Like a duck on water: why annualised salaries require ongoing work

In our recent article, Annualised salaries and set-off clauses: are they worth the trouble?, we explored some of the practical and technical challenges that arise with the use of annualised salaries and set-off clauses in the context of high-profile underpayment cases. Following more recent developments, what started as a cautionary tale with some tips to keep in mind is now becoming a significant governance and compliance issue. 

Like a paddling duck on the water, annualised salaries look relatively simple if/when implemented well, but there is much work required ‘below the water line’ to keep this particular duck afloat! What was once called a payroll error is now more likely to be called wage theft. We will almost certainly have a new Senate Inquiry into these issues, with the Opposition supporting a new Senate Committee inquiry into the extent and amount of unlawful underpayment of employees’ remuneration by employers,[1] and other members of the Senate likely to support this. 

We have recently seen some of Australia’s most iconic names and brands self-reporting to the Fair Work Ombudsman (FWO) with admissions of underpayments, and a flurry of publicity. And, reflective of the mood, the FWO ‘means business’. It has ominously warned businesses that they “must understand that admission is not absolution. Companies should expect that breaking workplace laws will end in a public court enforcement outcome.”[2]

The issue is no longer one of tedious administration. It is one of accountability and the social license to operate. It is another example of how organisations should re-evaluate their approach to risk management and compliance when doing business in Australia.

In this article, we explore how we got to this point with a view to some insights on what employers can now do.

How did we get here?

Annualised salaries are attractive to employers for their apparent ease of administration. Rather than have to deal with the burden of calculating overtime, penalty rates, allowances and other obligations that arise under awards or enterprise agreements, an annualised salary offers the ease of a set amount each week. 

From an employee’s perspective, the certainty of each payment is also attractive. A payment system that ‘smooths out lumps’ makes it easier to budget and plan.

For all the purported ease of annualised salaries, however, a number of challenges quickly emerge. First and foremost is the relative complexity of the Australian workplace relations system. The very attractiveness of annualised salaries – i.e. reducing administrative burdens – belies the work and vigilance needed to ensure that the salary actually meets those underpinning legal entitlements. And those entitlements change. An employer simply cannot ‘set and forget’.

Connected to the relative complexity of industrial relations system is the lack of understanding of many of the workplace obligations. There can be a lack of understanding by payroll functions (sometimes based overseas) of Australian workplace laws, and the payroll function is often disconnected to the legal or HR functions. Of course, even where legal or HR eyes are cast over the system, reasonable minds may differ. The interpretation of awards is often not clear, and enterprise agreements that are drafted between parties are often notoriously ambiguous. 

There is often confusion and uncertainty about whether an award applies to a person, particularly where the employee may be perceived to be in a management-type role or receive higher than award level remuneration. Of course, modern awards can apply to employees on higher remuneration, provided their duties and principal purpose of employment aligns with a classification under an award. 

Genuine errors of interpretation of the law also occur. As was recently demonstrated by the Mondelez case[3] - which confirmed that personal leave should be accrued and deducted in days, not hours, and provided 10 days for all employees irrespective of their work arrangements – common understandings of how the laws work can be wrong. 

There are other factors at play, with various changes to the workplace. We are seeing a diminishing role and prevalence of employee representatives (e.g. unions). Previously, unions may have intervened at an early stage where payroll errors were identified. There is less of a reliance on enterprise agreements which could package up components of remuneration and instead an increased reliance on awards, not tailored to suit a specific business, which has added to payroll complexity. Wage growth is low, and margins tight, with many employers paying ‘closer to the line’ and not updating or reviewing their arrangements. Finally, corporate attention has not been focused on compliance with HR issues to the same extent it has on tax, corporations law or competition law obligations.

What now?

Against this backdrop, and in an environment of increased external scrutiny of corporate practices, the game has changed. 

Additional regulatory powers

The FWO has been ‘called to arms’, equipped with additional funding and powers to investigate alleged underpayments. It has announced that its priority for 2019-20 is to take a stronger approach to enforcement.[4] This includes pursuing and prosecuting non-compliant companies and individuals and naming and shaming employers who underpay workers or deprive them of their entitlements to send a message of deterrence to employers breaking the law. The FWO has also toughened its compliance and enforcement policy with a view to increasing the amount of compliance notices issued. As mentioned above, recent developments appear to have hardened the approach of the FWO even more.

The Federal Government has increased the penalties available, with a single contravention of the Fair Work Act 2009 now attracting a maximum penalty of $12,600 for individuals and $63,000 for companies. Each serious contravention (that is when a court finds that a person or company knowingly contravened an obligation under workplace laws and the contravention was part of a systematic pattern of conduct) attracts a maximum penalty of $126,000 for individuals and $630,000 for companies.[5] Penalties for failing to keep records or provide payslips have also increased.

The FWO has enhanced powers to investigate, fine and commence proceedings against an employer for underpayment contraventions in relation to any employees, including full time and part time employees who may be subject to set off clauses or annualised salary arrangements.

Recently, increased enforcement action against employers failing to properly remunerate employees on annualised salaries came to the fore with the restaurant group associated with George Calombaris, MADE Establishment Pty Ltd. MADE was penalised by the FWO for underpaying employees $7.8 million because their annualised salaries were not above the award. In August 2019, the FWO also required defence manufacturer Thales to enter a court enforceable undertaking, for failing to ensure employees’ annualised salaries were above the relevant award and enterprise agreement. Of course, more recently, Woolworths disclosed up to $300 million in underpayments.[6]

Criminalising ‘wage theft’

Responding to community concerns, the Federal Government has proposed criminalising wage theft, releasing a discussion paper calling for submissions on the issue. 

The Government’s rationale for criminalising wage theft is to protect workers and prevent non-compliant employers from having an unfair advantage over employers who pay the correct employee entitlements.

It is not yet clear what the threshold for criminal conduct would be, however the Government has stated that it does not intend to penalise employers who make genuine mistakes. Rather, employers who engage in ‘clear, deliberate and systemic’ exploitative conduct and who see fines for underpaying employees as the ‘cost of doing business’, are the target of these reforms.

The discussion paper also considers possible maximum criminal penalties for such conduct. It suggests the punishment should be similar to comparable forms of wrongdoing, such as the model work health and safety laws, the ‘corrupting benefits’ provisions of the Fair Work Act 2009 (Cth) and general theft offences. Such forms of wrongdoing carry a maximum of 10 years’ imprisonment.[7]

Senate Inquiry

As mentioned above, a Senate Inquiry into underpayments is almost certainly on its way. To be voted on by the Senate on 11 November, but with the numbers apparently in hand, the Senate Inquiry is likely to be asked to examine the following matters:

• the reasons for wage theft and whether it is regarded by some businesses as ‘a cost of doing business’;
•  the cost of wage and superannuation theft to the national economy;
•  the best means of identifying and uncovering wage and superannuation theft;
•  the taxation treatment of people whose stolen wages are later repaid to them; and

• the most effective means of deterring wage and superannuation theft.

We can reasonably expect that the FWO will be a lead player in the Inquiry, updating and informing on the full extent of its investigations to date. We also expect senior officers of corporations will be called to account, with CEOs asked not only ‘how and why’ about underpayments, but also what the Board and senior management did to prevent the underpayments occurring.

Be aware of changes

We highlighted in our previous article the change to annualised salary arrangements in light of the 2019 ‘Annualised Wage Arrangements’ decision by the Fair Work Commission, which will take place in March 2020.[8] These new requirements on employers will increase the scope for potential FWO enforcement action. In anticipation of these award changes, employers (who rely on these clauses) should ensure they are familiar with what their new obligations will be and have the requisite systems in place to fulfil their new obligations under the affected awards. Alternatively, as highlighted in our previous article, employers should consider a common law set-off arrangement outside of the award provisions.

What should employers do?

Fundamentally, annualised salaries and the use of set-off clauses are valid so long as the amount paid to the employee is sufficient to fully meet the employer’s obligations under an award or enterprise agreement, and various other requirements (e.g. drafting, monitoring, time recording etc.) are met. It follows, however, that employers who use annualised salaries must have strong systems in place to ensure compliance. 

Much like work health and safety, we expect to see increased focus on the steps that Boards and senior management have taken to ensure compliance with workplace laws. Senior managers and Boards are likely to be asking for assurance from their legal and HR departments that their business will not be caught up in the next wave of very public scrutiny of these issues. 

At a minimum, we suggest employers implement the following steps to ensure ongoing compliance:

• Incorporate compliance checking protocols for engaging new employees. Compliance issues can occur from the outset of an employment relationship. Those involved with recruitment need to be aware of industrial instrument obligations and have systems in place to ensure compliance of proposed employment arrangements. This may include, for example, setting salary “floors” in payroll systems and providing guidance regarding the uplifts required in annualised arrangements to compensate for anticipated overtime and other allowances and loadings. Of course, having well drafted employment contracts is a good start.
  
  
• Annual salary reviews. Award rates generally increase every year on 1 July. Employers should regularly review and update employees’ salaries to ensure employees are receiving a salary rate of pay sufficient to cover the relevant award’s base rate for ordinary hours.
  
  
• Accurate record keeping. Accurate records are critical to any accurate payment. The Fair Work Act and Fair Work Regulations require accurate employee records, including in some cases prescriptive content for time records and pay slips such as the rate of pay, loadings, allowances and hours worked (where an employee receives an hourly rate of pay). For employers relying on annualised salaries, ensure that there are systems in place to record start and finish times and unpaid breaks.
  
  
• Annual salary reconciliations. Employers should review the actual hours worked by employees and reconcile it against the hours actually paid to an employee and the amount the employee would have received under an industrial instrument.
  
  
• Improve communication between departments. Many of the recent large-scale underpayment admissions have come as a result of a payroll departments not fully understanding the legal obligations. Employers should ensure payroll regularly checks they are meeting their payment obligations to employees, with specialist HR and/or legal advice.
  
  
• Upgrade payroll systems. The Australian industrial relations system is complex. Many payroll systems are developed overseas for simpler industrial relations systems and are largely ineffective or cumbersome in calculating the relevant entitlements for workers under the Australian system, or have not been updated to reflect changes to relevant industrial instruments. Employers should review and upgrade their payroll systems to ensure they are calculating employee entitlements correctly.
  
  
• Monitor trends in payroll queries and complaints. Where there is smoke, there is often fire, so it is prudent for employers to have a system in place to monitor and interrogate trends in individual employee payroll queries and complaints. This will assist employers to ‘join the dots’ and proactively identify compliance issues potentially affecting a broader class of employees.
  
  
• Consider available mechanisms to implement annualised salary arrangements. Many employers rely solely on common law set-off clauses in providing employees with annualised salaries. However, employers should also consider the feasibility of other options. While annualised salary arrangements under modern awards are becoming increasingly complex to implement, they do offer the advantage of being deemed to have satisfied key award entitlements including overtime, penalty rates, allowances and annual leave loading. Employers could also consider using individual flexibility arrangements. For more senior employees, an annual guarantee of earnings, which suspends the application of the modern award to the employee entirely for the duration of the guarantee,[9] may be an attractive and relatively simple option.

Finally, it should be obvious that doing nothing is no option for any business with a significant number of employees. A surprisingly large number of employers have been caught out in recent underpayment issues, and they are from a wide variety of industries. It is time for businesses to take stock, and make sure that all that work required ‘below the water line’ is actually going on.