Should holiday pay include commission and overtime?

UK workers are entitled to a minimum of four weeks' annual leave under EU law plus a further 1.6 weeks under domestic UK law (equivalent to the eight UK bank holidays per year). A worker is entitled to be paid their "normal remuneration" during statutory annual leave. However, historically in the UK, employers have tended to exclude overtime and commission from holiday pay calculations. Recent case law has brought this practice into question and employers who have not already done so should consider addressing how they calculate holiday pay.

Below are some Q&As dealing with the key points for employers.

Should commission be included?

In the recent appeal of a case involving a British Gas salesman who earned a low basic salary but substantial sales commission, the Court of Appeal held that, as his commission was contractual and results-based, it should have been taken into account when calculating his holiday pay for the minimum four-week period of holiday required by EU law (the EU holiday period). The Court of Appeal, however, emphasised that their decision was based on the particular facts of the case and is not a general ruling that all commission payments should be factored into the holiday pay calculation. British Gas sought leave to appeal to the Supreme Court but it was refused, meaning that the Court of Appeal decision is final.

Should overtime be included?

Compulsory overtime payments should be included in the calculation of holiday pay. Overtime may also be "non-guaranteed" i.e. where the employer does not have to offer overtime but the worker must work it if asked to. In three key cases in 2014 the Employment Appeal Tribunal (EAT) ruled that payments for non-guaranteed overtime should be included in the calculation of holiday pay for the EU holiday period.

Voluntary overtime should also be included if it is worked over a sufficient period of time on a regular or recurring basis so that it has become part of an employee's "normal remuneration". A recent Employment Appeal Tribunal case makes clear that voluntary overtime does not have to be worked every week in order for it to be sufficiently regular or recurring – in that case, the EAT found that working voluntary overtime once every four or five weeks was enough to make the overtime payments part of the employee's normal pay for the purpose of holiday pay. 

What about other payments?

Payments exclusively to cover occasional or ancillary costs need not be included within holiday pay. However, the EAT has held that allowances which are directly linked to a worker's work and are more than merely expenses should be included. This might cover, for example, standby and emergency call-out payments and possibly also travel allowances, depending on the circumstances.

Whether or not an annual bonus should be included in a holiday pay calculation is currently untested in the courts. In the British Gas case mentioned above, the Court of Appeal specifically declined to make a ruling as to how an annual "banker's bonus" should be treated for holiday pay purposes.

What is the appropriate reference period?

Where basic pay varies, UK law requires holiday pay to be calculated on the basis of average pay over a reference period of at least 12 weeks prior to the calculation date. No such statutory rules apply to commission or overtime payments. Employers could use the same 12-week reference period as applies to basic pay or alternatively some other period. There is no hard and fast rule. Instead, employers should consider whether they could reasonably justify the chosen reference period as being representative of a normal working pattern.

Must overtime and commission be included in holiday pay for the whole 5.6 weeks' leave?

No. The rulings referred to above apply only to the EU holiday period and not the additional 1.6 weeks' holiday under UK law (the UK holiday period), although employers could choose to include commission and overtime in all holiday pay. Where employees are entitled to different holiday pay amounts, depending on whether they are for the EU holiday period or for the UK holiday period, this will create administrative challenges for employers.

How far back can employees claim underpayments of holiday pay?

A claim for non-payment of holiday pay under the Working Time Regulations must be brought within three months of the date on which it should have been paid. However, a claim may also be framed as an unlawful deduction from wages in which case the time limit is three months from the last in a series of deductions. The EAT ruled in 2014 that claims will be out of time if there has been a break of more than three months between successive underpayments, and confirmed in 2017 that the three month limit is a clear rule, subject to an equitable discretion of a court or tribunal to extend time.

An underpayment is only possible in relation to the EU holiday period and the EAT ruled that workers cannot retrospectively designate which holiday is within the EU holiday period and which is within the UK holiday period. In practice, therefore, this may significantly restrict the ability of workers to create an "unbroken" series of underpayments and bring retrospective claims.

Additionally, the Government has introduced regulations which apply to claims made on or after 1 July 2015. Only underpayments made within two years prior to a claim may be the subject of a claim.

What about employees who transfer to a new employer?

Employers could be found liable for historic liabilities associated with staff who have TUPE transferred into the organisation. However, it is relatively standard to obtain an indemnity from the outgoing provider or seller in respect of liabilities relating to the period prior to the transfer date.

Could there be an impact on pension schemes?

Pension scheme rules may link contributions or benefits to a definition of pay that includes variable pay (such as providing that all pay is pensionable). If so, it is possible that the calculation of contributions or benefits may need to be adjusted where holiday pay was included in that calculation but without any element of commission or overtime.

What should employers do now?

Employers who have not yet reviewed their policy on holiday pay should do so now, particularly where their employees receive overtime, commission payments or other types of variable remuneration. This will involve reviewing which elements of remuneration are included and how an amount for variable elements of pay should be calculated for a particular holiday period.

Each case depends on its facts and whilst there are still a number of unanswered questions, employers can now be satisfied that the following general principles apply to the four weeks of EU-derived holidays:

• during those four weeks, a worker should be placed in a position in terms of remuneration which is comparable to a period of work, so that there is not a disincentive to take holidays;
• to achieve this, workers should be paid their "normal remuneration" whilst they are on holiday, which will include payments which are intrinsically linked to the performance of the tasks which the worker is required to carry out under their contract of employment, and payments relating to their professional and personal status; and
• payments in respect of the following items form part of the "normal remuneration" of workers who receive such payments: contractual results-based commission, compulsory overtime (guaranteed or not) and sufficiently regular or recurring voluntary overtime.

It remains to be seen how the law will develop in relation to annual bonuses and other types of non-contractual payments.  Until the law is settled on those other components, we advise that employers assess the extent to which those types of payments form part of employees' "normal remuneration", and whether their non-payment during holidays could create a disincentive to take holidays.  We will continue to monitor the case law, and are able to assist with advice on specific remuneration components in the meantime.