Sharpen Your Set-Off Clause

A set-off clause in a common law contract may be the easiest way to save admin time with salary annualisation, but it comes with unique compliance challenges.

From March 1, 2020, the Fair Work Commission (FWC) is bringing into force new rules for annualised salary arrangements in 22 modern awards, with new requirements for timekeeping and reconciliation.

As a popular alternative to these annualised salary clauses, there was a concern that common law contracts would be considered by a Court or watchdog to be regulated by the new annual wage arrangement rules, with new obligations.

However, the Commission has made it clear that an employer and employee are not obliged to rely only on an annualised salary arrangement administered under an award. Instead, they can choose to apply a common law employment contract (correctly drafted) with a clause to ‘set-off’ (or ‘buy out’) the employee’s modern award entitlements.

As the FWC Full Bench stated in the Annualised Wage Arrangements Decision [2019] FWCFB 4368 (section 22): ‘…an employer is able to pay an employee to whom an award applies an annualised salary arrangement that compensates for or “buys out” various identified award entitlements … The model clauses do not seek to invalidate or regulate any such contractual arrangement.’

Develop an enforceable clause Having a set-off clause in your contracts of employment is usually the easiest way to implement salary annualisation. However, a set-off clause will usually carry the most risk in circumstances where it involves a poorly drafted clause, or it did not arise from a formally recognised process under the Fair Work Act or a modern award.

Remember, just because you pay an above-award rate doesn’t mean you aren’t underpaying employees – the rate must adequately compensate the employee for all award entitlements.

You must ensure the contract of employment lists each and every one of the award entitlements that the employee would otherwise be due for each pay period (such as overtime, all penalty rates, and all allowances) that is to be set-off against the annualised salary.

Set-off clause pain points:

  • Non-financial entitlements: A set-off clause may not be able to adequately satisfy non-financial entitlements or obligations arising under a modern award and these must still be covered elsewhere in the employment contract.
  • Employees with significant variations in work hours: This scenario will test your employment contract if put to the ‘better off overall’ test.
  • Modern award changes: Employers may need to redraft set-off clauses in employment contracts, particularly where the agreement incorporates or references the award.

If an employment includes that if even some of the employee’s remuneration satisfies a specific aspect of employment (such as ordinary hours), that same amount cannot be used to cover another award obligation (such as overtime or penalty rates).

Keeping clause compliant As the modern award provisions continue to be payable with a set-off clause (the salary pays for it), the record keeping obligations of the Fair Work Act 2009 and Fair Work Regulations 2009 continue to apply. If an employee is entitled to an overtime rate, the record of the overtime worked must be retained, whether the employee was specifically paid an overtime rate or not.

To stay compliant with their legal obligations, employers need to perform regular audits of annualised salaries vs. full award wages to see if the salary is still above the required award rate and run regular audits to compliment hours-and-pay record keeping.

Even with an adequate contractual set-off clause, underpayments can still occur, so seek comprehensive legal advice when using these instruments to safely incorporate any award entitlements.

Visit our annualised salary webpage to see our growing collection of resources for payroll professionals dealing with the new rules, and subscribe to our mailing list to get a soon-to-be released series of Your Action Plan resources packed with expert advice and opinion on staying compliant.