A recent decision in the UK Employment Appeals Tribunal (EAT) has changed the way holiday pay should be calculated in the UK. This decision not only carries cost implications for UK employers it also perfectly illustrates the primacy of European Law over UK law in certain areas.

The normal practice in the UK for many years has been to calculate holiday pay based on normal hours and basic pay. Overtime pay was not included in the equation. Court decisions, including at Court of Appeal level, had approved this approach.

Then up stepped the European Court of Justice (ECJ) in 2012 with a clarification of the European Working Time Directive. The ECJ said the Directive required holiday pay to be based on “normal remuneration”. Normal remuneration, it said, was remuneration which was “intrinsically linked” to the performance which was required under the employment contract. It should therefore include overtime, certainly where overtime was required by the contract and possibly voluntary overtime as well.

The recent EAT decision has now followed the ECJ approach and ignored the decisions of previous UK courts.

Implications

Anticipating this decision, there was real concern amongst British businesses that there could be large back claims for historic under-payment of holiday pay. This now seems less likely as the EAT ruled that claims for under-payment of holiday pay must be made within three months of the under-payment.

In addition, the overtime payment calculation should only relate to the 4 week holiday entitlement defined in the Working Time Directive and not to any additional holiday agreed with the employer.

However, there are clearly issues for employers to be aware of. First, the cost of overtime working will certainly rise. How much it will rise is less clear. There are uncertainties around how to calculate “normal remuneration” to include what may be irregular overtime work. In addition, there will be a need to distinguish for each worker whether the holiday in question is part of his or her European 4 week entitlement or some enhanced entitlement. At least for now, it would appear that it is the employer who will decide whether the holiday is the employee’s “European” entitlement or not. This may also help to keep down costs.

The final uncertainty is that the EAT decision may be appealed to the Court of Appeal, the very court that took the opposite approach in the past.

Running parallel to this question is the matter of whether employee commission payments (such as sales commissions) should be included in calculating holiday pay. A UK court decision on this matter is due in February 2015.