Counting the Cost: The Hidden Problem of Underpaid Holiday Pay

It's that time of year when thoughts turn to taking a summer holiday. One of the perks of being an employee is the right to paid holiday. But many employees are unaware that in taking holiday they could actually be losing pay. The reason for this is a little publicised change to the law on holiday pay that occurred two years ago.

The new holiday pay rules

First, some background. The Working Time Regulations 1998 (WTR) gives every worker the right to 5.6 weeks’ paid statutory annual leave. When calculating holiday pay, an employer is first meant to work out a week’s pay using an average of the worker’s pay over a 52-week reference period. New rules introduced on 1 January 2024 mean that variable remuneration must now be taken into account when determining an employee’s weekly pay for holiday pay purposes. 

The rules confirm that the following types of payment should be included in the definition of a week’s pay:

• payments, including commission payments, intrinsically linked to the performance of tasks which a worker is obliged under their contract to carry out;

• payments for professional or personal status relating to length of service, seniority or professional qualifications; and

• payments, such as overtime payments, which have been regularly paid to a worker in the 52 weeks preceding the calculation date.

Due to a quirk of law, this requirement only applies to 4 weeks of the statutory annual leave entitlement. This is because the new rules were designed to codify the established position under EU case law and therefore only relate only to the EU law derived portion of a workers’ holiday entitlement (4 weeks’ holiday). 

Risks to employers of the ‘wait and see’ approach

Despite the introduction of the new rules, it seems that many employers are either unaware of this change in the law on holiday pay or have chosen to ignore it. This may be down to reluctance to change existing processes or due to the impact that the pay calculations will have on the overall wage bill. 

Some employers may be adopting a ‘wait and see’ approach in the hope that employees remain ignorant of their holiday pay rights. However, such an approach is risky. 

Firstly, any employee who has been underpaid holiday pay may bring a claim for underpaid holiday pay in the employment tribunal. This is usually done as a claim for a series of deductions from wages. Such claims have a backstop of two years. This means that the employee can only claim for two years’ underpayment of holiday. Even with that limit, an employer could potentially be facing quite a significant bill for underpaid holiday pay, particularly if a significant amount of its employees regularly receive variable remuneration. 

Secondly, employees also have the right to bring an alternative claim against their employer for failure to pay holiday pay correctly in line with the WTR. Where an employee succeeds in such a claim, the employment tribunal will order payment of the amount due.

Thirdly, there is now a new enforcement authority aimed at reducing holiday pay underpayment. The Fair Work Agency established on 7 April 2026 will enforce statutory annual leave entitlement and the payment of statutory holiday pay. These powers are expected to come into force during 2027.

What employers should do now

Given the litigation and enforcement risks, the prudent employer should take timely steps to calculate and pay employees’ holiday correctly. There's another benefit to employers who do so. 

The three-month time limit for an employee to bring an unlawful deductions claim starts to run from the last date on which holiday pay was underpaid. A holiday pay claim under the WTR must be brought within three months of the date when the specific payment fell due. This means that any employer who starts to pay holiday pay correctly starts the clock running for an employee to bring a claim in time.

Making an assessment of exactly what elements of variable remuneration should be included in holiday pay calculations is complex. For elements that are routinely paid, such as commission and shift allowances, the position is likely to be clear. However, for elements that are paid infrequently, such as overtime or bonuses, the position will require specific legal analysis. Legal advice is recommended. 

Getting holiday payments right will ensure that every employee can have a happy holiday.

For further advice on calculating holiday pay correctly, please contact Kathleen Bada in the Employment team at Charles Russell Speechleys.