The Set-Off Clause Problem: Why Your Employment Contracts Might Not Be as Safe as You Think
Employment contracts should protect your business, not put it at risk. But for many employers using set-off clauses, recent legal developments suggest you could be walking a fine line without even realising it.
If your contracts include a clause that bundles award entitlements like overtime, allowances and penalties into one neat annual salary, you might want to take a closer look.
It’s a practice that’s been common for years, but now there’s fresh concern that many of these clauses aren’t worth the paper they’re written on.
Let’s unpack what set-off clauses are, why they’re popular, and what recent court rulings have changed about how they should be used in practice.
What Is a Set-Off Clause?
A set-off clause is a provision in an employment contract that allows an employer to pay a single annual salary that covers more than just the base wage. It’s used to offset things like:
- Overtime
- Penalty rates
- Allowances
- Loadings
In theory, the clause allows you to simplify payroll by rolling all these entitlements into one tidy number. As long as the total amount paid is equal to or greater than what the employee would have received under the relevant Modern Award or other relevant industrial instrument, it should meet the Better Off Overall Test (BOOT).
Sounds straightforward, right? The reality is far more complex, and risky.
Why Businesses Use Set-Off Clauses
For many employers, particularly those paying well above award wages, it makes sense. If someone’s on a competitive salary, it feels unnecessary to also tally up every Saturday shift or tool allowance separately.
Set-off clauses are commonly used for:
- Salaried roles covered under a Modern Award
- Senior team members paid above award
- Roles where penalty rates or allowances might occasionally apply
They’ve been considered lawful and widely accepted under Fair Work legislation, provided they’re accurate, specific, and well-drafted.
But that’s where the problem starts.
The Hidden Risk: Poor Drafting
The majority of set-off clauses in circulation are either too vague, reference the wrong Award, or lack specific detail.
These kinds of errors are more common than you’d think, even in contracts drafted by professionals.
Here’s what often goes wrong:
- Clauses don’t list specific award entitlements being offset
- Wrong Award names or clause numbers are referenced
- Broad, catch-all language like “all award entitlements” is used
- The contract hasn’t been updated for years despite award changes
If your set-off clause falls into any of those categories, it could leave your business exposed.
The Case That Changed Everything
A recent High Court case involving Coles and Woolworths has sent shockwaves through employment law circles.
Both companies used set-off clauses in their contracts and believed they were covered. The courts disagreed.
The result? Massive backpay liabilities, reportedly into the millions (if not billions).
Two key lessons emerged from this case:
- Set-Offs Must Apply Within Each Pay Cycle
Both companies had taken an “averaging out” approach, assuming that as long as staff were better off over time, it was fine. The ruling made it clear that the annualised salary must compensate for award entitlements within each pay period (e.g. weekly or fortnightly), not across the year.
In other words, you can’t rely on good months to cover underpayments in bad ones.
- Record Keeping Still Matters
Even if you’re paying above award, you still need to record what the employee would have earned under the award for each pay cycle. That includes:
- Ordinary hours
- Overtime
- Penalty shifts
- Allowances
Without those records, you can’t prove that the employee was better off, and the set-off clause won’t save you.
So... Should You Still Use Set-Off Clauses?
They’re not off the table entirely. Set-off clauses can still be effective if they’re:
- Drafted by an expert in employment law
- Highly specific and detailed
- Regularly reviewed and updated
- Supported by strong payroll records
- Applied correctly within each pay cycle
But there’s a growing case for considering Individual Flexibility Agreements (IFAs) instead.
Why IFAs Might Be a Safer Bet
IFAs are allowed under every Modern Award and give you more protection when structuring above-award salaries. They:
- Clearly outline what’s being offset
- Include specific calculations
- Are tailored to the role and the award
- Offer more transparency for both employer and employee
They’re detailed, thorough, and leave far less room for confusion.
What You Should Do Right Now
If your business uses set-off clauses, take this as your prompt to act.
Here’s where to start:
- Review your contracts: Are your set-off clauses clear, accurate and current?
- Check the award: Are the right clauses referenced? Are you actually covering what you think you are?
- Update your payroll records: Can you prove the BOOT is being met every pay cycle?
- Seek expert advice: Don’t rely on generic contract templates or lawyers unfamiliar with workplace legislation.
And importantly, don’t treat employment contracts as a set-and-forget task. Awards change. Businesses evolve. Compliance is ongoing.
Final Thought
Paying above award doesn’t automatically protect your business. In fact, without the right documentation, it can make things worse.
Whether you stick with set-off clauses or shift to flexibility agreements, what matters is clarity, accuracy and consistency. Because when contracts fall short, the cost of getting it wrong is more than just financial, it damages trust, credibility and the future of your business.
An Invitation
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