Annualised Salaries Under Scrutiny: What Employers Need to Know Now

Annualised Salaries Under Scrutiny: What Employers Need to Know Now

A landmark Federal Court decision has redefined how Australian employers must manage annualised salaries, putting an end to broad set-off clauses and forcing businesses to rethink payroll compliance on a pay-period basis.

On 5 September 2025, the Federal Court of Australia handed down a decision that’s already reshaping how employers approach pay structures – particularly those relying on annualised salaries to meet Modern Award obligations. The case, involving Woolworths and Coles, has serious implications for any business using set-off clauses to offset award entitlements like overtime and penalty rates.

The Court’s message was clear: set-off clauses can only operate within a single pay period. Employers can no longer average payments over months or years to meet award requirements. Each pay cycle must independently satisfy all entitlements under the relevant Award.

This decision came after years of investigation by the Fair Work Ombudsman (FWO), which found Woolworths and Coles had underpaid salaried managers covered by the General Retail Industry Award. The companies had assumed that paying above-Award salaries over a 26-week period would cover all entitlements. But the Court disagreed, stating this practice failed to meet the legal requirement to pay entitlements in the pay period they were earned.

Annualised Salaries Decision: Critical Changes for Employers 

The days of relying on broad salary structures and vague set-off clauses have passed us by.

Employers must now take a much more granular approach to payroll compliance. And while this might sound daunting, there are clear steps businesses can take to protect themselves and ensure they’re doing the right thing.

1. Review employment contracts thoroughly
   
   Start by revisiting all employment contracts for Award-covered employees. If your contracts include set-off clauses that attempt to offset entitlements over extended periods – like the 26-week clause used by Woolworths, they need to be updated. Contracts should clearly state salary payments are intended to satisfy award entitlements within each pay period, not across multiple periods.
   
   Professional advice is essential here. Even well-drafted clauses won’t protect you if they don’t align with the Court’s interpretation. Make sure your contracts are not only legally sound but also practically enforceable.
2. Audit your payroll systems
   
   Next, take a close look at your payroll systems. Are they capable of tracking start and finish times, overtime, penalty rates, and allowances for each employee in each pay period? If not, it’s time for an upgrade.
   
   Many employers rely on rosters or basic clock-in data, assuming that’s enough. But the Court made it clear: raw data isn’t sufficient. You need detailed, accurate records that show exactly what entitlements were earned and paid in each cycle.
   
   If your system can’t do that, you’re exposed, not just to underpayment claims, but also to civil penalties for failing to meet record-keeping obligations under the Fair Work Act and Regulations.
   
   
3. Reconcile payments every pay period
   
   This is perhaps the most important change. Employers must reconcile payments made in each pay period against the entitlements owed under the relevant Award – i.e. checking whether employees received the correct overtime, penalty rates, allowances, and loadings based on the actual hours they worked.
   
   You can still pay employees a salary, and you can still include a set-off clause in the contract. But you must be able to prove the salary covered all entitlements for that specific pay period. No more averaging. No more assumptions.
   
   
4. Consider moving away from annualised salaries
   
   Where the employee’s role is covered by Modern Awards, it may be safer to move employees onto a wages model. This allows for more precise tracking of entitlements and reduces the risk of non-compliance.
   
   Annualised salaries aren’t illegal, but they are now inherently risky unless managed with extreme care. If your business doesn’t have the systems or resources to monitor entitlements pay-period by pay-period, a wages model may be the better option.
   
   
5. Train your HR and payroll teams
   
   This decision represents a major shift in employment law and your HR and payroll teams need to understand it. Provide training on the implications of the ruling, the importance of accurate record-keeping and how to reconcile entitlements correctly.
   
   Make sure everyone involved in payroll understands that overpayments in one period can’t be used to offset underpayments in another. Each pay cycle must stand on its own.
   
   
6. Keep records that meet legal standards
   
   Under section 557C of the Fair Work Act, the burden of proof in underpayment claims falls on the employer. If you don’t have proper records, you’ll struggle to defend yourself. Make sure your records clearly show:
   
   – Start and finish times.
   – Overtime hours.
   – Penalty rates.
   – Allowances and loadings.
   – Payments made in each pay period.
   
   Don’t rely on rosters or general time logs. You need specific, detailed records that align with the entitlements under the relevant Award.
   
   
7. Prepare for potential back-pay claims
   
   If you’ve been using annualised salaries and broad set-off clauses, you may be at risk of underpayment claims. Woolworths expects to pay $530 million on top of the $486 million it has already repaid. Coles is looking at an additional $150–$250 million, not including interest and superannuation.
   
   These figures are a stark reminder of what’s at stake. If you suspect there may have been underpayments, consider conducting a payroll audit and seeking legal advice on how to rectify the situation.

Key Takeaways

The Federal Court’s decision is a wake-up call for Australian employers. It’s no longer enough to pay above-Award salaries and hope that covers everything. You must now prove, pay-period by pay-period, that all entitlements have been met.

It’s a big shift. By taking the right steps now like reviewing contracts, upgrading systems, training staff and keeping accurate records, you can protect your business and your employees.

If you’re unsure where to start, reach out to Akyra as this is one area where proactive action is far better than reactive remediation.