On the seventh day of Christmas…tips on saving tax on holiday pay accrual

David McBain

David McBain

Audit Partner

Keeping track of holiday entitlements and holidays taken by your team can be a bit of an administrative burden on your business. However, with many businesses perhaps faced with a busy run up to Christmas, did you realise there may be tax savings to be made? 

It is generally the case that most employees will not take their holidays in a regular pattern throughout the year. Indeed, many employees tend to defer taking holidays towards the later part of your holiday year, keeping holidays “in reserve” for any unforeseen needs. And, whilst your business may close down over the Christmas break, in the lead up period activity levels can sometimes be high meaning that fewer holidays are taken than are being earned.

Tax saving on holidays accrued

The tax saving here comes from the potential to accrue for holiday pay “earned” but not yet paid by the year-end within the accounts. Take for example, an employee with 25 days entitlement to holiday in the holiday year which runs to 30 June 2017. The business has a financial year-end of 31 December 2016 and the employee has taken 10 days holiday by the end of December 2016. Their pro-rata entitlement during that period will be 12.5 days and so the business accrues for the 2.5 days not paid by the end of the year.

Alternatively, if the holiday year coincides with the financial year-end, and holidays haven’t been taken in full by the end of that year, the unpaid element is likely to be paid for in January’s payroll or may alternatively be available for carry forward by the employee. In either case, the ability to accrue in the December accounts remains.

The principle of making provision for holiday pay set out above has recently been mandated for medium and large companies with the introduction of accounting standard FRS 102. However, FRS 102 is now starting to apply to many small companies too and, even for other businesses such as unincorporated partnerships, the principle of making a provision remains equally valid.

The benefits of holiday pay accrual

Although making a holiday pay accrual will likely not be at the forefront of your thinking around the Christmas period, the good news is that any accrual made is likely to be tax deductible, provided the holidays are paid for within nine months of the year-end. Some welcome festive cheer!

On a practical point, the business should ensure that they have a copy of any HR/payroll report detailing holidays taken and booked to the end of the financial reporting period. If the holiday allowance period does not match with the financial reporting period, a calculation of the number of holiday days each employee has amassed at the financial report date is commonly undertaken by time apportioning their holiday allowance. The same calculation method should be used from year to year. A comparison of holidays taken to holidays accumulated will highlight a deficit or surplus per employee which should then be multiplied by the average salary.

When staff take more holidays than their entitlement

Where an employee has taken more paid holidays than they are entitled too, a prepayment should be recognised in the financial statements. Less good for tax purposes but better for the bottom line of the business!

An average salary can be calculated as an average across the entire workforce. This approach may be appropriate when the coverage of employees who will be carrying forward holiday is consistent with the different pay levels across the business. Where there is a large number of differing pay levels and the pay awards are highly dispersed, it may be more appropriate to calculate average pay at each pay award level. 

Tax savings are not just for Christmas!

Remember too, that tax savings through holiday pay area not just for Christmas – they’re for all year-round. So if you don’t have a 31 December year-end the same principles can deliver a tax-saving gift at other times of the year too.

Got a question? If you have any queries about managing your cash flow, get in touch with a member of our Audit team for an initial, informal chat.