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How should holiday pay on termination be calculated? Are there any statutory rules that must be considered?
The Working Time Regulations 1998 (WTR) define entitlement to statutory annual leave. The right to holiday leave applies to "workers", not just to "employees", and includes agency workers and work experience trainees.
A worker's statutory annual leave entitlement is four weeks. According the Regulation 13 of the WTR, the only situation in which a worker's entitlement to holiday leave may be replaced by a payment in lieu is where the worker's employment is terminated.
Regulation 14 of the WTR explains how entitlement is calculated for employees who leave the employment part way through the holiday year. Entitlement involves a calculation using - the worker's annual holiday entitlement expressed in days,
- the proportion of the leave year between the start of the holiday year and the day on which the termination takes effect, and
- the period of leave taken by the worker between the start of the holiday year and the day on which the termination takes effect.
Annual entitlement
A worker's annual entitlement in days depends on the number of days worked in a week. If five days are worked each week, the annual entitlement is 20 days. For three days, the entitlement is 12 days, and so on. Some employers calculate annual entitlement in hours, to suit workers whose working hours vary day by day.
Holiday year
Most employers have a defined holiday year, e.g. 1 April to 31 March. If it is not contractually defined, each worker's holiday year starts from the date the employment began, and from the anniversary of that date in subsequent years. For example, the holiday year for a worker who started on 11 October 2004 would be the year from that date, and each successive holiday year would also start on 11 October. This worker is entitled to the full four weeks statutory entitlement in the year to 10 October 2005.
Calculating entitlement
If the holiday year is defined in the contract, the entitlement to termination holiday pay is based on the period of time between the start of the holiday year and the date of termination, and the proportion that that period is to the full holiday year. The Regulations do not state how this proportion should be calculated. Many employers determine the proportion by taking the number of whole calendar months in the holiday year up to the termination date. It could more accurately be calculated by using weeks or days.
If whole calendar months are used, the calculation is:
annual entitlement in days × the number of calendar months in the holiday year up to the termination date ÷ 12
If days are used, the calculation is:
annual entitlement in days × the number of days in the holiday year up to the termination date ÷ 365, or 366 if appropriate.
From that calculation is deducted the number of days of holiday leave taken so far in the holiday year. If the result is not a whole number, it is not rounded.
If the result of the calculation is negative, the worker has "overtaken" entitlement. There is no entitlement to termination holiday pay. The employer may recover the value of the overtaken holiday, but only if the worker's contract permits it. There is no statutory right to recover overtaken holiday pay.
If the result of the calculation is positive, the worker has "undertaken" entitlement and is entitled to holiday pay on termination.
Example 1
The employer's holiday year runs from 1 April to 31 March and a 5-day worker leaves on 24 September 2004, having taken 5 days holiday in the holiday year to date.
Using months for the calculation, the worker would have entitlement to 3.33 days termination holiday pay (i.e. 20 days × 5 months ÷ 12 months = 8.33 days - 5 days already taken = 3.33 days)
Using days for the calculation, the same worker would have entitlement to 4.70 days (i.e. 20 days × 177 days ÷ 365 days = 9.70 days - 5 days already taken = 4.70 days)
Although the calculations give different results, neither is incorrect as the Regulations do not define how to calculate the "proportion". However, in some circumstances, the monthly calculation can deprive an employee of entitlement when there is clearly a "proportion" of the year to consider.
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Example 2
The employer's holiday year runs from 1 April to 31 March and a 5-day worker leaves on 22 April 2005, having taken no holiday in the holiday year to date.
Using months for the calculation, the worker would have no entitlement to termination holiday pay (i.e. 20 days × 0 months ÷ 12 months)
Using days for the calculation, the same worker would have entitlement to 1.21 days (i.e. 20 days × 22 days ÷ 365 days = 1.21 days)
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Employers who give far more than 20 paid days of holiday each year, including paid bank holidays, may feel that holiday entitlement for leavers will easily exceed the statutory entitlement. This is not necessarily the case. Taking the situation in example 2, it doesn't matter how many days contractual entitlement a worker has, the entitlement for the first 22 days of the holiday year is still nil.
Consequently, employers may properly use whole months of employment to determine holiday entitlement on termination, but care must be taken not to deny workers their statutory entitlement when the proportion of the holiday year up to the termination date indicates that there should be some entitlement.
Problems can also arise where the rate at which termination holiday is paid is less than that required by the statutory "week's pay" rules defined in the Employment Rights Act 1996. If an employee's normal earnings vary because bonuses or commissions are paid, or because of varying shift premiums, the rate of holiday pay must be based on a 12-week average, not on the employee's basic rate of pay. A basic explanation of the "week's pay" calculation appears in the DTI's PL711 booklet. See www.dti.gov.uk/er/pay/rules-pl711.htm
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