Post Brexit reforms – changes to holiday entitlement and pay

As part of the wider process of reviewing the current state of UK laws in the wake of the Retained EU Law (Revocation and Reform) Act 2023, the government has published draft regulations that make some significant reforms to the way in which employees and workers accrue, and are paid for, holiday “to ensure that they are fit for purpose for both businesses and workers alike”.

The Employment Rights (Amendment, Revocation and Transitional Provisions) Regulations 2023 (the “Regulations”) are set to come into force on 1 January 2024 and will go some way to addressing the complexity that employers have had to grapple with over recent years when dealing with holiday entitlement and pay.

In this Law-Now we look at the changes and what employers should be doing now to prepare.

Holiday entitlement in the UK

Under the Working Time Regulations 1998 (“WTR”), workers’ annual holiday entitlement of 5.6 weeks is split into:

• 4 weeks (Regulation 13 leave), which implements the right to annual leave under the European Union Working Time Directive (“EU leave”); and
• an additional 1.6 weeks (Regulation 13A leave), based solely on the WTR (“Additional leave”).

The distinction is significant because European and subsequent domestic case law has made clear that workers are entitled to their “normal pay" for their 4 weeks’ EU leave entitlement, which includes overtime pay, commission, and allowances. However, the 1.6 weeks’ Additional leave, in most circumstances, is limited to basic pay only.

Whilst the government initially considered amalgamating these two leave entitlements, so as to remove this potentially confusing difference in pay rates, it has decided not to do so, meaning the difference in pay rates will remain. Although many employers have already adopted processes to pay employees “normal pay” for their entire holiday entitlement, the lack of reform on this point means there is still scope to pay the Additional leave at basic pay only.

Calculating holiday pay

As noted above, the European and subsequent domestic case law has evolved to identify the types of payments which should be included when calculating “normal pay” for the purposes of a holiday pay calculation. This has required employers to look beyond the WTR to understand the categories of pay to which workers are entitled in respect of the 4 weeks’ EU leave entitlement.

The government has recognised that this had become complicated for employers and has therefore decided to incorporate the principles from the European case law into the WTR. This will be a disappointment to some employers who may have hoped that the government would take the opportunity to disapply the European case law and adopt a ‘basic pay’ position for both types of leave. However, this would have been contrary to the government’s stated intention to protect workers’ rights following the UK’s withdrawal from the European Union.

The Regulations state that holiday pay for EU leave should include:

(a)payments, including commission payments, which are intrinsically linked to the performance of tasks which a worker is obliged to carry out under the terms of their contract;

(b)payments for professional or personal status relating to length of service, seniority or professional qualifications;

(c)other payments, such as overtime payments, which have been regularly paid to a worker in the 52 weeks preceding the calculation date.

However, by simply importing the principles from existing case law, the Regulations retain the possibility for arguments about exactly which payments should fall inside and outside of each of these categories. This lack of certainty, and as there is currently no mention of guidance being published to accompany the Regulations, which would be welcome, means that these changes are unlikely to mark the end of litigation on this front.

Accrual of holidays for part-year and irregular hours workers

Another area of complexity for employers has been understanding whether, and how much, holiday accrues for workers with irregular hours or irregular working patterns. Most recently the Supreme Court judgment in Harper Trust v Brazel  set hares running when it decided that employers are not able to pro-rate the annual holiday entitlement of some part-year workers, regardless of how many weeks they actually work in a year. For further information on that decision, see: No pro-rating of holiday for “part-year workers”.

To address this, the Regulations introduce definitions of irregular hours and part-year workers and provide for their holiday to accrue at the rate of 12.07% of hours worked in the relevant pay period, up to a maximum of 28 days (i.e. the existing 5.6 weeks’ entitlement). This accrual method will apply to holiday years commencing on or after 1 April 2024.

The 12.07% figure is calculated by taking the 5.6 weeks’ entitlement and expressing it as a percentage of the number of working weeks in a year (46.4 weeks). This reflects the approach that was previously endorsed by the government and ACAS, and which has continued to be used by some employers, but which case law had found was in breach of the WTR. There are also specific rules about how leave accrues during periods of sick leave and statutory family leave.

Under the Regulations, a worker is an irregular hours worker if, under the terms of their contract, the number of paid hours that they will work in each pay period is wholly or mostly variable. A worker is a part-year worker if, under the terms of their contract, they are required to work only part of that year and there are periods within that year of at least a week during which they are not required to work and for which they are not paid.

This change, taken with the rolled-up holiday pay provisions noted below, is likely to be a welcome simplification of what was a complex area for both employers and workers alike.

Rolled-up holiday pay

Rolled-up holiday pay involves paying an employee an additional sum on top of their normal hourly rate to cover holiday pay. This practice had been deemed unlawful by the courts in most circumstances, due to the risk of disincentivising workers from taking holiday and therefore undermining the health and safety considerations that underpin the European leave entitlement. However, the government noted that rolled-up holiday is, in reality, still widely used by businesses as a simpler way to calculate holiday pay for workers on irregular hours or zero-hours contracts and has decided that the ability to do so should be written into law.

Whilst the government acknowledged the health and safety concerns, it considered on balance that there were existing “proportionate” safeguards in place, for example, in the duty on employers to provide an opportunity for workers to take leave and in the 48-hour limit on average weekly working time.

The Regulations, therefore, allow employers the choice to pay rolled-up holiday pay, but only to irregular hours workers and part-year workers; it is not an option available to all workers.  Workers will not be able to insist an employer provides the rolled-up payment, the decision will rest with the employer. As with the 12.07% accrual method noted above, the ability to pay rolled-up holiday pay will apply to holiday years commencing on or after 1 April 2024.

To be compliant, the Regulations require employers to pay holiday pay at a rate of 12.07% of the workers earnings in the relevant pay period for the full holiday entitlement and do not distinguish between EU leave and Additional leave periods. As a result, it may mean that more holiday pay is payable than under the ‘standard’ regime. The rolled-up holiday pay must also be paid at the same pay intervals and clearly marked on the worker’s payslips.

Again, this is likely to be a welcome step for employers and indeed workers, who prefer the simplicity of this approach, and employers will no longer need to worry about the possibility of their practice being challenged as unlawful. However, employers will remain responsible for the health and safety of their workers and will need to ensure that this practice does not result in employees working excessive hours and not taking their holiday entitlement.

Carry over of holidays

The Regulations also include the rights derived from case law for workers, in certain circumstances, to carry over annual leave from the year in which it accrues to the next holiday year. This includes situations where workers have not taken leave because they were on sick leave, taking maternity/family-related leave and where they were unable to carry over annual leave because their employer did not inform them of their right to take leave, or because they were not given an opportunity to take it. Again, the intention here is simply to reflect the existing case law, so there is no change to the current position and it does not require immediate action by either employers or their employees.

Actions for employers

Since their introduction 25 years ago, parts of the WTR have been substantially challenged with many employers deciding that they are not fit for purpose, due to their conflict with European Union law  and as they are unable to be interpreted in a way which reflects the changing nature of employment relationships and how employees and workers are engaged by businesses. The Regulations are a welcome step in codifying and clarifying the calculation of holiday pay and a step forward in the evolution of the right to paid holiday to meet the realities of the modern workforce and the gig economy. However, even with these changes, paid holiday entitlement, and the administration of that entitlement, remains a complex area, and no doubt challenges will arise under these new rules as they bed in.

In the immediate term, employers should consider the following:

• Reviewing holiday pay for the four weeks’ EU leave - Although the codification of “normal pay” in the Regulations is intended simply to maintain the status quo, the fact this is now written into statute means that employers who did not increase pay for the EU leave in light of the case law, will be at increased risk of claims after 1 January 2024 if they do not alter their approach. Employers with complex reward structures and multiple allowances should also take the opportunity to check that their approach to calculating holiday pay reflects the requirements of the Regulations.
• Review holiday accrual for irregular hours and part-year workers - Employers will need to identify if they engage these types of workers and, if so, review their current practices and procedures to ensure they reflect the new 12.07% accrual rules, and the different rules that apply to these workers when on sick leave and other types of leave.
• Deciding whether to operate rolled up holiday pay - Employers who decide to adopt rolled up holiday pay for their irregular or part-year workers, will need to make sure that their contractual documentation allows for this, and that they comply with the requirements of the Regulations, including adopting the correct rate for the rolled up holiday pay and that the payment is clearly marked on payslips. Employers adopting rolled up holiday pay must also ensure that this does not result in workers not taking holiday, or risk claims around health and safety and under the WTR themselves.

Co-authored by Klaudia Dybas, Trainee Solicitor at CMS.