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How to Manage a Payroll Error

Reading time: 13 mins

Australian employers must manage a payroll error under the law, or face legal consequences. Employees and the employer can correct payroll errors when both parties agree and the correction aligns with the law.

Payroll is one of the least appreciated yet most important functions in a business. When the payroll team does well, employees are happy and the company avoids legal consequences. On the other hand, payroll mistakes can have an impact on the entire company.

Some employers are not sure about their legal responsibilities regarding payroll errors. They can also be unsure about how to handle these errors to avoid legal consequences.

Can an employer rely on a contract to correct payroll errors?

Many employment contracts have a clause that permits the employer to deduct amounts from the employee’s wages.

A common clause in standard employment contracts often states that:

In the event an error has been made in the payment of an employee’s salary, overtime payment or leave accruals, balances or usages, the employer shall, for purposes of future compensation, adjust such compensation to the correct amount, giving written notice to the employee.

On this basis, the employer could simply deduct the amount owed from the next payment. However, the law does not allow for this to happen.

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Approval for deductions by agreement

Under section 324(1)(a) of the Fair Work Act, an employer can only make authorised deductions. These deductions can be made from an employee’s wages, incentive-based payments, bonuses or allowances, if both:

  1. the employee approved the deduction in writing; and
  2. the deduction is principally for the employee’s benefit.

In addition to the above, section 324(1) of the Fair Work Act permits the employer to make deductions where:

  • the employee approves the deduction under an enterprise agreement;
  • A modern award or an order of the Fair Work Commission authorises the deduction; or
  • Legislation or a court order authorises the deduction.

An employer must be careful before relying on a contract to correct payroll errors. The Fair Work Act provides that the employee’s written approval must:

  1. specify the amount of the deduction; and
  2. the employee can withdraw their approval at any time.

Employment contracts rarely specify the amount of the deduction. For this reason, these clauses are generally invalid. And even if the clause were effective, the employee has the right under the law to withdraw their consent at any time. This is regardless of the terms of the employment contract.

Employees can only have payroll deductions if an employment agreement specifies the amount.

Disputes about payroll deductions

If an employer relies on such a contractual clause and the employee later disputes the deduction, the employer may:

  1. have to repay the amount to the employee; and/or
  2. be subject to a civil penalty.

Therefore, employers should be cautious when relying on a general deduction clause in employment contracts. The employee must provide written consent to a specific amount, regardless of the terms of the employment contract. That is, unless an industrial instrument, legislation, or court order properly authorises the deduction.

Can an employer correct an overpayment of wages in a later payment?

Sometimes a payroll error or misjudgement can lead to an overpayment of wages. Overpayment of wages generally occurs in two cases. The first is a clerical error or the entry of incorrect data into a payroll system without intention.

The second is a misunderstanding regarding an employment contract, industrial instrument, Award, enterprise agreement, or National Employment Standards.

Managing overpayment of wages

An employer can only deduct money from an employee’s pay under certain circumstances. Which include if permitted by an industrial instrument (e.g., an enterprise agreement or modern award), legislation or court order.

An employer cannot deduct money from an employee’s future pay without their permission if it is not explicitly allowed. This applies even if the employee received an overpayment.

If an employee agrees, an employer can likely deduct overpaid wages. This is especially true if the reason for the overpayment was merely an error in the payroll.

The High Court dealt with the right to recover incorrect payments in David Securities Pty Ltd v Commonwealth Bank of Australia. This case dealt with the issue of the right to recover monies paid as a result of a mistake of law. The Court ruled that the party who made payments by mistake should not benefit unfairly and ordered them to reimburse the amount.

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How can employers recover an overpayment of wages?

An employer may seek recovery of an overpayment by negotiating and recording a written agreement with an employee. The employee typically determines how to repay the money and sets the amount and frequency of each payroll deduction. The amount and frequency of the deductions must be reasonable.

For example, A payroll error overpaid Jason $2,000 over three years. Under his award, his employer cannot automatically deduct this overpayment from his future pay.

Jason and his employer, Amelia, meet to discuss the overpayment. Jason agrees to repay the money, and they work out a solution.

Amelia says Jason can decide how the money will be repaid and the amount and frequency of payments. Jason tells Amelia that he prefers to deduct $20 from his weekly pay until he repays the full $2,000. They both put the agreement in writing and signed it.

Jason chose how much and how often he would repay, making this repayment method fair.

Suppose an employee refuses to agree to repayment. In this case, the employer must take independent action to recover the overpayment, such as through civil recovery action. An employer should consult a workplace lawyer if they cannot reach a repayment agreement.

Can an employer deduct money owed from an employee’s wage?

Sometimes employees owe money to their employers at the end of their employment. There are various reasons for this, such as:

  • repayment for the purchase of products
  • cash loans
  • cash shortfalls
  • rent or benefits with a payment plan
  • overused holidays
  • overpaid wages
  • errors

The employer can ask for their money back if the employee resigns. The easiest way to recover money is to deduct the amount the employee owes from their final wages.

Employers often ask workplace lawyers if it is possible to deduct the money they believe the employee owes them. Employers need to understand that what looks easy, may not be.

The law does not allow an employer to recover money owed by deducting the employee’s wages. In most cases, the employer is no better off than any other creditor unless the employee consents in writing.

While there should be accountability for things like cash shortfalls, the law states that it cannot take the form of a deduction from wages. The employer may need to act to recover overpaid amounts if they refuse to pay. This action may involve seeking help from an employment lawyer and filing a civil claim in court.

Employers must not make the mistake of entering into unlawful deductions. Unlawful deductions can result in steep civil penalties up to $630,000 for companies and $126,000 for individuals.

Notice periods and reductions in pay

Typically, the employer and the employee must give written notice if they want to end the employment relationship.

If an employee terminates his employment, he may have to do so in writing by letter (or email) to his employer. Similarly, when an employer gives notice to an employee, the employer must give the employee notice.

In both cases, the notice period:

  • begins on the day after the employee has given notice that he wishes to terminate his employment;
  • ends on the last day of employment.

An employer must observe the following minimum notice periods when dismissing an employee:

Employment Term

Minimum Notice Period

1 year or less

1 week

More than 1 year – 3 years

2 weeks

More than 3 years – 5 years

3 weeks

More than 5 years

4 weeks

Employees not covered by an Award or employment contract do not need to give notice when they resign. However, the employee’s employment contract, applicable Award, or registered agreement, will usually specify the notice period required. An employment contract cannot provide for less than the legal minimum specified by the National Employment Standards.

For instance, a contract or agreement may require a longer notice period, such as 1 month instead of 1 week.

Payment in Lieu

Generally, the employee will observe the notice period. However, sometimes the employer will not require the employee to work the notice period. If this happens, the employer and the employee can decide the employer will pay the notice period instead. If the employee does not work the notice period when the employment relationship ends, this is notice-not-worked.

For instance, if a dismissed employee wants to leave during the notice period. The employer can choose to reduce the time before an employee leaves their job earlier than planned.

If the employer doesn’t agree to shorten the notice period, the employee can resign and give the minimum notice required. The time the employee has already worked during the original notice period is not counted.

Minimum notice periods

The minimum notice period an employer must observe depends on the length of service.

Continuous service includes authorised unpaid leave (e.g. unpaid parental leave). Service will not include periods of unauthorised leave or absence.

For example, Hannah has been employed for 5 years and 3 months. This includes 12 months of unpaid parental leave. Hannah’s manager is letting her go because her job is no longer necessary. They are deciding how much notice she should be given.

Hannah’s award refers to the National Employment Standards for notice periods. The employee’s continuous service includes 12 months of unpaid parental leave. Hannah’s employer must give her 4 weeks’ notice.

Where an employer provides for a longer notice period than provided for in the award, registered agreement or employment contract, the employee only has to work the minimum notice period. They can work out the additional notice period if they wish. If the employee only works the minimum notice period, the employer does not have to pay for any extra notice period.

Taking leave during a notice period

An employee can also take annual leave during the notice period if the employer agrees to the leave. However, the employer cannot force an employee to take leave during the notice period.

An employee may take sick leave during a notice period if he or she:

  1. gives notice of the leave as soon as possible
  2. provides proof if the employer requires it (e.g. a medical certificate).

An employee who has used up all their sick leave may take unpaid sick leave. They must notify the employer of this and provide evidence.

According to the National Employment Standards, notice periods do not apply to employees who:

  • are casual workers
  • work under a fixed-term contract.
  • are undertaking seasonal work
  • are dismissed for serious misconduct (e.g. theft, fraud, assault or sexual harassment)
  • have a training arrangement and are employed for a fixed period or for the duration of the training arrangement (with the exception of apprentices)
  • work as daily hire labourers in the construction industry, or in the meat industry in connection with the slaughter of livestock
  • are weekly hire workers in the meat industry and whose dismissal depends on seasonal factors (but not if the dismissal is for other reasons).

In the case of apprentices, the employer must provide notice to the apprentice unless they are:

  1. employed for a specified period or task; or
  2. dismissed for serious misconduct.

Frequently Asked Questions

How do I determine if an overpayment or underpayment of wages has occurred?

Check payroll records to make sure payments match employee contracts or agreements. Ensure that pay rates are at least equal to the minimum pay rates in an Award or enterprise agreement.

Employers must also confirm whether any overpaid is owed or additional allowances.

Employers need to actively find and fix wage errors. These errors can come from administrative mistakes, misinterpretation of industrial agreements, or other reasons.

Employers need to take action to address these errors promptly. By doing so, they can ensure fair compensation for their employees.

This means telling affected employees promptly. It also means investigating why the error happened. Additionally, it involves calculating the correct amounts owed and correcting the mistake.

It’s important to have open communication with the employees who were impacted by the mistake. Make sure they understand what went wrong. Outline the steps that will be taken to correct it and provide a timeline for fixing the issue.

Asking the employee how they want the error fixed is a good idea. This is especially important if they receive too much payment. This will help ensure that the repayment plan is fair.

Employers apply tax and superannuation to the correctly calculated wage.

Seek advice from an employment lawyer, and engage in open communication with the employee. Notify the employee in writing of the payroll error, including where you have overpaid an employee. The company may need to take legal action if an employee has left the company or refuses to pay.

About the Author

Farrah Motley
Director of Prosper Law. Farrah founded Prosper online law firm in 2021. She wanted to create a better way of doing legal work and a better experience for customers of legal services.

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