New Federal Court decision on employment contracts forces costly payroll system changes for SMEs lacking corporate HR resources, says COSBOA.
What’s happening: The Federal Court has ruled employers cannot use contractual set-off clauses to balance payroll across multiple pay periods. All award entitlements must now be met within each individual pay period, ending common averaging practices for annualised salary arrangements.
Why this matters: Small businesses face costly compliance overhauls without the HR infrastructure of large corporations. The ruling forces immediate review of employment contracts, payroll systems and timekeeping processes, creating significant financial and legal risks for SMEs already struggling with complex workplace laws.
The Federal Court’s recent decision on contractual set-off clauses has sent shockwaves through Australia’s small business community, with industry leaders warning of an “impossible regulatory burden” that threatens to cripple SME operations.
The Federal Court struck down the use of contractual annualised salary arrangements used to “set-off” or absorb entitlements owing under an industrial instrument, fundamentally changing how businesses can structure their payroll systems.
The ruling prohibits employers from using set-off clauses in employment contracts to balance out overpayments in one pay period against shortfalls in another. Annual salary payments can only legally be set off against modern award entitlements that accrue within the same pay period, whether weekly or fortnightly.
Court strips flexibility
COSBOA Chair Matthew Addison has condemned the decision as a backward step for workplace relations flexibility.
“This is ridiculous. Annualised salary arrangements were already difficult enough for small businesses to manage, and this decision makes it near impossible,” Mr Addison said.
“Small business owners 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.”
Compliance nightmare
The decision creates several critical challenges for small businesses. Contractual set-off clauses are now limited to a single pay period, preventing employers from pooling or averaging payments across multiple cycles, even when annual salaries were designed to absorb entitlements such as overtime or penalty rates.
Annualised salary arrangements face particular scrutiny, with employers no longer able to use these structures to absorb fluctuations in entitlements unless each individual pay period fully meets all award obligations.
Even carefully drafted employment contracts may not provide adequate protection. The Court’s decision questioned whether any contractual wording could lawfully permit set-off arrangements across multiple pay periods, creating uncertainty for employers who believed their contracts were compliant.
System overhaul required
The ruling significantly increases the risk of underpayment claims, with small businesses potentially facing backpay liabilities, penalties and regulatory scrutiny if they fail to meet award obligations within each pay period.
Record-keeping obligations have been reinforced, requiring employers to maintain accurate, detailed and accessible records of employee hours, overtime and entitlements for each pay period. Partial or incomplete records will not suffice under the new interpretation.
“Small businesses want to do the right thing, pay their staff fairly and stay compliant, but the rules keep shifting under their feet,” Mr Addison said.
Reform urgently needed
The decision highlights the growing complexity of Australia’s workplace relations system, particularly for small businesses lacking dedicated compliance resources.
“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,” Mr Addison said.
COSBOA is calling on the Government to pass urgent legislation to address the issue and provide clarity to small businesses. The organisation argues that SMEs face a disproportionate share of workplace compliance obligations and require protection from excessive regulatory burden.
The ruling comes at a challenging time for small businesses, which are already grappling with additional compliance pressures including the government’s “payday super” reforms requiring superannuation payments within seven days of payday by mid-2026.
For small business owners, the immediate priority is reviewing existing employment contracts and payroll arrangements to ensure compliance with the new interpretation. However, the broader implications suggest a need for systematic reform to create more manageable workplace laws for Australia’s SME sector.
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