By Vaughan Granier
The leave that your employees accrue during the year is calculated on the basis that all employees should receive equal to four weeks of paid annual leave per year of work. But there are some limited circumstances where annual holiday entitlements must be applied differently. Usually, this occurs when you employ someone on a fixed-term contract to work for you for less than 12 months, or when you employ someone on a casual contract who works so sporadically that it doesn’t make sense for them to accrue paid annual holidays. If this sounds confusing to you, don’t worry – you’re not the only one. And you’ve come to the right place for help!
I previously explored the dynamics of annual leave entitlements for casual workers in this blog on the challenge of managing casual contracts. In this article, I’ll focus on the complexities surrounding annual leave entitlements and fixed-term contracts. I’ll draw on two common problems I see employers face when using fixed-term contracts to offer some practical advice on how you can avoid some of the pitfalls in this tricky area of the Holidays Act.
The three types of fixed-term contracts
When it comes to annual holiday requirements, fixed-term contracts can be devious for several reasons. Firstly, because they create a situation where holiday pay must be processed differently compared to most other workers. Secondly, because there’s a very real risk that a fixed-term employee may continue to work for more than 12 months, which among many other concerns, will impact your obligations to that employee under the Holidays Act. Thirdly, there are three different variations of a fixed-term contract and holiday pay rules can vary across these different categories.
The three types of fixed-term contract are:
- Fixed-term employees of less than six months duration;
- Fixed-term employees of between six to 12 months duration; and
- Fixed-term employees of greater than 12 months duration.
The challenge of annual leave calculations for fixed-term workers
The main cause of problems when calculating annual leave for fixed-term workers is that paid annual leave is usually only an entitlement after 12 months of service. Fixed-term work is based on the expectation that you only need the employee for a short period of up to a year.
Before those 12 months are up, annual leave can be “earned” by an employee, but it can’t be used as leave. The Holidays Act 2003 provides an alternative way for a fixed-term employee to earn annual leave on a pay-as-you-go (PAYG) basis before their 12 months of service is up.
PAYG and annual leave under the Holidays Act 2003
PAYG holiday entitlements are calculated as 8% of gross earnings. This payment can be either paid out in each pay run or saved up to be paid out on termination of the fixed-term contract.
Section 23 (s23) & section 24 (s24) of the Holidays Act 2003 (the Act) are rigid in their application of the law for holiday pay, stating:
- when an employee works for less than 12 months, they should be paid out PAYG entitlements at 8% of their gross earnings in each pay run; and
- when an employee is entitled to holidays (i.e. works longer than 12 months), the employer “…must pay the employee for the portion of the annual holiday entitlement not taken…”.
In layman’s terms, this means that when an employee’s service crosses over 12 months, the law automatically entitles that employee to four weeks paid annual leave.
s24 permits you to deduct from your employee’s final pay for annual leave already taken. But there’s no mention of any permission for you to deduct for PAYG already paid. So, you could be liable for four weeks accrued annual leave in addition to the 8% PAYG leave you have already paid out if your employee continues to work for you beyond the initial 12 months of service.
Applying holiday entitlements to different fixed-term arrangements
If we go back to the three different types of fixed-term contracts, you can see below how PAYG entitlements apply according to the duration of the agreement:
- A fixed-term employee on a contract, fewer than six months, will never be entitled to take annual leave – they simply will not work with you for long enough. So, they can earn their annual leave as PAYG leave which can be paid out in each pay run, or as a lump sum at the end of their contract.
- A fixed-term employee who will work for between six to 12 months won’t be able to take annual leave as a paid holiday (unless there is a renewal or an extension of the contract) because it’s not expected that they’ll be working for you for more than a year. Similar to the first contract type, your employee on a six to 12-month fixed-term contract can earn their annual leave as PAYG leave which can be paid out in each pay run, or as a lump sum at the end of their contract.
- A fixed-term employee whose fixed-term contract may last for longer than a year will, according to s23 of the Holidays Act 2003, be entitled to take annual leave after 12 months. In this case, if you’re paying 8% PAYG leave in each pay run without proper process and a clear written agreement, you’re at risk of having to pay your employee for annual holidays on top of PAYG leave.
These three methods of calculating annual leave according to the fixed-term duration appear straightforward. However, they can become complicated if you’re not fully aware and prepared for some of the difficulties of managing fixed-term contracts. Let’s look at two of the most common challenges employers who engage fixed-term workers can face.
Challenge 1: when a fixed-term contract continues over 12 months
Fixed-term contracts can easily be rolled over without a formal agreement. This is especially common when your employee’s termination is linked to the completion of a project. It’s also a risk in seasonal workforces where fixed-term contracts for short-term work are common.
Remember how you can only use the PAYG leave payments while a fixed-term contract remains under a 12-months duration? If your employee continues to work beyond their 12 month fixed-term contract for any reason, and there’s no written agreement in place to clearly stipulate the reason, terms, and expectations for the extension of service, you’ll have to pay for annual leave twice: once as the 8% PAYG arrangement, and then again to meet the four weeks paid annual leave that your employee is now entitled to after 12 months’ continuous employment.
On top of having to pay the additional annual leave, you may also be found to be in breach of the Holidays Act 2003 and penalised for not having the record-keeping required to support the consecutive rolling over of a fixed-term contract.
My advice here is to monitor your fixed-term agreements closely and to normalise the accrual of leave as the standard way to comply with the Holidays Act requirements. This means that when a contract of less than 12 months terminates, you’ll pay out the accumulated balance of annual leave on termination. This way, if the arrangement extends over 12 months, you’ll never be caught in a position where you owe four weeks paid annual leave on top of the 8% PAYG leave that you have already paid out.
Challenge 2: when a fixed-term contract is not genuine
Another common problem with managing fixed-term contracts arises when the nature of work isn’t genuinely fixed-term. Sometimes fixed-term agreements are used to get around probation period requirements, which is not an acceptable use of a fixed-term contract. A fixed-term contract may also be misused by an employer when the future is uncertain (COVID-19 is an example of this) to avoid the long-term commitment and costs of a permanent agreement. However, even if you terminate a fixed-term contract “correctly” (in terms of the actual wording of the contract) you may still be liable to a personal grievance for unfair dismissal.
When a fixed-term arrangement is not genuine you risk ending up with an employee whose service crosses over the 12-month fixed-term period and the same issues will apply as above: the employee will be entitled to four weeks paid annual leave on top of the PAYG leave payments, and your business will be at risk of penalties for breaching the Act.
The easiest way to mitigate risk in this situation is to make sure your fixed-term agreements are genuine. Genuine reasons include:
- you hire the employee to cover a seasonal period or a period of leave taken by another employee e.g. parental leave; or
- you hire the employee to fulfil extra resourcing for a specific project.
It’s best practice to regularly review all your existing fixed-term employment contracts to make note of any that are getting close to the 12-month end date. HR Assured clients can use the Document Reminder and Notes tools in the HRA Cloud to set a reminder for when it’s time to review a fixed-term arrangement. If there’s any chance that your employee’s contract will be extended for more than 12 months, you should proactively set out to update your written agreement. By doing this you can give evidence for the extension and stipulate that annual leave will be accrued and be paid out on termination instead of PAYG leave. There won’t be much you can do about PAYG leave already paid out – there is no mechanism to set it off against accruals. To avoid any uncertainty, it’s always best to be clear in your employment agreements about the structure for annual leave accrual.
If you’re an HR Assured client and you have any doubts about managing annual leave and holiday entitlements across different employment categories, contact our dedicated Telephone Advisory Service at any time, day or night, for advice.
If you’re not yet an HR Assured client, you can try our award-winning Telephone Advisory Service by contacting our team here for a complimentary, no-obligation consultation.
Vaughan Granier is the National Workplace Relations Manager for HR Assured NZ. He has over 24 years of experience in international human resources, health and safety, and workplace relations management. With over 10 years working in New Zealand and Australian companies, he provides in-depth support to leadership teams across all areas of HR, Health and Safety, and employee management.