Author: David Jenkins, NZPPA CEO

Salary averaging is not, by itself, a statutory method for determining what an employee must receive for a week of annual holidays under the Holidays Act 2003.

Before using salary averaging as part of any leave calculation under the Holidays Act 2003, employers and payroll practitioners need to understand exactly how the arrangement will work and what effect it may have on employees’ leave.

This needs to happen before salary averaging is agreed with employees or set up in the payroll system. Many of the questions we receive through the NZPPA PayTech AdviceLine come after an arrangement has already been introduced. By then, payroll is often trying to untangle unexpected results because employees have started questioning their leave balances, deductions or rates of payment.

Decisions that affect leave should never be made in isolation or based solely on what a payroll system can be configured to do. The proposed arrangement must first be checked against the requirements of the Holidays Act.

This article looks at what salary averaging can and cannot do, the practical issues that should be considered before it is introduced, and the risks of getting it wrong.

Background

For annual holidays, section 21 requires the employee to be paid the greater of:

• ordinary weekly pay (OWP) at the beginning of the holiday; or
• average weekly earnings (AWE) over the preceding 12 months.

For an employee receiving a fixed annual salary, dividing the salary by 52 may correctly identify the salary component of OWP where that represents what the employee receives for an ordinary working week. However, this does not remove the requirement to:

• include any other regular payments required by section 8, such as regular allowances, commission, incentive payments or regular overtime;
• calculate AWE using Holidays Act gross earnings divided by 52; and
• pay the greater of OWP or AWE.

When salary averaging may be compliant

A salary-averaging arrangement may be compliant where:

• the employee is contractually paid a fixed amount each week or pay period, even though their hours vary across a roster cycle;
• that averaged salary genuinely represents the employee’s ordinary contractual remuneration;
• all relevant regular payments are included when determining OWP;
• the statutory AWE calculation is also completed; and
• the resulting annual holiday payment is no less than the greater of OWP and AWE.

For example, an employee works alternating 36-hour and 44-hour weeks but receives a fixed annual salary of $78,000. The weekly salary is $1,500. That amount may be their base OWP if the employment agreement establishes a fixed salary across the roster cycle. However, payroll must still include any other regular OWP components and compare the resulting OWP with AWE.

When salary averaging would not be compliant

It would not be compliant to simply:

• average the employee’s salary or rostered hours across a year;
• use that average as the automatic leave payment rate;
• ignore what the employee ordinarily receives for the particular working week;
• exclude regular additional payments; or
• fail to compare the result with AWE.

Where the employee’s OWP cannot be determined under the ordinary definition, section 8 provides a specific four-week formula. An employer cannot replace that statutory formula with a different salary-averaging methodology merely because it is administratively convenient.

The employee’s employment agreement may specify a special rate or formula, but it cannot produce less than the employee’s actual statutory OWP. MBIE confirms that annual holiday pay must be calculated each time leave is taken and paid at the greater of OWP or AWE. Employment New Zealand—Annual holiday pay and Holidays Act 2003.

In short: salary averaging can form part of determining OWP, but it is not a substitute for the Holidays Act calculations or the greater-of comparison.

Salary averaging can be compliant in limited circumstances, but it cannot automatically determine both an employee’s “week” and their payment for annual holidays. These are two separate requirements under the Holidays Act 2003.

1. Determining the employee’s week

The statutory annual holiday entitlement is four weeks—not a fixed number of hours or days. A week should reflect the employee’s genuine working week at the time the annual holiday is taken.

Where the employee has a clear work pattern, that pattern determines the week. For example:

• 40 hours over five days means one week is normally five days or 40 hours.
• 24 hours over three days means one week is normally three days or 24 hours.
• A regular rotating roster may require the week to be determined across the roster cycle.

Where there is no clear working week, the employer and employee may agree on a fair and reasonable method of defining the week. That method might use average hours over an appropriate representative period. Employment New Zealand recognises that averaging may be used where the pattern is unpredictable, provided it fairly and reasonably reflects the employee’s working week and is agreed between the parties. Employment New Zealand—Taking annual holidays

However, simply dividing expected annual hours by 52 would be risky if:

• the resulting week does not reflect the employee’s current work pattern;
• the employee regularly works more than the averaged hours;
• seasonal or roster variations are ignored;
• the averaging period is unrepresentative; or
• the method reduces the employee’s entitlement below four genuine working weeks.

The averaging method should be reviewed when the employee’s work pattern changes. It should not become a permanently fixed conversion that disconnects the leave balance from the employee’s current working week.

2. Determining payment for the week

Even if salary averaging provides a fair method of defining the employee’s week, it does not determine the statutory payment for that week.

Under section 21, annual holidays must be paid at the greater of:

• ordinary weekly pay (OWP) at the beginning of the annual holiday; or
• average weekly earnings (AWE) for the preceding 12 months.

For a fixed-salary employee, the weekly salary may be the starting point for OWP. However, OWP must also include applicable regular payments, such as regular allowances, commission, incentive payments and regular overtime.

Payroll must then calculate AWE using Holidays Act gross earnings divided by the statutory divisor of 52 and pay the greater result. Employment New Zealand—Annual holiday pay

Example

An employee works a seasonal pattern and is paid a fixed salary of $78,000:

• agreed representative working week: 35 hours;
• weekly salary: $78,000 ÷ 52 = $1,500;
• AWE at the start of the holiday: $1,575.

If the agreed 35-hour week fairly reflects the employee’s working week, it may be used to determine that taking 35 hours represents one week of annual holidays.

However, the employee must receive $1,575 for that week because AWE is higher than the $1,500 salary-based OWP.

In conclusion, salary averaging is potentially compliant for defining a week only where the employee’s week is genuinely unclear and the averaging method is agreed, representative, fair and reasonable. It cannot be used merely for payroll convenience or where it deprives the employee of four genuine working weeks.

For payment, salary averaging cannot replace the statutory calculation. The employee must receive at least the greater of OWP or AWE.

Also, this analysis relates specifically to annual holidays. Sick leave, bereavement leave, family violence leave, public holidays and alternative holidays are day-based and must generally be paid using relevant daily pay or, where legally permitted, average daily pay.