Leave is consistently the number one area where businesses fall short on payroll compliance, and the reports of Holidays Act non-compliance haven't slowed down.
Reform is on the way. The Government is actively developing replacement legislation to simplify the rules around holidays and leave, but the Holidays Act 2003 remains in force until that work is complete.
In the meantime, the complexity is real, and the compliance obligations haven't changed.
So why is paying annual holidays so difficult to get right, and why are so many businesses still getting it wrong?
Why annual holiday pay is hard to get right
Most businesses genuinely want to pay their staff correctly, so the problem isn't intent, it’s understanding.
The Holidays Act is notoriously difficult to interpret, and even harder to apply consistently across different employment situations. Add to that the common misconception that payroll software handles all of this automatically, and you've got a recipe for non-compliance.
Software is a tool, not a guarantee. If it's not configured correctly for your specific employment agreements and pay structures, it can process payroll efficiently while still getting the numbers wrong. And if the Labour Inspectorate comes knocking, "the software did it" isn't a defence.
How to calculate annual pay correctly
When paying an employee's annual holidays, they must be paid whichever is the higher of their ordinary weekly pay or their average weekly earnings.
Ordinary weekly pay
Ordinary weekly pay is everything an employee is normally paid weekly under their employment agreement, including:
regular allowances (such as shift allowances)
regular productivity or incentive-based payments (including commission or piece rates)
the cash value of board or lodgings
regular overtime
For many employees, this is straightforward because their pay is the same each week.
If the employee's work pattern varies week to week and it's not possible to determine a clear ordinary weekly pay, you can use their last 4-week average instead:
Go to the end of the last regular pay period before the holiday.
From that date, go back 4 calendar weeks. Or, if the pay period is longer than 4 weeks, go back the length of the pay period.
Work out gross earnings for that period.
Deduct any irregular payments from gross earnings.
Divide by 4
Average weekly earnings
Average weekly earnings is the employee's gross earnings over the 12 months immediately before the end of the last payroll period before the annual holiday is taken, divided by 52.
What's excluded from gross earnings?
Unless the employment agreement states otherwise, gross earnings don't include:
reimbursement payments
truly discretionary or ex gratia payments
payments for cashed-up holidays
payments made by ACC
The most important step: know your software
Understanding the calculation is only half the job. The other half is knowing whether your payroll system is applying it correctly for your specific situation.
Some systems default to average weekly earnings regardless of whether ordinary weekly pay would be higher, which can result in underpayment.
Others apply the 4-week average where it doesn't apply, or miscalculate gross earnings by including or excluding the wrong payments.
If you've never checked how your software handles annual leave calculations, it's worth doing, and this is exactly the kind of issue a payroll review picks up.
If you'd like some help working through it, I'm happy to take a look.
Updated April 2026 | Originally published November 2021
About the author
Karyn Campbell is a New Zealand payroll consultant and founder of Payroll Consult. With 5+ years running her own consultancy and a background in payroll software – including roles across client support, onboarding, and partnership management at a leading NZ payroll provider – Karyn brings a rare combination of technical knowledge and real-world compliance experience. She works with business owners, bookkeepers, and payroll teams across New Zealand, specialising in payroll audits, system reviews, and fixing complex payroll issues for teams that don’t work a typical 9-5.
