Holiday Pay and Overtime: Where SMEs Still Get It Wrong
Holiday pay might seem straightforward at first glance, but for many SMEs, it remains a common area of confusion and risk.
Changes in case law over the years have made it clear that holiday pay is not just about basic salary. Overtime, commission and other variable earnings can all come into play, and getting it wrong can lead to disputes, backdated claims and compliance issues.
This guide explains where businesses often go wrong and how to approach holiday pay correctly.
Understanding holiday pay rights in the UK
Under UK employment law, workers are entitled to paid annual leave. For most full-time employees, this is at least 5.6 weeks per year.
Holiday pay should reflect what an employee would normally earn if they were working. This principle is key, particularly when pay varies from week to week.
How holiday pay is calculated
For employees with fixed hours and pay, holiday pay is usually straightforward.
However, for those with variable pay, calculations must take into account average earnings over a defined reference period. This typically includes:
- Regular overtime
- Commission payments
- Certain bonuses linked to performance
The aim is to ensure employees are not financially disadvantaged when taking leave.
The role of overtime in holiday pay
One of the most common areas of misunderstanding is how overtime should be treated.
Regular overtime
If overtime is worked regularly, even if it is not guaranteed, it is generally expected to be included in holiday pay calculations.
Voluntary overtime
Voluntary overtime can also need to be included if it is worked consistently over time. The key factor is whether it forms part of ‘normal pay’.
Commission and bonuses
Commission and some bonuses, particularly those directly linked to work performed, should also be reflected in holiday pay. These elements ensure that employees receive a realistic representation of their usual earnings during leave.
Why the rules have changed
A number of legal rulings over the years have clarified that holiday pay should reflect normal remuneration, not just basic pay. These decisions were designed to prevent employees from being discouraged from taking leave due to financial loss. For employers, this means holiday pay calculations must be more comprehensive than they once were.
Common mistakes SMEs still make
Despite clearer guidance, many businesses continue to make avoidable errors. One of the most frequent issues is failing to include overtime that forms a regular part of an employee’s earnings. Holiday pay for variable workers should be calculated using the correct averaging period. Using outdated or inconsistent timeframes can lead to underpayment.
Confusion between workers and employees can result in incorrect entitlements being applied. Each of these mistakes can create compliance risks and potential financial liability.
The risks of getting holiday pay wrong
Errors in holiday pay are not just administrative, they can have serious consequences. Incorrect payments can lead to complaints, grievances and a breakdown in trust.
Employees may also bring claims for unlawful deduction of wages, which can be time-consuming and costly to resolve. They may also be required to repay underpaid holiday over a period of time, creating unexpected financial pressure.
Best practice for SMEs
To reduce risk and ensure compliance, businesses should take a proactive approach.
- Review how holiday pay is currently calculated
- Ensure overtime, commission and bonuses are assessed correctly
- Use appropriate reference periods for variable pay
- Keep clear and accurate payroll records
- Regularly review policies in line with current guidance
Taking these steps helps ensure consistency and reduces the likelihood of issues arising.
How The HR Dept can support your business
Holiday pay is an area where small mistakes can quickly escalate into larger issues. By reviewing your approach and ensuring it reflects current legal expectations, you can protect your business and provide clarity for your employees.
Holiday pay calculations can be complex, particularly as employment law continues to evolve. The HR Dept works with SMEs to review payroll practices, update policies, and ensure compliance with current regulations.
From HR audits to ongoing advisory support, we help businesses understand their obligations and implement practical solutions.
