By Vaughan Granier
An important decision has passed in the Court of Appeal that could affect many employers who operate commission, incentive, or bonus schemes. In this article, you’ll learn about the new guidance on ordinary weekly pay (OWP) calculations for employees who receive a commission.
Calculating holiday pay under the Holidays Act 2003
Annual leave pay is calculated, according to s21(2)(b) of the Holidays Act 2003 (the Act) as being:
“The greater of the employee’s ordinary weekly pay as at the beginning of the holiday; or the employee’s average weekly earnings for the 12 months immediately before the end of the last pay period before the annual holiday.”
To ensure annual leave is being calculated correctly for your employees you must first ensure that your payroll system has an automatic process for identifying which is “greater” – your employee’s average pay or their OWP. If this check isn’t automatic, you’ll need to perform it manually each time an employee, who receives variable pay, requests annual leave.
Second, the question needs to be asked: what is the employee’s “ordinary weekly pay”? The Act describes OWP in detail in section 8, and for the most part, the issues are clear and easily defined.
Ordinary weekly pay under the Holidays Act 2003
Essentially, an employee’s OWP is the gross earnings you normally pay them for a weeks’ work, including salary, wages, regular allowances, and regular incentive payments.
But what if the amount you pay an employee each week varies, and it’s not possible to determine an employee’s normal weekly income? Section 8(2) of the Act outlines a formula you can use to find the average weekly pay for annual leave calculations.
The average weekly pay formula
To calculate the average weekly pay of an employee, you follow this formula:
(a-b) / 4
- Go back four weeks from the date of the last pay period;
- Take the gross earnings for that entire period (“a”);
- Deduct from the gross earnings any one-off or irregular payments that the employer is bound to pay (“b”); and
- Divide by four.
A frequently debated question here is whether “OWP” should include commission or bonuses when it’s unclear if your employee is earning an incentive-based amount regularly. Recently a court case arose addressing this, and the matter has reached the Court of Appeal.
The Court of Appeal sheds light on what’s “ordinary” for employees’ earning commission.
In Labour Inspector v Tourism Holdings Limited, bus drivers employed by Tourism Holdings earned irregular weekly wages as they work different days each week. Drivers could also increase their income by selling tourist activities and earning a commission.
Because the number of days a driver worked each week would vary, Tourism Holdings would work out the drivers’ average weekly earnings using the s8(2) formula above:
- by taking a driver’s four weeks gross earnings from the date of the last pay period,
- deducting “productivity or incentive-based payments” (specifically, the commission earned from tourism sales); and
- dividing by four.
The dispute that arose from this was around the definition, and exclusion of, the drivers’ commission payments. Tourism Holdings deducted those payments from the calculation of average pay because it regarded them as “not a regular part of the employee’s pay”. But the Court of Appeal disagreed with this interpretation. It decided that commission is a part of an employee’s ordinary weekly pay, if they receive those payments “regularly”.
How to determine whether commission is “regular” or not?
Regular, as defined here by the Court, has two components that are each sufficient on their own to affect the OWP calculation:
- Substantively regular: that is, calculated in the same way on a regular basis using the rules of the commission or incentive scheme; or
- Temporally regular: that is, calculated and paid regularly and similarly in time and manner.
In the court case example above, bus drivers regularly sold tourism packages every week expecting commission according to a predetermined structure, and received income from commissions on a regular basis. The commission system Tourism Holdings operated was regular (substantive regularity), and the payments driver’s received were regular through payroll (temporally regular).
This definition of the word regular is very broad, and so it doesn’t necessarily bring absolute clarity to employers who operate commission-based or incentive schemes.
What does this mean for your business if you operate an incentive scheme?
In my view, and unless this decision is appealed to the supreme court, your annual leave calculations should include commission or bonus payments where your employee relies on commissions received through your incentive system as a variable but a regular part of their usual pay.
It’s worth noting that the s8(2) OWP formula of using the last four weeks, could result in a spike in annual leave pay where annual leave is taken in the four weeks immediately succeeding a commission or incentive payment.
The impact of this decision is likely to increase the amount of a commission-based employee’s average pay. This is very important if you use the average pay rate to calculate holiday pay for your workers. If you’re not already including these bonus payments when working out the average weekly pay, you should consider changing that approach to protect yourself against the risk of a claim for arrears holiday pay. It’s best to seek advice as the way forward can vary depending on your organisation’s reward or commission structure.
For advice on holiday pay and commission calculations contact our friendly team at HR Assured.
Vaughan Granier is the National Workplace Relations Manager for HR Assured NZ. He has over 24 years’ 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.