Do employers have to pay annual leave loading to employees on termination?


Do employers have to pay annual leave loading to employees on termination?

There has been uncertainty about this since the introduction of the Fair Work Act in 2009. Now, following a decision of the Federal Court of Australia, the uncertainty is likely to have been resolved (for now).

But first, let us remind ourselves of what the loading is, and why it exists.

The 17.5% loading is an entitlement featured in many awards and enterprise agreements, and is payable in addition to an employee’s base rate of pay whenever they take annual leave. Originally, it was introduced in industries where paid overtime was a regular occurrence. As workers only receive their base rates of pay while on annual leave, those who regularly worked overtime would be disadvantaged in their take-home pay by going on annual leave – as they would not have the opportunity to work overtime while on holiday. As compensation for this shortfall, the 17.5% annual leave loading began to appear in awards to offset the loss of opportunity to work overtime. Then, over time, the loading became a feature of most awards – even in industries and jobs in which regular paid overtime was uncommon.

Payable on termination?

When a worker’s employment comes to an end, their employer is required to pay out the balance of any untaken annual leave they have accrued. This is a given. However, historically it was a feature of many awards that the 17.5% annual leave loading was not payable on top of this termination payment. In fact, even amongst the current modern awards, almost a quarter explicitly or implicitly provide that the loading is not payable on termination.

Uncertainty has arisen, however, due to the wording used in section 90(2) of the Act, which states very broadly that an employee must be paid the same annual leave entitlements on termination as they would if they had taken the leave during their employment.

The Fair Work Ombudsman has for some time publicly supported an interpretation of section 90(2) which holds that annual leave loading is payable on termination. This has conflicted with the views of employer organisations, as well as the authors of the Labor Government’s review of the Act in 2012 and current Coalition policy – which call for the legislation to be tweaked to remove any suggestion that annual leave loading is payable on termination.

Last week, the Federal Court appears to have settled how the courts will interpret the issue. In a nutshell, it held that the 17.5% annual leave loading is payable on annual leave termination payments. And this will be the case even if an award or enterprise agreement expressly states that the loading is not payable on termination. This is because awards and enterprise agreements must always comply with the National Employment Standards, and section 90(2) of the Act is part of the National Employment Standards,

What does this mean moving forward?

The most immediate issue is that of past underpayments. If, as an employer:

  • you have workers who are covered by an award or enterprise agreement, AND
  • that award/agreement includes an entitlement to 17.5% annual leave loading, AND
  • you have not been adding the 17.5% loading to the annual leave balance payout on termination

then you have underpaid those workers. Employees are able to seek to recover past underpayments for a period of six years. If you have concerns about the exposure you are facing as a consequence, and what to do about it, we strongly recommend you obtain legal advice from someone.