How do you calculate holiday pay in the UK?

What is the issue?

All employees in the UK are entitled to a minimum of 5.6 weeks (28 days) paid holiday in each year. But how much pay should an employee receive whilst he is on holiday? Should it just be base salary, as historically provided for by UK legislation? Or should holiday pay correspond to “normal remuneration” and, accordingly, take account of payments that are intrinsically linked to performance of the employee’s role such as overtime and commission? In other words, should the pay that an employee receives during holiday parallel the pay that he would ordinarily receive if he was attending work?

The question of how an employer should calculate holiday pay in the UK has been the subject of numerous litigation battles conducted at both a domestic and European level. In short, the cases are following a trend: holiday pay should equate to pay that is normally received by an employee.

On 25 March 2015, we received the most recent installment in the string of holiday pay judgments when the Employment Tribunal (“ET”) issued its decision in the case of Lock v British Gas Trading Limited. This case is key for many US businesses because it focused on the issue of whether or not commission payments should be included in holiday pay calculations. If you have a sales team based in the UK, this is an issue to have firmly on your radar.

What was the question in Lock?

Mr Lock’s claim was for unlawful deduction of wages based on holiday pay being calculated only on his basic salary in accordance with the UK Working Time Regulations (“WTR”) and not including a payment for commission he had earned for “live” sales. This commission was a significant part of his remuneration package. For workers who have normal working hours, as Mr Lock did, the black and white wording of the WTR only permits payments other than basic salary to be taken into account in holiday pay in specific and limited circumstances. These circumstances do not include commission paid for success (i.e. a payment such as Mr Lock received for closing a sale).

The European Court of Justice (“ECJ”) had previously held that this was contrary to the Working Time Directive (“WTD”), being the European level legislation from which the WTR is derived. The WTD required that Mr Lock should be paid his normal remuneration i.e. his basic salary and a payment reflecting his sales commission. If not, Mr Lock would suffer an adverse financial impact potentially deterring him from actually taking holiday. The question for the ET was therefore whether the UK rules on calculating holiday pay, provided for in the WTR, could be interpreted to give effect to the ECJ decision.

So what did the Employment Tribunal say?

• A worker should receive his or her “normal remuneration” during the four weeks statutory holiday provided for in the WTR derived from Europe (although not during the additional 1.6 weeks of holiday provided by UK law).
• To achieve this in Mr Lock’s case, a new regulation should be read into the WTR which essentially required Mr Lock’s holiday pay to be calculated as if he fell within the category of workers whose weekly pay varied by the amount of work done. This calculation already takes into account any additional payment made to a worker reflecting the amount of work done in a specific time frame (along with basic salary).
• Further hearings would be held to determine any holiday pay that Mr Lock had not received taking into consideration the facts of his case, including the terms of the commission scheme operated by British Gas. 

What are the key points for employers?

• This ET decision is itself unsurprising and is in line with other cases that holiday pay must reflect “normal remuneration” and is limited to the four weeks statutory holiday derived from European law (and not the additional 1.6 weeks provided by UK law).
• Of more interest for those grappling with revising their holiday pay calculations will be the issues still to be determined in this case and the light an ET may shed more generally on this area:
  • The ECJ has already indicated that commission such as Mr Lock’s (here it was roughly 60% of his remuneration package) should be reflected in holiday pay as being part of his normal remuneration. Would that conclusion be different if the commission element was significantly less or payments were perhaps less regular?
  • Was the British Gas commission scheme already structured to compensate him for holiday periods so there was no unlawful deduction in respect of holiday pay? This was an issue expressly left open by the ET in Mr Lock’s case to be considered at a future date.
  • Should the subsequent hearing find that there was an unlawful deduction in respect of holiday pay, the thorny question arises as to how the commission element of holiday pay will be calculated. This is potentially controversial given the fluctuating nature of commission payments and the scope for employees to thereby manipulate the system to take holiday when the commission element of their holiday pay will be at its highest (this is a matter for a later hearing but it is possible that there will be a 12 week reference period).
  • If there is found to be an unlawful deduction of wages will the ET try to limit the scope of such claims?
• It is also notable that the ET decision expressly states that “this case does not concern whether any other form of remuneration (such as discretionary bonuses, for example) ought to be taken into account in determining holiday pay“. This leaves open the question of what is a “similar payment” to commission. 

Conclusion

In the immediate term, the Lock decision unfortunately does not provide employers with the additional clarity needed on how commission (and indeed, other similar payments) should be reflected in holiday pay. What is notable is the explicit reference to a scheme being structured in a way that the commission element of holiday pay is already taken into account and it will be interesting to see how a subsequent hearing deals with this and, as relevant, any applicable reference period for calculating the commission element of holiday pay.

However, what is clear is that any US employer that pays commission (or any other form or variable remuneration) to its UK will need to keep a careful eye on the developments and the implications for commission schemes and remuneration structures.