Author: David Jenkins, NZPPA CEO

Recently, I have been updating past articles that we still get frequent questions on through the NZPPA PayTech AdviceLine, adding any new insights and developments. This article was first published back in 2018.

One of the common areas payroll faces from the Holidays Act is how various payments impact or do not impact leave provided under the Act. In this post, I aim to address some common issues and misunderstandings regarding the application of backpay payments in payroll, as well as their potential flow-on effects under the Holidays Act.

Firstly, a backpay is an agreed term. There is nothing in legislation that states an employer has to make or pay backpay (except as part of a remediation process when leave provided under the Holidays Act has been incorrectly calculated and is paid as backpay). There is legislation on how it is taxed, specifically as a “retrospective payment” (as an extra pay) under Section RD7(3) of the Income Act 2007.

There are three main reasons why payroll is instructed to pay backpay to an employee:

1. Part of an agreed wage or salary increase. For example, a settlement of a CEA (collective agreement between an employer and union) of a 3% wage increase, backdated for nine months from when negotiations started.
2. A process mistake. For example, a salary increase was agreed two months ago, but the paperwork was never forwarded to payroll.
3. A payroll calculation error. For example, a payroll system has been miscalculating leave, and once uncovered, it was found that a backpay payment needs to be paid to an employee.

Issues with backpay and the Holidays Act

In this section, I will discuss the issues related to the three described reasons for when backpay could be paid.

1. Backpay from a wage or salary increase backdated by agreement

The following is one of the frequently asked questions about paying a backpay:

• “We have to pay backpay agreed from a settlement by a collective. Does this mean payroll has to recalculate any leave taken during the period the backpay relates to?”

The short answer is “no” unless it has been agreed to do so.

Leave is calculated at the time it is taken at the rate the calculations provided under the Holidays Act (if that can actually be done with an unworkable Act). Backpay paid does not mean that the employer has to go back and recalculate any leave taken during that period (unless it has been agreed to do so). If it has not been agreed, then the backpay is the only payment that has to be paid.

As an agreed taxable payment, this backpay will be part of the gross earnings for leave for the next 12 months and so will inflate the leave rate for average weekly earnings (annual holidays) and average daily pay (BAPS alternative calculations when the RDP cannot be defined). So, the employee actually gets the benefit of the backpay for future leave taken.

2. Backpay from a process mistake

The common question for this type of backpay is:

• “We have just found out that an employee was given a salary increase two months ago, but we did not receive the paperwork until recently. We now have a backpay for the period during which the new rate was not paid.”

There was an agreement to increase the employee’s salary in the above example, so there are two things that payroll will need to do here:

1. Pay the difference from the old rate to the new rate for the period it was agreed to be paid but was not.
2. Recalculate any leave that was taken during this period, as the new rate should have been used because it would have impacted gross earnings.

3. Backpay from a payroll calculation error

Here is another common question arising from the issues with the Holidays Act:

• “We have been working through issues found with our setup of the Holidays Act and now have to make a backpay.”

There are two things payroll needs to consider here:

1. If the error was to do with the calculations under the Holidays Act, then the remediation is actually calculating what should have been paid when leave was taken, so it has determined the correct rate for leave. Making this payment will resolve the issues with leave.
2. If the error is from another part of payroll, such as how a bonus was calculated that created an underpayment, this will impact any leave taken since that time. If an agreed taxable payment were underpaid, it would not be part of gross earnings for leave, and leave would need to be at least examined to determine if the underpayment has impacted the rate for leave taken since that payment was made.

Issues with payroll systems

I wanted to add a new and separate section that needs to be taken into account, as this can undermine how payroll manages backpay and especially the tax requirement as extra pay.

There are two key issues that I have seen in payroll systems:

1. Some payroll systems used in NZ do not offer the ability to do an extra pay tax calculation. This can mean payroll is forced to do an extra pay calculation outside of the payroll system when processing an extra pay in relation to backpay. This defeats the purpose of having a payroll system and can create non-compliance depending on how the extra pay has been calculated and the results brought back into the payroll system. It’s a hassle for the payroll provider to provide the extra pay calculation in their system.
2. Some payroll systems will automatically recalculate any leave that has been taken when an agreed backpay (covering a period of time) is to be paid (when there is no agreement or a need to recalculate leave that the employee took). This is the payroll provider dictating an activity that is not its position to take. It is up to the employer to decide whether to proceed, not the payroll provider, as it is based on an agreed term.

In conclusion, a backpay does not mean you have to recalculate leave that the backpay relates to, as it all depends on the circumstances of why it is being paid in the first instance.

It is essential that anything agreed is stated in writing, so payroll has clear instructions on how this payment will be applied regarding the Holidays Act.