Employment Court widens the definition of gross earnings - Employers beware

PAYMENTS MAY NOW BE PART OF ‘GROSS EARNINGS’ DESPITE BEING LABELLED ‘DISCRETIONARY’ AND AS SUCH BE LIABLE FOR INCLUSION IN THE CALCULATION OF HOLIDAY PAY

Gross earnings provide the basis on which an employer calculates an employee’s annual holiday pay.

If an employer does not get this calculation right based on a misunderstanding of what constitutes ‘gross earnings’, they may find themselves in a situation where an employee’s holiday pay entitlements have been underpaid, resulting in an unexpected liability under the Holidays Act 2003 (“the Act”).

Recently, the Employment Court has issued a decision limiting the scope of payments that fall outside the definition of gross earnings. We discuss this decision below.

What are gross earnings?

Under section 14 of the Act, “gross earnings” means:

• all payments the employer must pay under the employment agreement, including:

•  salary or wages;

• allowances (except non-taxable payments to reimburse the employee for any actual costs incurred by the employee related to his or her employment);

•  payment for an annual holiday, a public holiday, an alternative holiday, sick leave, bereavement leave, or family violence leave taken by the employee during the period;

• productivity or incentive-based payments (including commission);

• payments for overtime; but

• excludes any payments that the employer is not bound by the employment agreement to pay the employee, such as discretionary payments.

“Discretionary payment” is further defined as:

• any payment that the employer is not bound by the employment agreement to pay the employee; but

• does not include a payment that the employer is bound by the employment agreement to pay the employee, even though

• the amount to be paid is not specified in the employment agreement and the employer may determine the amount to be paid, or

• the employer is required under that employment agreement to make the payment only if certain conditions are met.

Metropolitan Glass & Glazing Limited v Labour Inspector, Ministry of Business and Innovation and Employment [2020] NZEmpC 39

The issue in Metropolitan Glass & Glazing Limited v Labour Inspector, Ministry of Business and Innovation and Employment (“Metropolitan Glass”) was whether payments made under an incentive scheme fell within ‘gross earnings’ for the purpose of calculating holiday pay. For the reasons set out below, the Employment Court held that the incentive scheme payments were gross earnings under the Act despite being labelled as discretionary.

Facts

The payments in Metropolitan Glass were made under a 2017 short-term incentive (“STI”) scheme, which was not referred to in individual employment agreements (“IEA”).However, the IEAs did provide for payment of ‘discretionary’ bonuses, which were payable on achievement of agreed KPIs and/or completion of projects on time and on budget.

Employees were invited to partake in the STI scheme by way of letter, which stated that:

• the scheme was not a term of the IEA and therefore not subject to ‘gross earnings’ for the purpose of holiday pay calculations;

• in consideration for the invitation to participate in the scheme, the employee agreed to an extended restraint of trade clause; and

• any payments made under the scheme were at the discretion of Metropolitan Glass.

To accept the offer, employees were required to sign the letter.

Findings

The first issue considered by the Court was whether the STI formed part of Metropolitan Glass’ IEAs. The Court held that policies or schemes can form part of the IEA without being expressly mentioned in the IEA if:

• the policies/schemes are incorporated into the ERA by reference; and/or

• it can be inferred from the circumstances that that the parties intended the relevant terms to have contractual force.

Because Metropolitan Glass required employees to agree to an extension of their restraint of trade to be accepted into the STI scheme, the Court held that that the parties intended for the terms of the STI to have contractual force. For the purpose of whether the payments fall within ‘gross earnings’ under section 14 of the Act, the STI scheme was held to form part of Metropolitan Glass’ IEAs.

The Court then considered whether payments under the STI scheme should nevertheless not be included in ‘gross earnings' due to being discretionary payments.

Despite Metropolitan Glass labelling the STI scheme as discretionary, the Court held that the intent of the payments must be considered, rather than how the payments are labelled.

Where the intent is for payments to be made based on productivity or incentives, these payments are part of gross earnings, even if the amount of payment is determined by the employer or if the payment is only payable if certain conditions are met. However, gross earnings do not capture reimbursing payments or truly gratuitous payments (for example, where an employer, of its own initiative, decides to pay a Christmas bonus). In Metropolitan Glass, the Court held that the STI scheme was clearly incentive based and thus not discretionary, notwithstanding that the amount of payment was determined by Metropolitan Glass and was only payable if certain conditions were met.

In summary, the Court held that the STI scheme formed part of the IEA, was incentive based, did not fall within the definition of ‘discretionary payment’, and therefore, payments made under the STI scheme fell within ‘gross earnings’ under the Act.

The current law

The Metropolitan Glass decision clarifies the law relating to bonuses and other payments as follows:

• Payments which are not referenced in an employment agreement will be included in holiday pay calculations if those payments were made under terms which can be inferred to form part of the employment agreement.

• Payments which are referenced in an employment agreement will be included in the holiday pay calculation if those payments are incentive/productivity based, notwithstanding that:

• the amount of payment is to be determined by the employer;

• payment is only made if certain conditions are met; and

• the payment is labelled ‘discretionary’.

Impact on New Zealand labour market

While the facts of Metropolitan Glass are specific, its findings set a precedent with implications across the New Zealand labour market.

The key indicator of whether a payment falls within ‘gross earnings’ is whether a payment was made under an IEA (and is incentive based, irrespective of whether or not it is labelled as discretionary), or under a document that can be inferred to have been intended to have contractual force. In short, substance prevails over form.

To avoid being captured by section 14 of the Act, the payments would need to be reimbursing in nature or truly gratuitous as. This limits the scope of payments that fall outside the definition of gross earnings.

However, watch this space. The Metropolitan Glass decision is being appealed to the Court of Appeal. We anticipate that a decision on the appeal will not be issued until 2021, at which point we will provide a further update.

Until then, we recommend employers err on the side of caution before deciding whether a payment is discretionary. Failure to correctly calculate your employee’s gross earnings may cause holiday pay entitlements being incorrect, in which case an employee may claim for payment of the shortfall. An employee may also be entitled to interest on the unpaid amount.