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Annual leave calculation
There are two main circumstances where the calculation of a day's pay causes problems. Firstly, when calculating compensation for untaken annual leave when somebody leaves, and, secondly, when deducting pay for industrial action. This latter issue is dealt with in our guide 'Employer Responses to Industrial Action'. In this advice note we examine the law relating to compensation for annual leave and provide advice on how to make calculations.
Compensation under the working time regulations
Under the Working Time Regulations (WTR), when a person's employment is terminated, he or she is entitled to be paid for untaken leave which has accrued under the provisions of the regulations. An employer may also extend this entitlement to contractual leave.
Regulation 14 of the WTR sets out how an employer should work out the sum to which the worker is entitled. This is either by the means of a relevant agreement, or, if there is no such agreement, a formula is set out.
Relevant agreement
A relevant agreement is either a collective or workforce agreement, or any other agreement in writing which is legally enforceable between the employer and the worker. It should be noted that if a contractual agreement is relied on, it must be in writing and therefore an employer cannot argue that it is custom and practice to work out compensation in a certain way.
The formula under regulation 14
If there is no relevant agreement an employer must apply the formula provided which gives the number of days for which compensation must be paid and then apply regulation 16 to work out a day's pay.
Example - working out annual leave compensation under the WTR
In this case the worker works a 5 day week and therefore his leave entitlement under the WTR is 28 days. The leave year started on April 1 and he left on 15 June. He had taken 2 days leave since April 1. He has normal working hours and his pay is £300 per week.
The formula involves multiplying the annual leave entitlement by the proportion of the leave year which has expired and subtracting the number of days already taken in that leave year. Hence in this example the calculation is as follows:
(28 x 76/365) - 2 = 3.8
The next step is to work out how much this equates to in monetary terms. Under the WTR a week's pay is worked out according to sections 221 - 224 of the Employment Rights Act 1996. Once you have got to a figure for a week's pay you would need to divide this by 5, since, under the WTR a week means the number of working days in a calendar week for the employee concerned. So, in this example 3.8 days equates to £228 (£300 / 5 x 3.8)
Compensation where the working time regulations are not relevant
As stated above, if there is a relevant agreement about the compensation that will be paid for untaken annual leave, the formula in the WTR will not apply. However, in a lot of cases, the agreement will simply state that 'a day's pay' will be paid for each day of holiday which has not been taken. The issue then arises as to whether 'a day's pay' means calendar days or working days. A number of cases have been brought about this issue. The tribunals/courts in all the cases considered the provisions of the Apportionment Act 1870, the relevant provisions of which are:
Section 2 'All rents, annuities, dividends and other periodical payments in the nature of income … shall … be considered as accruing from day to day, and shall be apportionable in respect of time accordingly'
Section 5 'The word 'annuities' includes salaries and pensions'
Section 7 'The provisions of this Act shall not extend to any case in which it is or shall be expressly stipulated that no apportionment shall take place'
Below is a summary of the cases which have dealt with this issue.
Thames Water Utilities v Reynolds [1996] IRLR 186
In this case, which was before the WTR came into effect, the industrial tribunal decided that holiday pay should be based on working days rather than calendar days. In other words, a day's pay should be 1/260 of a year's salary, rather than 1/365. However, the EAT disagreed on the grounds that, as there was not express stipulation to the contrary, the Apportionment Act applied and that 'day to day' in that Act meant calendar days, not working days. Therefore, a day's pay was equivalent to 1/365 of annual salary.
Taylor v East Midlands Offender Employment [2000] IRLR 760
In this case the EAT accepted that the Apportionment Act applied but that 10 days' holiday equated to 2 working weeks and therefore there was an entitlement to 14 days' holiday. The EAT pointed out that this calculation was consistent with the definition of a week's pay set out in ss221-224 of the Employment Rights Act 1996 which is used for the purposes of calculating paid annual leave under regulation 16 of the WTR.
Leisure Leagues UK Ltd v Maconnachie EAT/940/01
In this case, the employer cited the Thames Water Utilities case as authority for saying that accrued holiday should be calculated on the basis of calendar days, rather than working days. However, the EAT said that this approach 'is at odds with the virtual universal practice in industry' and pointed out that Thames Water Utilities was heard before the introduction of the WTR which provide for a week's pay to be based on the number of hours worked in a week, rather than the number of hours in a day or week. They were also influenced by the fact that if a day's pay was worked out as 1/365 the hourly rate could end up being below the national minimum wage. They therefore held that a day's pay should be worked out using working days.
Taken together, the three cases above appear to lead to confusion. However, the two most recent cases do come to the same conclusion, albeit by a different methodology, which is that pay should be based on working days rather than calendar days.
What approach should authorities follow?
This will depend firstly on whether the authority includes a term in its contracts which states that payment for accrued holiday pay will be calculated on a specified basis (e.g. by using calendar days).
If yes:
The formula you have set out will apply.
If no:
(i.e. you make no provision at all or simply say you will pay for accrued holiday pay).
You should make the payment on the basis of working days. This will ensure that you comply with the case law as set out above. It will also satisfy the requirements of the Working Time Regulations.
Additionally, if there is no formula at present an authority could consider:
a) Reaching an agreement with the trade unions (although in reality they are unlikely to accept anything less favourable than using working days anyway), or
b) Introducing a clear formula for new staff.