Does our way of calculating holiday entitlement on termination, based on whole months of service, meet the statutory requirements?

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.

The following guidance applies to holiday years starting April 2009 or later and relates specifically to a worker’s statutory leave entitlement.  A worker’s statutory annual leave entitlement, including paid customary holidays, in a holiday year is 5.6 weeks.

Where workers are entitled to more than 5.6 weeks in a holiday year, employers may use any method they wish to calculate holiday entitlement on termination for the extra contractual entitlement.  In practice, employers generally use the same calculation method for all holiday leave, whether it is statutory or contractual.

According to Regulations 13 and 13A 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 calculating the proportion of the holiday year between the start of the holiday year and the day on which the termination takes effect, applying that proportion to the 5.6 weeks’ annual entitlement and then reducing that entitlement by the period of paid leave already taken by the worker in that period.

Annual entitlement

A worker’s annual entitlement is commonly expressed in days, depending on the number of days worked in a week.  If five days are worked each week, the annual entitlement is 28 days (5.6 × 5).  For three days, the entitlement is 16.8 days (5.6 × 3), and so on.  (Note that the maximum number of statutory days’ entitlement for a 6-day worker is 28 days.)

Some employers, however, calculate annual entitlement in hours, to suit workers whose working hours vary day by day.  If 30 hours are worked each week, the annual entitlement is 168 hours (5.6 × 30).  If weekly hours are 18, the entitlement is 100.8 hours (5.6 × 18), and so on.

Holiday year

Most employers have a defined holiday year, e.g. 1 April to 31 March.  If it is not defined contractually, 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 9 October 2011 would be the year from that date, and each successive holiday year would also start on 9 October.  This worker is entitled to the full 5.6 weeks statutory paid leave in the year to 8 October 2012.

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 as appropriate).

From the result of that calculation is deducted the number of days of holiday leave taken so far in the holiday year.  The result of the calculation is left with any decimal fractions, not rounded up or down.

If the result of the calculation is negative, the worker has “overtaken” entitlement.  There is no entitlement to termination holiday pay.  There is also no statutory right for the employer to recover overtaken holiday pay.  The employer may recover the value of the overtaken holiday, but only if the worker’s contract permits it.  If there is no such contractual provision, any recovery by the employer from termination payments is an unlawful deduction from wages.

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 25 September 2011, having taken 5 days holiday in the holiday year to date.

Using whole months for the calculation (i.e. the 5 months from April to August), the worker would have entitlement to 6.67 days termination holiday pay (i.e. 28 days × 5 ÷ 12 = 11.67 days – 5 days already taken).

Using days for the calculation (i.e. the 178 days from 1 April to 25 September), the same worker would have entitlement to 8.65 days (i.e. 28 days × 178 ÷ 365 = 13.65 days – 5 days already taken).

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 altogether when, in reality, there is clearly a “proportion” of the year to consider.

Example 2: The employer’s holiday year runs from 1 April to 31 March and a 5-day worker leaves on 24 April 2011, 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. 28 days × 0 ÷ 12).

Using days for the calculation (i.e. the 24 days from 1 to 24 April), the same worker would have entitlement to 1.84 days (i.e. 28 days × 24 ÷ 365).

Employers who give far more than 28 paid days of holiday each year, including paid customary holidays, may feel that holiday entitlement for leavers will easily exceed the statutory entitlement.  This is not necessarily the case.  Taking the situation using whole months in Example 2, it doesn’t matter how many days contractual entitlement a worker has, the entitlement for the first 24 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 when there is clearly a proportion of the holiday year up to the termination date for which there should be some entitlement, but the calculation results in no entitlement.

Regulation 35 does not allow employers to contract out of any of the WTR rights unless that is specifically permitted by the WTR, i.e. under the provisions of a collective or workforce agreement.  There is no such provision with regard to Regulation 14 of the WTR, so not to provide some paid leave in the situation described in Example 2 could be found by a tribunal to be in breach of the Regulations.

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.