In 2003, the Minister of Labour issued a schedule to clarify the requirements of the Basic Conditions of Employment Act (BCEA) for the correct calculation of leave pay, notice pay and severance pay.
Some 13 years later, many employers have yet to catch up – with the result that they don’t make enough provision in their budgets for the cost of paying out an employee’s leave pay when he or she leaves the company or takes a long holiday.
In summary, the BCEA says the calculation of an employee’s leave pay must take into account irregular frequency payments such as performance bonuses, commission and overtime. The guiding principle is that when employees exercise their right to take leave, they should not earn less than when they are at work. They should also not earn more when they are not working.
Specifically, section 21(1) of the Act states that: “An employer must pay an employee leave pay at least equivalent to the remuneration that the employee would have received for working for a period equal to the period of annual leave, calculated:
(a) at the employee’s rate of remuneration immediately before the beginning of the period of annual leave; and
(b) in accordance with section 35.”
The Act contains similar provisions for notice pay and severance pay calculations.
Section 35(4) specifies that employers calculate leave, notice and severance pay as follows: “If an employee’s remuneration or wage is calculated, either wholly or in part, on a basis other than time or if an employee’s remuneration or wage fluctuates significantly from period to period, any payment to that employee in terms of this Act must be calculated by reference to the employee’s remuneration or wage during:
(a) the preceding 13 weeks; or
(b) if the employee has been in employment for a shorter period, that period.”
Though the Act specifies the averaging period as 13 weeks, employers can interpret this to be a minimum period. If a fairer overall result for the employer and the employee can be achieved by averaging the remuneration over the entire year, this is also acceptable. Note that the only deviation from the 13 week averaging period that is acceptable is that of a year.
Also note that this calculation of leave pay applies only to annual leave specified by the BCEA. Any leave the employer grants in excess of the Act’s minimum of 21 calendar days can be accumulated valued and paid at the discretion of the employer. A savvy employer will clarify this point in its terms of employment and HR policies.
How to calculate leave pay while still employedThe first scenario where an employer might need to calculate leave pay is when an employee takes annual leave. If the employee earns only fixed amounts such as a salary, there are no fluctuating payments to be averaged and included into the remuneration rate per day. The employee will simply be paid his or her usual remuneration.
If the employee earned overtime, commission or a performance bonus in the 13 weeks before taking leave, these fluctuating payments must be taken into account. The employer would average them out over the 13 weeks prior to the leave and include this figure into the remuneration rate per day. If the fluctuation is seasonal (for example, a bonus at the end of the financial year), it makes sense to calculate an average over the year.
How to calculate leave pay on terminationAt first impression it would seem that there should be no difference between how the leave pay is calculated when the employee is terminated and the calculation used when he or she takes annual leave while still employed.
However, the calculation of leave pay, notice pay and severance pay upon termination must include the following categories of payments:
1. Payments in kind (employer contributions and benefits that are remuneration) that the employee no longer enjoys following termination. If the employee does not receive a payment in kind during the notice period, then the equivalent cash value must be paid as compensation. For example, if housing is normally provided, and a payment is made in lieu of notice, the housing must still be provided, or an equivalent cash payment made.
2. Any untaken annual leave days that must be paid for on termination must be paid for at a rate that includes both the normal remuneration value as well as the average of the variable remuneration value. The normal remuneration is an additional value included because the employee did not enjoy the benefit of ‘paid’ annual leave while still employed.
3. Non-discretionary bonuses must be pro-rated and included because the employee will no longer be employed at the time when the bonus would have been paid out.
In conclusion, remember the principles: employees should not earn less while on annual leave than when at work otherwise they would be financially prejudiced by doing so, balanced by the fact that the employer is not expected to pay ‘twice’.
As the global market leader of integrated accounting, payroll & HR and payment systems, we have become an indispensable business partner to the country’s Small & Medium Businesses. For us, this isn’t just about providing use the smartest technology to reinvent and simplify business accounting and payroll, but also helping clients to navigate the tax and legal environment.
Rob Cooper is the Tax expert and Director of Legislation at Sage.