Understanding Annual Leave in Australia
By Paolo, 30.12.2022
Annual leave is a paid entitlement available to employees to take time off from work.
Together with Personal/Carer’s Leave, Annual Leave is a core employee entitlement and part of the Fair Work 11 National Employment Standards. This means that as a core entitlement, it cannot be removed or reduced from the employee’s core working rights through any Employment Agreement.
This blog article answers the most common questions about Annual Leave in Australia.
Please note, the rights and requirements outlined in this blog relate to the Annual Leave entitlements stipulated by the Fair Work. Additional Leave offered by certain employers on top of the entitlements set out by the National Employment Standards may have different treatments explicitly outlined in the Employment Agreement.
Who is entitled to Annual Leave?
Full-time and Part-Time employees are eligible to receive Annual Leave entitlements. Only Casual employees are not entitled to Annual Leave.
How much Annual Leave is an employee entitled to?
Eligible Employees are entitled to 4 weeks of Annual Leave over the course of 12 months. Some Awards or other Employment agreements may grant more than 4 weeks of leave: many Awards, for example, grant 5 weeks of Annual Leave per year to Shiftworkers.
However, an Employment Agreement cannot reduce Annual Leave entitlements to less than the 4 weeks set out by the National Employment Standards.
How is Annual Leave accrued?
Employers are required to accrue Annual Leave entitlements for any of their Full-Time and Part-Time employees from the first day of employment (this includes any probationary periods).
Full-Time and Part-Time employees are entitled to a minimum of 4 weeks (pro-rata) of Annual Leave over 12 months. The Annual Leave accruals never expire, and any untaken balance must roll over the next year of employment.
Annual Leave is calculated as a percentage of the Ordinary Hours worked over a pay period.
This means an employee accrues Annual Leave whilst on Annual Leave as well as any other types of paid leave. Employees also accrue Annual Leave when taking some types of Unpaid Leave, including Community Service Leave, Ancilliary Leave and Jury Duty.
In some States or Territories, Annual Leave is also accrued whilst absent on Workers’ Compensation.
However, employees do not accrue Annual Leave whilst working Overtime, or on the unused leave balances paid out at termination of employment. It is also important to note that Government Paid Parental Leave is considered Unpaid Leave and excluded from any Annual Leave accruals.
During the COVID-19 Pandemic, some employees were asked to stand down whilst a business had been shut down. Furthermore, if employees became sick with COVID or were at risk of having been exposed to the virus, they were granted up to 2 weeks of Unpaid Pandemic Leave. Employers were required to accrue Annual Leave during these unpaid absence periods.
How is Annual Leave calculated?
Most Accounting and Payroll software applications can calculate Annual Leave accruals. The easiest way to manually calculate 4 weeks of Annual Leave accruals is by multiplying the Ordinary Hours worked by 7.6923%. Alternatively, it is also possible to use the Fairwork PACT (Pay and Conditions Tool) available on the Fair Work website.
Is an Employer required to show Annual Leave Balances on the Payslip?
Fair Work does not require Employers to show Annual Leave balances on Payslips. However, employers must keep current and accurate records of Leave accruals and are required to inform their employees of their Leave balances upon request.
Although there is no obligation to display Annual Leave balances, employers must show any periods of Annual Leave taken on the employee’s payslip.
How can Annual Leave be taken?
There are very few restrictions applied to an employee’s ability to choose when and how to take their Annual Leave entitlements.
Annual Leave can be taken for a few hours, a full day or week, or even a longer period. Generally, an Employer can only direct an employee to take Annual Leave after the employee has accumulated excessive leave balances (commonly over 6 weeks) and raise it as an Occupational Health & Safety issue.
Alternatively, employees can ask their employer to cash out some of their accrued Annual Leave.
How does Cashing Out Annual Leave work?
Section 93 of the Fair Work Act 2009 stipulates that a Modern Award or Enterprise Agreement may include the provision for Cashing out Annual Leave upon request by an Employee. However, such a request can only be approved if it meets all of the following conditions:
- A Cashing Out Annual Leave written agreement must be made each time Annual Leave is cashed out;
- The employee needs to have at least 4 weeks of annual leave left after the Cash-out;
- The payment for the Cashed out annual leave must be the same as what the employee would be paid if they took leave;
- Parents’ approval must be obtained for employees under 18 years old;
- Employees can only cash out a maximum of 2 weeks every 12 months.
What happens when an employee exceeds their Annual Leave Balances?
When an employee exceeds their Annual Leave accruals, it is at the employer’s discretion to decide whether to allow the employee to go on negative leave balances or to put the employee on Unpaid Leave.
Some companies allow Purchase Leave arrangements, where employees have the choice to purchase additional days of Annual Leave by reducing their Annual Salaries.
How is Annual Leave paid and taxed?
As a minimum, Annual Leave must be paid at the employee’s base rate of pay for Ordinary Hours worked.
Most Awards also require employers to pay an additional percentage on top of the employee’s base pay rate. This is called Annual Leave Loading.
How does Annual Leave Loading work?
Most Awards and Enterprise Agreements, require employers to pay their employees Annual Leave Loading. This is an additional amount calculated as a percentage of the employee’s base rate. Generally, the additional payment of Leave Loading relates to providing the employee with a payment to recover a loss of opportunity to work overtime whilst on leave.
Commonly, the applicable Leave Loading percentage is 17.5%. However, some Awards include provisions that stipulate the Leave Loading should be paid at the higher rate between 17.5% and the penalty rate applicable to the rate the employee receives when working specific shifts.
Example 1: Leave Loading 17.5%
Jane works as a Receptionist. Her job is classified under the Clerks Award, and her base pay rate is $30 per hour.
The Clerks Award sets the leave loading as a straight 17.5% of the employee’s Ordinary Time Earnings. Therefore, Jane’s pay rate for Annual Leave is $30 + $30*17.5% = $35.25.
Example 2: Leave Loading at a higher percentage
Sheila works as a Full-time Retail Assistant for a sports clothing store. Her job is classified under the General Retail Industry Award, and her base pay rate is $30 per hour.
The Retail Award specifies the applicable percentage of Leave Loading is the higher rate between 17.5% and the penalty rate applicable to the rate the employee receives when working specific shifts.
Sheila is always rostered to work Tuesdays to Saturdays. Under the Retail Award, Saturday is paid at a 125% penalty.
Sheila takes 1 week of Annual Leave. Her pay will need to be calculated as follows:
Annual Leave Tuesday – Friday 30.4 hours paid at $30 + $30*17.5% = $35.25 per hour.
Annual Leave Saturday 7.6 hours paid at the higher rate between $30 + $30*17.5% = $35.25 and $30+$30*25% = $37.50.
How is Annual Leave Taxed and Reported to the ATO?
When employees take Annual Leave, the taxation treatment of the Annual Leave payment is the same as their regular wages and salaries, as standard PAYG withholding tax tables apply. Superannuation must also be calculated on this amount.
The same applies to any Annual Leave Cash Out amounts paid at the employee’s request.
Employers are required to report the period of Annual Leave paid to the employee as ‘Other Paid Leave’ to the ATO via Single Touch Payroll.
If the Leave Loading is paid to recover a loss of opportunity to work overtime, this amount must be paid separately from the regular rate and reported to the ATO as ‘Overtime’ via Single Touch Payroll. In this instance, Superannuation is not calculated on the Leave Loading amount.
If Leave Loading is not paid to recover a loss of opportunity to work overtime, Leave Loading can be added to the rest of the Leave payment and reported as ‘Other Paid Leave’.
How is Unused Annual Leave paid and taxed on termination of employment?
Annual Leave, as set out by the National Employment Standards, must either be taken by the employee during the employment or be paid out on Termination of Employment. All unused Annual Leave balances must be paid out to the employee regardless of the termination reason, including serious misconduct.
Although, in certain circumstances, Fair Work allows employers to withdraw one week of pay from employees who have not given the required period of notice, this amount cannot be withheld from the employees’ unused Annual Leave balance.
The same conditions apply when employees have purchased items or borrowed money from their employer and have not yet repaid their debt upon their termination. The employer can withhold unpaid wages to repay the outstanding debt, but they are not allowed to withhold from the employees’ unused Annual Leave balance.
How is Annual Leave Taxed and reported to the ATO on termination of Employment?
The Tax Treatment applicable to unused leave paid out on termination differs depending on the type of termination.
If an employee is terminated due to Genuine Redundancy or an approved Early Retirement Scheme, the applicable tax on Annual Leave is a fixed 32% and the leave payout amount is reported to the ATO as ‘Lump Sum A’.
If the employee is terminated due to any other reasons.
Any Annual Leave accrued before 18 August 1993 is taxed at a fixed 32% and reported to the ATO as ‘Lump Sum A’.
Any Annual Leave accrued from 18 August 1993 is taxed using the Marginal Tax Rate over a 52-week period. The Unused Annual Leave payout is reported to the ATO as ‘Unused Annual Leave’.
Superannuation is not payable on Unused Annual Leave on termination.
Can Annual Leave be Salary Sacrificed into Superannuation on termination of employment?
Some employees may request to salary sacrifice part or all of their leave payout in an attempt to save taxes. Unfortunately, unless the Salary Sacrifice arrangement was stipulated at the time the Employment Agreement was signed, this request would constitute a breach of an ‘Effective Salary Sacrifice arrangement’.
Accepting, Rejecting, and Directing Annual Leave Applications
Submitting, Approving and Cancelling Annual Leave Requests
The Fair Work Act only provides general guidelines on the topic of Annual Leave requests. It simply states that Annual Leave should be taken at a time mutually agreed upon by the employer and the employee and that the employer may only refuse the Annual Leave request if such request is deemed ‘unreasonable’.
Some examples of unreasonable Annual Leave requests include:
- the period over which the employee wishes to take annual leave;
- the operational requirements of the business;
- whether the leave would cause a detriment to the business if taken at the time requested;
- whether the employee gave reasonable notice.
Typically, Companies introduce company policies that state how employees should submit Annual Leave requests. Commonly, employers require Annual Leave requests to be submitted in writing either by filling out a form, via email or through the company’s payroll software.
These policies often include other rules around Annual Leave requests, including restrictions to take Annual Leave at the same time as other employees working within the same team or at certain times during the year (known as Black Out periods).
Once a leave request is approved, employers do not have the right to cancel the request and withdraw the approval. The cancellation of the Annual Leave request should be made in agreement with the employee.
If an employer terminates an employee for refusing to agree to cancel their Annual Leave, this could escalate into an unfair dismissal claim or other legal claims.
Directing Employees to take Annual Leave
Employers can only direct their employees to take Annual Leave in two instances:
- When the business shuts down for a determined period;
- When the employee has excess Annual Leave accruals.
Directing Employees to take Annual Leave during a business shutdown
Employers can direct their employees to take Annual Leave if they temporarily close their business. This typically happens during the Christmas Holiday period.
In this instance, employers must give their employees the required notice period. The number of weeks of notice varies depending on the employees’ classified Award. Fair Work provides a dedicated page outlining the rules and regulations about directing employees to take Annual Leave for each Award.
Directing Employees to take Excessive Annual Leave
Employers may direct employees to take Annual Leave when their current balance exceeds a certain number of weeks. This is generally over 6 weeks of Annual Leave. However, the excessive leave period may vary pending on the classified Award or Employment Agreement.
When employees have excessive untaken Annual Leave, they have up to 12 months, from the date the employer has made the request, to take the excessive Annual Leave and reduce their balance.
Annual Leave Implications when a Business Change Ownership
The implications on Annual Leave entitlements upon a business changing ownership vary depending on how the business ownership changes.
Broadly, there are three scenarios to be considered:
- The existing company shareholders transfer their shares to other shareholders;
- The employees are transferred to another legal entity, regardless of whether the new entity is owned by the same shareholders, sole Director or new owners;
- The existing entity falls into voluntary or involuntary administration, and a new entity with different owners takes over the business.
Annual Leave Implications when shares are sold between shareholders
As the trading entity remains the same, this change does not affect Annual Leave balances.
Annual Leave Implications when the legal entity changes
There are no hard and fast rules to determine what happens with the employees’ Annual Leave balances. However, the employee will either receive a payout of all Annual Leave balances at the time the entity changes or the Annual Leave balances are transferred to the new entity. Annual Leave Balances cannot be written off when a legal entity changes by either the business changing its trading entity or selling the business.
Employers who change Legal entity or sell their Business to new owners, should include the value and implications of the Annual Leave balances in the Sales Agreement and inform their employees in writing of such implications.
Annual Leave Implications when an entity is in Liquidation
If an entity goes through voluntary or involuntary administration, a liquidator is appointed to sell the company’s assets and distribute the proceeds to repay the company’s outstanding liabilities. Employees’ liabilities are the top priority for the company to repay. However, the company may not have enough assets to liquidate to cover all its employees’ liabilities. Therefore, in this scenario, employees may not receive payment for part or all of their Annual Leave balance.
Conclusions
As Annual Leave is one of the core entitlements that form the Fair Work National Employment Standards, employers should ensure they manage this entitlement correctly.
Failing to calculate or pay Annual Leave correctly or withholding unused Annual Leave payout may result in immediate action by Fair Work Australia.
As for any other components that make up the complex Australian Industrial Legislation, Annual Leave is once again an easy concept on the surface but stores many levels of complexity.
With Payroll data becoming more timely and transparent to the Australian Government, it’s best to be outsourced to a registered professional.
References
https://www.fairwork.gov.au/leave/annual-leave/payment-for-annual-leave
https://www.fairwork.gov.au/employment-conditions/hours-of-work-breaks-and-rosters/hours-of-work
Disclaimer
This blog and attached resources are of general nature designed for informational and educational purposes only. They should not be construed as professional financial advice for your individual business. Should you need such advice, consult a licensed financial or tax advisor.
