Government to legislate on holiday entitlement and pay: here’s what it means for employers

Earlier this year, the government published two sets of proposals for reforming holiday rights. We now have the government’s response and draft regulations. It’s a quick turnaround time: the new regulations will come into force on 1 January 2024 and will change holiday laws in ways that will impact many, if not most, employers.

In a welcome move, the government is going to legislate to allow rolled-up holiday pay (for some workers in defined circumstances) and make sure that holiday stays in proportion to time worked (correcting recent caselaw on this). Otherwise, the government has opted to write many existing EU rules into the new regulations, including rules about holiday pay. Some employers might see this as a missed opportunity to come up with a bolder and less complicated system, but any other approach would have risked criticism that the government was downgrading workers’ rights.

Here’s our summary of the key changes.

Holiday pay must include overtime and commission

Currently, employees have two separate holiday entitlements:

• four weeks’ leave based on EU law; and
• an extra 1.6 weeks’ leave based purely on UK law.

According to EU case law, the 4 weeks’ EU leave must be paid at ‘normal’ pay, which means including regular overtime and commission in the calculation. In contrast, the additional 1.6 weeks’ leave can – at least for most workers – be paid at basic pay only. There’s been uncertainty over what rules would apply from 1 January 2024 when EU supremacy over UK law ends. Would the EU caselaw still be applicable?

The government has decided to keep these two distinct pots of annual leave and their associated minimum rates of pay. The plan to merge the two entitlements into one single pot of 5.6 weeks’ annual leave, removing this potentially confusing distinction, has been dropped.

This means that, going forward, workers will continue to have a minimum entitlement of four weeks at normal pay and 1.6 weeks at basic pay.

What is normal pay?

The regulations don’t use the expression ‘normal pay’ but they do say that, going forward, pay for the four week EU-based leave entitlement must include:

• payments, including commission payments, which are intrinsically linked to the performance of tasks which the worker is obliged to carry out under the terms of their contract;
• payments for professional or personal status relating to length of service, seniority or professional qualifications;
• other payments, such as overtime payments, which have been regularly paid to the worker in the last 52 weeks.

This effectively writes EU caselaw on holiday pay into UK legislation. This may disappoint those who’d hoped for a return to a simpler approach of basic pay for all holidays, but it will reassure others who were concerned that workers would lose out financially if EU holiday rules about normal pay were scrapped.

By keeping two distinct pots of leave, the government is preserving the complexity associated with two levels of payment. But, in practice, many employers already take a pragmatic approach, paying all 5.6 weeks annual leave at the higher ‘normal pay’ rate. As the draft regulations maintain the status quo, there’s no need to change this practice.

There are still some employers who have never adjusted their holiday pay approach to reflect EU rules about normal pay. If you’re one of those employers, then you should take advice on moving to a more compliant footing now that it’s clear that the EU rules are being kept rather than scrapped. You may otherwise be vulnerable to backpay claims for miscalculating holidays (in Great Britain, these can go back for a two-year period).

What “type” of leave is being taken?

The new regime sheds no light on the ongoing debate about how to tell which type of annual leave entitlement is being taken when. Last month’s ruling in the Agnew case caused further confusion on this when the Supreme Court concluded that different types of leave are not necessarily taken in sequence and that, if it’s not practical to distinguish between them, all the leave to which a worker is entitled forms part of a single composite pot. If you are paying all holiday at the higher ‘normal pay’ rate, this is less of a concern in practice. If not, the potential for uncertain and complex holiday pay calculations remains and is something that should be addressed through employment contracts.

Rolled-up holiday pay is to be allowed – for some

The term “rolled-up” holiday pay refers to the practice of paying an employee’s holiday pay at the same time as basic pay (i.e. “rolling” the two payments together). This system was ruled unlawful by the European Court of Justice in Robinson-Steele v RD Retail Services because of the risk that it would discourage workers from taking time off. Despite this, many employers have continued to roll up holiday pay for some workers, given the headaches associated with doing anything else. The government has confirmed that it is pressing ahead with plans to authorise this approach in certain circumstances.

The draft regulations would allow rolled-up holiday pay for holiday years from 1 April 2024, as long as:

• the worker counts as an irregular hours or part-year worker;
• holiday pay is calculated at 12.07% of all pay for work done;
• the extra 12.07% is paid at the same time as pay for the work done; and
• the holiday pay is itemised separately on the payslip.

There are some special rules for calculating rolled-up holiday pay if the worker is on sick leave or family leave.

This approach will not be mandatory, but if you are an employer struggling with how to calculate holiday entitlement and pay for workers whose hours are irregular or occasional, then this could be a welcome development. Many such workers are not obliged to work any particular days, making it tricky to earmark any day as a holiday and make the correct payment. The new system means that you can manage holidays by simply paying an extra 12.07% pay supplement. When the worker takes holiday, they do not get paid extra holiday pay.

Potential pitfalls?

There are a few potential drawbacks with rolled-up holiday pay:

• Rolled-up holiday pay is only available for people working on a part-year or irregular hours basis. The government has dropped its original idea of allowing it for everyone. So, if you do choose to offer rolled-up holiday pay, you must ensure that the worker is eligible first.
• The rolled-up holiday pay option doesn’t allow scope for distinguishing between different types of leave and paying them at different rates. The supplement must be paid on all earnings. There may be some situations in which that could make holiday more expensive.
• A word of caution about working time. Rolled up holiday pay doesn’t mean that workers can start working 52 weeks of the year, without taking any holidays. The onus is still on you to make sure they have at least 5.6 weeks off (which can be tricky when we still don’t know what this means – see below). The difference is just that, when they do take that time off, it would be unpaid as holiday pay has been accounted for in the rolled up holiday pay supplement.

New accrual system for irregular hours workers and part-year workers

For holiday years from 1 April 2024, irregular hours and part-year workers will accrue annual leave entitlement on the last day of each pay period at the rate of 12.07% of the number of hours that they have worked during that pay period. This is subject to a maximum of 28 days per year.

This will be a completely new provision in the existing legislation which, to the relief of many employers, is designed to correct flaws identified by the Supreme Court in the Harpur v Brazel case (where the court observed that the current rules don’t allow annual leave entitlement to be lawfully pro-rated downwards to reflect hours actually worked).

There are special rules for continuing to accrue annual leave entitlement during sick leave or family leave.

The new system differs from the one that the government originally consulted about, which would have involved looking back to the previous holiday year and multiplying last year’s hours by 12.07% to get next year’s pot of holiday entitlement, which would have presented a number of challenges.

The new accrue-as-you-go approach means that irregular hours workers and part year workers will build up holiday entitlement as they work, rather than getting a whole year’s holiday entitlement up front at the beginning of the year. Their entitlement will stay in proportion to hours worked.

It will be up to employers to decide if staff can book and take more holidays than they’ve technically accrued under the new rules, and of course existing contractual promises will need to be honoured.

There’s also ongoing lack of clarity about how staff in this category are supposed to book and take time off, especially when they have the freedom to work as much or as little as they want at times of their choosing. So, while we now have a clear method of calculating the number of hours of holiday they have accrued, there’s no clearly defined way of converting that into the requisite amount of absence on annual leave.

Rules about carrying forward holiday

The draft regulations also state that workers can carry forward untaken holiday if employers don’t:

• recognise their right to paid annual leave (because, for example, they are wrongly classed as a self-employed independent contractor);
• give them a reasonable opportunity to take leave or encourage them to do so; or
• warn them of the risks of losing their annual leave entitlement at the end of the holiday year.

These carry forward rights apply to the four-week entitlement based on EU law, and are intended to restate current EU principles.

In practice, the new wording means that the risks of misclassifying someone as a self-employed independent contractor have not gone away or been mitigated. Someone who is wrongly classed as an independent contractor will continue to amass holiday entitlement, with liability only being extinguished once the employer recognises their right to paid annual leave and expressly draws it to their attention. Holidays cannot be carried forward beyond the end of the first full leave year in which the employer observes these rights. It’s important to remember that there’s no two-year limit in place in this scenario (as there is for claims for miscalculated holiday pay).

Rules about carrying forward accrued holiday missed due to sickness or maternity leave

Current EU caselaw allows workers to carry forward holidays they have accrued but were unable to take due to being on sick leave or family leave. Again, the government plans to write the current rules into legislation, although it is introducing some helpful clarity about the long stop deadline for taking holiday an employee was unable to take due to sick leave. Going forward:

• Workers will be able to carry forward their whole 5.6 weeks’ statutory annual leave entitlement into the next holiday year if they can’t take it due to family leave.
• Workers will be able to carry forward their four weeks’ EU-based annual leave entitlement if they can’t take it because of sick leave but this must be used up within 18 months of the end of the holiday year in which the entitlement originally arose. This will helpfully limit the ability of employees who have been on long term sick leave for many years to accrue a huge entitlement requiring payment on termination of employment.

Who counts as an irregular hours worker or part-year worker?

As explained above, for workers in this category, rolled up holiday pay will be allowed and there’s a new accrual system. How are these workers defined?

• Irregular hours worker: if the number of paid hours that they will work in each pay period is, under the terms of their contract, “wholly or mostly variable”. Note that this covers people with an irregular number of hours – workers whose hours are fixed but whose working pattern is irregular are not included.
• Part-year worker: if they are required to work only part of the year, with periods of at least a week which they are not required to work and for which they are not paid. This covers term-time workers such as the teacher in Harpur but also others, for example some seasonal workers.

There is likely to be some uncertainty about which workers fall within these definitions. Some casual workers are engaged on an assignment-by-assignment basis with no relationship between assignments. Whether these workers are caught will require careful analysis of the terms during each assignment and of any umbrella or overarching contract.

Where does the 12.07% come from?

12.07% is the statutory minimum holiday entitlement in a year (5.6 weeks) expressed as a percentage of the number of working weeks in a year (46.4 weeks). Using 12.07% to calculate holiday entitlement or pay for irregular hours or part-year workers keeps their entitlement in line with that of a regular full-time worker.

What about Northern Ireland?

Employment law is devolved to Northern Ireland so the new holiday rules will not apply there.

What should employers do now?

Employers should start reviewing their current approach to holidays against this new system:

• If you have populations of workers who are paid overtime, commission, or allowances etc then double check that this is being factored into their holiday pay correctly.
• If you want to pay holiday at different rates then you’ll need a system for identifying which type of holidays are which. This has been made more problematic by the recent Supreme Court ruling in Agnew, but we think it’s still possible to direct that holidays are used up in a particular order by setting this out clearly in a contract or policy.
• If you have workers who count as irregular hours or part-year workers, then review your approach against the new accrue-as-go system. You can contact us for more details about the rules for accruing holiday during sickness and family leave.
• Do you want to move to rolled up holiday pay for any populations? Check eligibility and consider what systems you can put in place to ensure compliance.
• Do you remind workers to use up their holiday entitlement and give them sufficient opportunity to do so? If not, they stand to benefit from the newly-explicit rules about carrying unused leave entitlement forward.
• What is your current policy on accruing holiday during sick leave and maternity leave? Is it in line with the new rules?
• Will any contracts or policies need changing?

Please contact us if you’d like support or further advice on getting to grips with the new regime.

The government’s response to the consultations about holiday reform can be found here and the draft regulations are available here.