers is that a part-time worker should not be treated unfavourably when compared to a full-time worker. 

Rolled-up holiday pay and the 12.07% calculation

Rolled-up holiday pay is where the employer paid holiday pay to the worker as they earnt their wages. Frequently, they used the 12.07% calculation, being statutory holiday weeks divided by the annual working weeks (5.6 / 46.4 x 100). This was ruled unlawful by a case law ruling from the European Court of Justice in 2006, however, now the UK has left the EU:

At the time of writing, the UK Government has not responded to either consultation.

Although not in law yet, rolled-up holiday pay and the 12.07% calculation look set to make a reappearance. This can have benefits for employers and workers; however, it does mean that workers will be paid their holiday entitlement on a rolling basis when wages are paid. Therefore, when they go on holiday, this will be unpaid. Could this prove a disincentive for workers to take their leave entitlement, the very reason for the 2006 case law ruling?!

Carrying Forward Leave

Currently, this is complicated for employers to administer and also for workers to understand, as each leave ‘type’ has different rules. Employers may not follow the rules and allow payments in lieu.

The July 2023 consultation proposes no major changes, despite Euroleave (4 weeks) and domestic leave (1.6 weeks) being merged into a single block. The rules will still be that 1.6 weeks can be carried forward into the next leave year by arrangement, except in some circumstances where it has not been possible to take the leave such as maternity and long-term sickness. 

Starters

Legislation prescribes the way the statutory 5.6 weeks is accrued for workers starting after the holiday year commences. This is at odds with the way it accrues for the ‘over and above’ block.

Although employers frequently do not treat the two types differently, the July 2023 consultation proposes that leave will accrue in equal instalments at the end of each pay period. So, for example, a new starter in month 6 of the holiday leave year will accrue their prorated amount in entitlements calculated at the end of each pay period (monthly, weekly etc). 

Of course, this is not a barrier to a worker taking their full prorated amount before it has accrued if permitted by the employer.

Leavers

For the 5.6 week statutory entitlement, the only time a worker can replace a leave entitlement with a payment in lieu is if the employment ends.

If the Working Time Regulations are amended as a result of the January 2023 consultation or the July 2023 consultation, this situation would not change.

Employers need to be mindful that, legally, a payment in lieu should only be made for untaken balances of ‘over and above’ leave, even if this is not what happens in practice.

Will things get easier?

Just when you think there is light at the end of a dark and complicated tunnel, consider that the consultations will only make changes in Great Britain. Northern Ireland’s rules will still differ unless they make corresponding changes at the same time. Without a devolved administration now, it is hard to see how this will happen.

We will, of course, keep on top of the situation and advise clients and users as and when changes are made and how to implement these effectively and consistent with the amended rules.

Sage has over 40 years of experience in the market and offers payroll solutions that not only facilitate efficient payroll processing but also create revenue opportunities for accountancy practice owners. To find out more visit the Sage website.

We've produced a series of short videos on how practices can offer a successful payroll service. Take a look now:

Replies (6)

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By johnthegood
15th Aug 2023 16:35

From what I can see the 12.07% is still being widely used, indeed the Iris payroll software staffology still uses this method by default, it also makes the admin very simple and seems like the most sensible option for workers with variable pay.

I guess the hope is that it comes back into law before any employees take the employer to court.

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By Hugo Fair
15th Aug 2023 21:38

Whilst not disagreeing with the general contents of a useful summary (which will of course be even more useful once/if the govt actually responds to the consultations with legislation before they lose power), I don't agree that:
"No organisation keeps records of which ‘type’ of leave a worker took and, therefore, what pay calculations should be performed."

It is undoubtedly uncommon (and could be outwith the Sage specification for all I know), but many of my clients (before I retired) had 'cafeteria benefits' systems ... where, amongst the benefits that could be chosen by employees, was an option to 'buy' or 'sell' holiday days.
Although you could configure alternative parameters, by default the system assumed the person's leave entitlement was held in 3 'pots' for the types set out above - and the rules applied discretely to these in order to determine whether a request to buy or sell was valid (and if so which pot was being adjusted).

Of course this was mainly the preserve of organisations with deep pockets (public sector or large corporates), but there's always a solution for those who care about 'doing things properly'!

Thanks (2)
Replying to Hugo Fair:
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By Hugo Fair
15th Aug 2023 21:53

"The then-Department for Business, Energy and Industrial Strategy (BEIS) published guidance in 2019 which is still relevant. This says employers may find it easier to calculate entitlements in hours rather than days."

Yet again, I agree BUT ...

1. A surprising (to me) number of employers don't record 'worked hours' (even many who are paying by the hour!) ... and often their software can't easily 'look back' to a previous tax year for auto-calculations within the main processing.

2. And I've seen near fisticuffs in Payroll depts where: one side, usually the employer, says 'the hours in question' are the actual/historical ones (even if there was an obvious unusual period) - whilst the other, usually employee, points them at the contracted hours going forward (not all hourly-paid workers are on zero hours contracts).

Ian may well known different, but I never obtained a categoric ruling on that aspect from BEIS (and now it's too late to do so)!

Thanks (2)
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By Owenhayes
17th Aug 2023 07:50

Euroleave involves four weeks' use-it-or-lose-it leave and pay based on normal remuneration, with overtime and commission included. Domestic leave encompasses 1.6 weeks that can be carried over by agreement, with pay calculated as per a "week's pay."

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By tom123
17th Aug 2023 10:24

I am really looking forward to this rationalisation etc - running a multi academy trust payroll.

We have probably "solved" the problem by overpaying - which is nice for the employee, but not ideal.

Thanks (1)
Replying to tom123:
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By Hugo Fair
17th Aug 2023 17:29

Trouble with that approach (apart from budget busting) is that it doesn't matter if you pay the right amount on average over the year (or indeed the right amount to everybody 99.9% of the time or ...) - all they have to do is to find that one instance of under-payment (exactly as per their attitude to NMW/NLW).

Then they immediately start sharpening the guillotine or at least preparing their fines/penalties and naming/shaming publications.

In order to somehow guarantee to be *always* paying at or above the minimum, you need to work out what that minimum is ... in which case you might as well just pay it.

Thanks (2)