Contractors who agree to work via an umbrella company in response to the Off-Payroll legislation must take precautions to ensure that they are receiving their full holiday pay entitlement.
In a bid to circumvent their compliance requirements under the Off-Payroll legislation, many contractor clients are imposing blanket bans on the engagement of limited companies, instead insisting that contractors provide their services via an umbrella company.
However, there is no statutory definition of an umbrella company, neither of how one should behave, despite calls from trade bodies to regulate the industry. As a result, there has been an emergence of payroll companies masquerading as umbrella companies without fulfilling the umbrella obligations.
As a by-product of these factors, there are reports that some contractors are bearing the brunt as a minority of unscrupulous firms adopt underhanded measures to increase their profits by withholding holiday pay entitlements. This is an issue which could snowball unless awareness is raised about the correct treatment of holiday pay by these payroll companies.
How do firms withhold accrued holiday pay?
Umbrella company holiday pay is paid out via one of two methods, both of which have been subject to reported abuse by non-compliant firms. The first is the accrued holiday pay model, whereby the umbrella company accumulates the contractor’s holiday pay entitlement and pays it to the contractor upon request.
“The accrued holiday pay model is the default model adopted by many umbrella companies and contractors should find this to be clearly defined in their employment contract,” notes Professional Passport CEO Crawford Temple.
A major criticism of this model is the fact that the contractor is required to claim any outstanding holiday pay by taking holiday from the umbrella company before the end of the year. If they fail to do so, they will lose the unclaimed entitlement. This is a stipulation that can be exploited by unethical umbrella companies, who simply fail to inform contractors of their entitlements.
“Paid annual leave is accrued throughout the leave year then taken as paid leave by agreement with the employer,” notes Martyn Valentine of The Law Place. “Unused annual leave doesn’t get carried over to the next leave year so it's imperative that all paid leave is correctly used.”
The Off-Payroll legislation has contributed to a rise in the use of payroll companies, as a result of blanket bans on limited companies imposed by clients. This results in contractors adopting an unfamiliar new working model, many of whom will be unaware of the fact that they are required to claim their paid holiday entitlement or lose it.
Temple argues that the underhanded approach taken by some umbrellas reinforces the importance of engaging accredited providers for contractors: “Some umbrellas aren’t entirely transparent when it comes to accrued holiday pay, and many won’t automatically pay out a contractor’s entitlement when they should be.
“This is why industry accreditation is a crucial characteristic for any contractor to look for when considering an umbrella company. A key requirement of the Professional Passport accreditation is that any outstanding holiday pay must be paid to contractors automatically when they leave.”
Rolled-up holiday pay model subject to reported abuse
The rolled-up holiday pay model has also been subject to some reported abuse. Here, the contractor’s holiday entitlement is accounted for and included in their payslip each month, with the logic being that the contractor then sets aside the amount paid to fund future time off. However, as Valentine explains, the payment structures put in place for some contractors are enabling abuse:
“A lot of umbrella contractors receive the bulk of their income in ‘commission’, which is included in their invoice and paid on top of a national minimum wage contract rate. Unfortunately, some umbrella companies that are paying holiday pay on a rolled-up basis are only calculating holiday as a portion of the minimum wage rate, when they should be determining it as a portion of the effective contract rate when commission is considered.”
One saving grace for contractors subject to this strategy is that it is difficult for the umbrella company to mask, as Temple highlights: “Holiday pay should always be calculated on the gross taxable pay. The usual percentage for 28 days entitlement is 12.07%. Umbrellas adopting this pay model are expected to clearly state the holiday sum on each payslip, so it should be fairly obvious to a contractor when they are receiving an insufficient holiday pay entitlement.”
Withholding holiday pay is unlawful
“Holiday pay certainly cannot be withheld,” says Valentine, who notes that doing so would be in breach of Regulation 13 of the Working Time Regulations (WTR) 1998, which determine a worker’s entitlement to annual leave.
“It’s also inconsistent with the calculation of holiday pay with reference to a weeks’ pay, as defined in the Employment Rights Act (ERA) 1996,” adds Valentine, alluding to the statutory entitlement of 28 days paid leave from the 52-week calendar year.
Valentine also notes that, following the Employment Tribunal (ET) case of British Gas Trading Ltd v Lock and anor , it is unlawful for umbrella companies to omit commission from holiday pay calculations. In a decision that was subsequently upheld by the Court of Appeal, the ET ruled that Regulation 13 of the WTR should be interpreted compatibly with the EU Working Time Directive so as to include commission payments in the calculation of holiday pay.
How to prevent withholding of holiday pay
For contractors, ensuring the full payment of holiday entitlement is largely a matter of due diligence. This process begins during contract negotiations, during which Valentine recommends contractors clarify the arrangement with regards to holiday pay:
“The first step is to ensure that the contract clearly specifies the holiday pay entitlement and ensure that there’s no discrepancy between the holiday entitlement provided in the contract and the default legal position. Umbrella companies are unregulated, and so contractors who are unsure about this matter are advised not to take any chances, but instead secure legal advice.”
Contractors may also be advised to avoid umbrella companies that aren’t entirely transparent about their policy. Many compliant umbrella companies will have a clearly stated policy and will tend to avoid the accrued model in favour of the less complicated rolled-up pay model. However, Temple argues that there is value to the accrued approach:
“Contractors can achieve more income if they plan when they take their holiday pay to utilise tax savings. The accrued model, though less transparent than the rolled-up model, enables this approach.”
Meanwhile, Temple reaffirms the importance of engaging demonstrably transparent umbrella companies: “Professional Passport accreditation involves a requirement that umbrellas applying the accrued model write to contractors in the three months leading up to their holiday year-end.
“This is to inform them of their outstanding entitlement and advise that this must be taken by a certain date or it will be lost. We also have a requirement that any balance of holiday pay be shown on each pay statement given to workers.”
How to enforce a claim for unpaid holiday pay
Contractors who have already had holiday pay withheld have a number of different means of recourse. Those attempting to enforce a claim for holiday pay under the WTR will need to make a claim via an ET, though a prerequisite to any ET claim is that the contractor first raises a grievance with the umbrella company and follows its internal grievance or appeal process.
Alternatively, a contractor might make a claim under section 23 of the ERA, on the basis that failure to pay holiday pay constitutes an unauthorised deduction from wages. This method has proven successful in several cases, including that of HMRC v Stringer 2009.
A claim made for breach of contract is another potential option. However, Valentine notes that such a claim can only be made where there is an agreement between the worker and employer that holiday pay will be paid at a set rate:
“This can prove problematic because, typically, it won’t be possible for the statutory right to holiday pay to be a term of the contract unless a specific agreement to pay the amounts is reached.”