Discretionary bonuses and annual leave

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For some lucky employees, the festive season means not only summer holidays but the prospect of a Christmas bonus as well.

While holidays are much anticipated by the average employee, they can cause quite a headache for payroll, particularly when calculating annual leave.

One of the most confusing issues that arises is whether bonuses should be included in gross earnings when calculating holiday pay based on average weekly earnings over the past 12 months. The answer largely depends on whether the bonus is discretionary. Under the Holidays Act 2003 discretionary payments are excluded from gross earnings for the purposes of calculating holiday pay.

The problem is, the Act does not contain a definition of ‘discretionary payments’, and employers may find that the definition of ‘discretionary’ is considerably different from what they understand the term to mean in everyday English.  In general, employers must look to cases in the Employment Relations Authority and the Employment Court to understand the rules around categorising a bonus as discretionary.

The important factor to consider when deciding whether a bonus is discretionary or not is to ascertain if the bonus forms part of the terms and conditions of employment or whether it is merely a payment that an employer makes where no obligation exists to pay it. An example of the latter would be where an employer spontaneously decides to give an employee a one-off reward for landing a big client or for coming in under budget on a project.

Where an employee receives a bonus, which is included as part of their remuneration package or one that is tied to a performance target, it is unlikely to be deemed a discretionary bonus even if the amount of the bonus varies from year to year and this variation in amount is said to be decided at the sole discretion of the employer. In such cases, payment of the bonus itself is not discretionary, as the discretion merely attaches to the amount to be paid rather than whether or not it will be paid.

In a 2014 Employment Court case, Howell v MSG Investments Limited, Mr Howell was to receive an incentive bonus on the conclusion of his employment, the value of which would be calculated 30 days following termination. In this case, the bonus was not discretionary and amounted to $3.2 million. As it was calculated and paid after termination, the employer claimed it should not be included in the calculation for annual leave, usually paid in an employee’s final pay. The Court did not accept the employer’s position and held that the bonus formed part of the terms and conditions of employment, regardless of when it was calculated and when it was paid. At 8 percent, this amounted to a whopping $256,000 that the employer was ordered to pay in holiday pay.

Another factor to consider is that discretion needs to be exercised in a fair and reasonable manner, not arbitrarily. In a 2015 Authority decision, Walker v Vulcan Steel Limited, the employer used a range of criteria to decide whether each employee received an annual profit share bonus. The criteria included attendance/time keeping, work productivity, attitude, customer service and being health and safety conscious. Mr Walker was denied his annual bonus due to alleged failings during the year of some of the criteria. However, the employer failed to inform Mr Walker that his ongoing conduct would result in the loss of his bonus and therefore, denied him the opportunity to improve. The Authority held that this caused Mr Walker to be unjustifiably disadvantaged and Vulcan Steel was ordered to pay Mr Walker a $3000 bonus, which was approximately 75 percent of the full bonus.

Unlike the 90-day time limit for raising personal grievances, claims for underpayment of annual leave under the Holidays Act can be raised going back six years so any miscalculation could prove costly.

It is highly recommended that employers check their employees’ employment agreements in relation to bonuses before calculating holiday pay, ascertain whether or not a bonus is a discretionary payment and seek legal advice if further clarity is needed.

Practica Legal would like to wish Waikato Business News readers a happy and safe holiday season.

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About Author

Erin Burke

Employment Lawyer and Director at Practica Legal Email: erin@practicalegal.co.nz phone: 027 459 3375

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