There have been significant recent developments to the rules on annual leave, with a decision from the Supreme Court of the United Kingdom followed by the publication of the draft Employment Rights (Amendment, Revocation and Transitional Provision) Regulations 2023 (the Employment Rights Regulations). We take a look at these regulations and what employers should be doing to prepare.

Background and timings

The Government previously consulted on the law on holidays in two consultations 1) on retained EU employment law reform and 2) on calculating holiday entitlement for part-year and irregular hour workers. It has now published its response to these shortly followed by the draft Employment Rights Regulations amending the Working Time Regulations 1998 (WTR).

The regulations are in draft form, but substantive changes are not expected. Once passed the Employment Rights Regulations are due to come into force on January 1, 2024, but the new regime for irregular hours workers and part-year workers (referred to below) will apply in respect of any leave years beginning on or after April 1, 2024.

Note the relevant provisions in respect of holiday in the new regulations apply to Great Britain (England, Wales, and Scotland) only as employment law is devolved to Northern Ireland.

Why are changes being made?

The Government has said that it is taking advantage of the opportunities offered by the Retained EU Law (Revocation and Reform) Act 2023 to remove unnecessary bureaucracy and simplify the rules on holiday (as currently these areas are too onerous or complex for employers), and to restate certain principles derived from EU law to ensure employees’ rights are maintained. While the Government’s intention is noble, unfortunately the Employment Rights Regulations do anything but simplify the rules on holiday and perhaps on second glance seem to go further than a mere restatement.

1) Unfortunately, the Government did not proceed with its proposal to create one composite pot of annual leave – leaving much of the existing complexity on holiday entitlement and pay.

Currently, all workers are entitled to 5.6 weeks of statutory leave – divided into four weeks derived from EU law (EU-Derived Leave) and an additional 1.6 weeks derived from domestic laws (Additional Leave), with different sets of rules for each pot (e.g., in respect of pay and carry over). Combining these into a single composite pot with consistent rules would have been a welcome simplification. Unfortunately, the Government decided against this approach – leaving a headache for employers.  

2) The Government is codifying categories of payment into the WTR that should be included when calculating holiday pay, with the intention of restating the principles from retained EU and domestic case law regarding “normal remuneration.”

Currently, Additional Leave is paid under specific rules of the WTR whereas payment for EU-Derived Leave has been interpreted more broadly – and often more generously – as requiring the employees receive their “normal remuneration” (which can include payments such as overtime and commission as set out in various retained EU and domestic case law).

The Government clearly intended to codify the principle of receiving “normal remuneration” into the WTR (although the Employment Rights Regulations do not actually refer to this phrase). From January 1, 2024, holiday pay calculations for EU-Derived Leave must include:

• payments, including commission payments, that are intrinsically linked to the performance of tasks which a worker is obliged to carry out under the terms of their contract;
• payments for professional or personal status relating to length of service, seniority or professional qualifications;
• other payments, such as overtime payments, that have been regularly paid to a worker in the 52 weeks preceding the calculation date.

This approach may seem consistent with the current principles at first glance, but on a closer look there are subtle, but potentially significant, differences. This unfortunately creates new points of uncertainty for employers as to what specific payments are included. It will be left to the domestic courts to interpret their meaning. For example, do annual discretionary bonuses count, if they are payments intrinsically linked to the performance or tasks which a worker is obliged to carry out? What does it mean in practice that a payment has been “regularly paid to a worker” – how regular is regular?

Note the law in relation to calculating holiday pay for Additional Leave is not changing – so this distinction remains. Following Agnew, if employers want to distinguish between the two types of leave by paying the different rates of holiday pay, they will likely need to set this out in contracts or policies.

Also, these types of payments are also to be included in respect of holiday pay calculations for irregular hours and part-year workers in respect of leave years beginning on or after April 1, 2024 (see below).

3) The circumstances in which unused holiday may be carried over into later leave year(s) from retained EU and domestic case law are to be written into the WTR.

The current default position regarding carry over of leave under the WTR is: (1) EU-Derived Leave may only be taken in the leave year in which it accrues so cannot be carried over (save for some limited exceptions made during the Covid-19 pandemic); and (2) Additional Leave may be carried forward into the next leave year if permitted under a relevant agreement (e.g., an employment contract). These differences are unhelpful in practice but remain in the law. 

Over the years, courts have interpreted the WTR to permit workers to carry over annual leave in additional circumstances. The Employment Rights Regulations aim to write into the WTR these decisions by creating statutory rights to holiday carry over, which are effective from January 1, 2024. Broadly speaking, workers will now be able to carry over:

• Both EU-Derived Leave and Additional Leave (so the full 5.6 weeks) into the following leave year if the worker cannot take leave due to being on statutory leave (such as maternity, adoption or shared parental leave etc.).
• EU-Derived Leave (four weeks) if the worker has been prevented from taking the leave in a leave year due to sickness – but it must be used within 18 months of the end of the leave year in which it accrued.
• EU-Derived Leave (four weeks) when the employer has failed to either: (a) recognize the right to take holiday or be paid for it; or (b) give the worker a reasonable opportunity to take holiday or failed to encourage them to do so; or (c) inform the worker that any leave not taken will be lost. Such leave is carried over indefinitely but must be used by the end of the first full leave year in which the employer has not failed to do the above.

The rights to carry over applicable to EU-Derived Leave will also apply to the full leave entitlement under the new holiday regime for irregular hours workers and part-year workers for leave years beginning on or after April 1, 2024 (see below) – providing a more generous right of carry over. In addition, for these workers a relevant agreement may provide for “part” of the annual leave to be carried forward into the next leave year in which it accrued – although it is not clear what “part” means in practice.

Giving the codification of these principles, it is ever more important for employers not just to permit workers to take their paid annual leave, but to actively and transparently encourage workers to take their leave, to pay workers correctly for holiday they take, and to keep workers up to date about when untaken leave will be lost. In the event the employer fails to do this, there could be costly claims for underpayment of holiday pay.

4) There is now a whole new regime for holiday entitlement and pay for irregular hours workers and part-year workers with which employers need to get to grips. This regime has a new accrual system permitting holiday to accrue at the end of each pay period at a rate of 12.07% of hours worked and permits rolled up holiday pay for these types of workers.

An entirely new regime for “irregular hours” and “part-year” workers (new concepts introduced into law) is provided for under new regulations 15B to 15F and 16A of the WTR. These new rules will be effective for any leave years beginning on or after April 1, 2024.

The rules apply to the following two types of workers:

• An irregular hours worker: in relation to a leave year where the number of paid hours that the worker will work in each pay period during the term of their contract in that year is, under the terms of their contract, wholly or mostly variable.
• An irregular hours worker: in relation to a leave year where the number of paid hours that the worker will work in each pay period during the term of their contract in that year is, under the terms of their contract, wholly or mostly variable.

But what these definitions mean in practice remains to be seen and will likely have to be considered by the courts – for example, what does “wholly or mostly variable” mean?

Other changes under this new regime include:

• Holiday accrual is now calculated in hours and as if there is one composite pot of leave. It accrues at the end of each pay period at a rate of 12.07% of the hours worked in that pay period. A “pay period” is not defined, so presumably has its ordinary meaning (e.g., a week if a worker is paid weekly).
• Irregular hours workers and part-year workers on sick leave or statutory leave (such as statutory maternity or paternity leave) continue to accrue annual leave under a new calculation set out in the regulations.
• Statutory accrued holiday is capped at 28 days, but with no guidance on what a “day” is in practical terms for workers working variable hours is another difficulty for employers.

Holiday pay under this new regime remains complicated and now employers can either:

• pay rolled up holiday pay (likely to be preferable to employers) – by paying a 12.07% uplift to the worker’s remuneration for work done in any given pay period. This payment of rolled up holiday pay must be shown as a separate item on payslips. (Note there are special rules regarding when a worker is on sick leave or statutory leave.) If the employer elects to pay rolled up holiday pay workers are still entitled to take their leave; or
• pay holiday pay when holiday is taken (which is now more complicated than ever) – calculated using a new formula that outputs an average hourly rate of pay, having first calculated a week’s pay based on a 52-week average method. This means that employers should be doing the calculation every time holiday is taken.

Whichever holiday pay option employers choose, the new codified categories of payments that need to be considered when calculating holiday pay for EU-Derived Leave (see above) will need to be taken into account for all Reg 15B leave.

5) The Covid-19 holiday carry over exception is being removed from January 1, 2024, and any holiday carried over under those rules that is unused up until that date must be used up by March 31, 2024 or it will be lost.

What should employers do to prepare for these changes?

Despite the intention to simplify and clarify the law, the new Regulations create a host of new complications for employers.

For some employers who have workers who work regular 9am-5pm days and who receive a base salary only, most changes will have limited impact on holiday entitlements and the value of holiday pay. However, for others who have varied workforces with irregular working hours or who pay additional amounts such as overtime, commission, or allowances then these new rules are likely to have a more significant impact.

Employers will need to review their approach to holiday and holiday pay, with updates potentially needed to employment contracts and non-contractual policies. Payroll practices will also need to be assessed to ensure they are aligned with the changes to the law.

In addition, employers must not just permit workers to take their paid annual leave, but to actively and transparently encourage workers to take their leave, be paid correctly for it, and to keep workers up to date to inform them when untaken leave will be lost. This will involve regular communications around leave entitlements and not just a reliance on handbooks, policies, and contractual terms. In the event the employer fails to do this, this could give rise to costly claims for underpayment of holiday pay.

As many of the changes come into effect from January 1, 2024 — and the new regime for irregular hours and part-year workers for leave years beginning on or after 1 April 2024 — there is a relatively short timeframe for employers to review their holiday practices to ensure they are complying with the law.