Court ruling on contractual set-off clauses creates ‘impossible’ payroll burden

A recent Federal Court decision on annualised salary arrangements creates an “impossible regulatory burden” for small businesses, small-business advocates have argued.

Earlier this month, the Federal Court of Australia struck down the use of contractual annualised salary arrangements, which are used to “set off”, or absorb, entitlements owing under an industrial instrument greater than the pay period itself, and which would otherwise result in underpayments.

The proceedings addressed alleged breaches of the Fair Work Act 2009 and the General Retail Industry Award 2010 (GRIA), in respect of salaried managers who worked in Coles and Woolworths stores, whose employment was covered by the GRIA.

Allegedly, underpayments for those workers had arisen, in part, from annualised salary arrangements that were said to be insufficient to cover the number of overtime hours worked by the relevant employees.

As a result of the judgment, employers can no longer use set-off clauses in employment contracts to balance out overpayments in one pay period against shortfalls in another, and instead, all entitlements must be paid in full within each individual pay period.

As reported in the wake of the court’s ruling, both supermarket giants advised the market that they will face additional costs that will run close to a cumulative $1 billion.

A full explanation of the judgment, and its practical application, is set out below.

‘Impossible burden’

Responding to the decision, the Council of Small Business Organisations Australia (COSBOA) has suggested that the striking down of contractual set-off clauses “creates an impossible regulatory burden for small businesses, adding yet another layer of red tape to already complex workplace laws”.

The council’s chair, Matthew Addison, said the ruling is a step backwards for flexibility and practicality in Australia’s workplace relations system.

“This is ridiculous,“ he said.

“Annualised salary arrangements were already difficult enough for small businesses to manage, and this decision makes it near impossible.

“Small business owners, Addison pointed out, don’t have the payroll departments, HR teams, or in-house lawyers that large corporates rely on.

“They now need to review every payroll process and employment contract to ensure set-off arrangements comply with the law, restructure salaries so each pay period meets all entitlements, and invest in robust timekeeping systems – all just to avoid compliance risk.

“For many, this isn’t just a technicality; it’s a major compliance headache that could expose them to huge financial and legal risks.”

Among the issues highlighted by COSBOA are the limiting of contractual set-off clauses to a single pay period (as employers will not be able to “pool or average payments across multiple cycles, even if annual salaries were designed to absorb entitlements such as overtime or penalty rates”), and that employers can no longer use annualised salary arrangements “to absorb fluctuations in entitlements unless each pay period fully meets all award obligations”.

Moreover, COSBOA said, the court’s decision increases the risk of underpayment claims.

“Small businesses could face backpay liabilities, penalties, and regulatory scrutiny if they fail to meet award obligations within a single pay period,” the council said.

Addison said: “Small businesses want to do the right thing, pay their staff fairly and stay compliant, but the rules keep shifting under their feet.

“This ruling highlights the need for guidance and support to help small businesses adjust their systems and contracts, and for long-term reform to ensure workplace laws are achievable for all employers, not just large companies.”

In response, COSBOA is calling on the government to pass urgent legislation “to fix this issue” and provide clarity to small businesses, which have a “disproportionate share of workplace compliance obligations”, and therefore need protection from what it called “excessive” regulatory burden.

Set-off decision explained

The judgment concluded that an employer is only permitted to set off award salary payments against obligations arising under the award within the same pay period.

“Put another way, an obligation to pay overtime in one payment cycle cannot be set off against payments made in excess of award obligations in a later (or earlier) payment cycle,” Justice Nye Perram of the Federal Court said.

“Both Coles and Woolworths’ letter of employment sought to achieve this kind of set-off outside of a payment cycle. I have read down their letters of employment to limit any set-off to within the same payment cycle.”

For Coles, which has a monthly payment cycle for salaried managers, this means the supermarket giant is permitted to set off its obligations under the award against the total amounts paid by Coles in that month.

“In practical terms, this will mean that the amount by which Coles pays a monthly salary to its salaried managers exceeds the monthly minimum wage, the total of the remaining monthly surplus will be available to be set off against any other obligations it has to make other payments under the award.”

As for the fortnightly pay period, Justice Perram similarly concluded the annual set-off clause was not effective outside of this cycle.

Woolworths had argued that the court should assess an employee’s compensation across the whole year to determine whether loss had been suffered, and should particularly pay attention to the pay periods in which employees were paid more than their award entitlements.

For example, if an employee is paid $2,000 per fortnight – and the minimum wage is $1,800 – and works ordinary hours on weekdays with no other entitlements for 21 fortnights of the year, then they complete $500 of overtime for five of those fortnights.

For those five fortnights, Woolworths said it should be entitled to set off the $200 it pays in excess of the wages for ordinary hours due under the award – being the difference between minimum wage and the $2,000 salary – against the $500 it owed each fortnight.

Justice Perram said that even in this example, Woolworths’ failure to make the additional payments of $300, or a total of $1,500, would be a contravention of the award.

Woolworths submitted that the fact that an employee received $4,200 for the year above the minimum wage should be set off against the $1,500, so no compensation should be payable.

Justice Perram did not accept this.

“The employee is to be restored to the position he or she would have been if the contraventions had not occurred,” Justice Perram determined.

“In that counterfactual, the employee would receive the $1,500 for overtime, but they would still have received their full salary of $2,000 for the 26 fortnights.

“This is because Woolworths was always contractually obliged to pay the salary.”

The proceedings were: Fair Work Ombudsman v Woolworths Group Limited; Fair Work Ombudsman v Coles Supermarkets Australia Pty Ltd; Baker v Woolworths Group Limited; Pabalan v Coles Supermarkets Australia Pty Ltd [2025] FCA 1092.