Why should businesses consider set-off clauses in Australian employment contracts?

Employment contracts are much more than just paperwork; they’re the foundation of a fair and organised working relationship. They set out key details like working hours, pay rates, leave entitlements, and expectations for employees. While not legally required in Australia, they’re widely seen as best practice, ensuring clarity and protection for both employers and employees alike.

Among the many aspects of an employment contract, some clauses can seem a little tricky to understand. One of these is the set-off clause, which plays an important role in balancing payments and obligations. Let’s break down what set-off clauses are, how they work, and why they matter.

1. What are set-off clauses?

The reason why an employer may decide to pay an employee a loaded rate of pay or an annualised salary, as opposed to paying the minimum amount as set out in the applicable modern award or enterprise agreement, is so that the above award or agreement rate of pay absorbs other award or agreement monetary entitlements. The loaded rate of pay or annualised salary may cover entitlements such as:

1. penalty rates (for example, weekend penalties and public holiday penalties);
2. overtime rates;
3. allowances; and
4. annual leave loading.

If an employer does intend a loaded rate of pay or annualised salary arrangement to be all-inclusive of monetary entitlements under an award or enterprise agreement, then it must ensure that it has a well-drafted set-off clause in its employment contracts. The set-off clause may allow the employer to rely on the loaded rate of pay or annualised salary in answer to an underpayment claim.

For a set-off clause to be effective, it must expressly state the purpose of the overpayment and to what payments it may be applied. For example, if an employer intends to pay an annualised salary over and above the minimum award salary to compensate the employee for annual leave loading, then the set-off clause should explicitly state that the salary paid to the employee is paid in full satisfaction of any obligation on the employer to make payment for annual leave loading. Then, if an employee were to make an underpayment claim claiming that they haven’t been paid annual leave loading, the employer will be able to rely on the set-off clause to defend such a claim (on the basis that the annual leave loading has been included in the employee’s annualised salary and the set-off clause allows the employer to set off such payment via the annualised salary).

For clarity, the ability to offset doesn’t extinguish an employer’s obligation to pay monetary entitlements under an applicable modern award or enterprise agreement because employers and employees can’t contract out of obligations under industrial instruments. Rather, employers must ensure that the wages or salary paid to employees is sufficient to meet all entitlements under an award or enterprise agreement, including base rates of pay, penalty rates, overtime, loadings, and allowances.

2. The risks of underpayments are high if you’re not on top of your compliance

Set-off clauses can be a valuable addition to an employment contract, offering flexibility to both parties. However, it’s important to recognise that there’s always the potential for an underpayment claim, even when an employee is paid above the minimum required by a modern award or enterprise agreement.

While paying an employee above the award rate may seem to eliminate the risk of underpayment, the all-inclusive salary must still meet or exceed both the minimum pay rates outlined in the applicable award or agreement and any additional entitlements. If the total payment doesn’t cover all required entitlements, the employer may be in breach of the Fair Work Act 2009 (Cth) (FW Act) and the relevant industrial agreement. This could lead to an underpayment claim and potential legal action by the Fair Work Ombudsman (FWO) or unions.

A key point to consider is that poorly drafted set-off clauses can expose the employer to such risks. These clauses must be clear about which entitlements are being offset by the higher salary. Whether you’re setting off one or several entitlements, it’s critical to be specific in the contract. If the set-off clause is vague or unclear, it could be deemed unauthorised or unfair by a Court, putting the employer at risk of underpayment claims.

3. How should employment contract set-off provisions be drafted?

Before implementing a set-off clause, it’s crucial to identify which employee entitlements will be offset against a higher base rate of pay. The clause must clearly specify which entitlements are covered and ensure that the higher base rate of pay fully compensates the employee for all these benefits. Importantly, the clause must not be detrimental to the employee. To ensure the clause is properly drafted and legally compliant, seeking professional legal advice is strongly recommended.

How Citation HR can help

Employment contracts are invaluable to all companies, regardless of size, and provide indispensable clarity surrounding the employment relationship. A properly drafted employment contract enables an employer to undertake effective and efficient employment relations processes where required.

Citation HR Software is fully equipped with employment contract templates, as well as other documents and policies, making it easy to manage this process. For existing clients of Citation HR, if you have any questions about including set-off clauses in Australian employment agreements or you have another workplace matter you need assistance with, please contact our HR Advice Line.

Not a Citation HR client? The team at Citation HR can support your business on a range of workplace matters. Contact us today to arrange a confidential, no-obligation chat. 

About our author

Tuvini Jayakody is a Workplace Relations Advisor at Citation HR. She assists clients with a range of employment relations and compliance matters via the HR Advisory Service. She is currently studying for a Bachelor of Commerce and Laws.