A court has ruled that overtime should be taken into account when holiday pay is calculated in a case that could leave small firms liable for “billions” of backdated payouts.

The Employment Appeals Tribunal said that employers must take regular overtime shifts into account, not just basic pay in what was seen as a test case for the industry that could have an impact on thousands of small businesses and their employees.

Simon Walker, director general of the Institute of Directors, said: “The holiday pay timebomb could have a hugely detrimental impact on businesses up and down the country. It is not an exaggeration to say that some small businesses could end up being wiped out if employers who have acted compliantly and in good faith face underpayment claims backdated as far as 1998.

“Not only do businesses face a huge spike in operating costs, but employees would also be encouraged to book holidays following bonuses or good overtime periods as it would enhance their pay. This would be an administrative nightmare on a number of fronts.”

The impact of the ruling is not expected to be felt for several years, as it is likely to be taken to either the Court of Appeal or the EU courts in what is expected to be a lengthy appeals process.