Reducing an Employee’s Pay: What You Need to Know (2023 Update)

by Ilyas Omari

July 12, 2022
Blog, Employment & HR

Reducing an employee’s pay without proper justification is usually illegal and considered unfair and unethical. However, as an employer reducing an employee’s pay may be inevitable at times.

So what are these circumstances that allow you to reduce the salary of your employees, without getting on the wrong side of the law? We’ve got all this and more covered in this article.
Read along to know how to legally reduce an employee’s pay, the legal consequences of illegally reducing an employee’s pay, the rules you must follow, and other key considerations.

3 Reasons To Reduce An Employee’s Pay

Before reducing an employee’s pay, it’s crucial to ensure that the reason you chose to reduce their pay is ethical and justifiable. Employers often reduce the pay of their employees for the following reasons:

Cost-cutting

If your business needs to cut costs, you can offer your employees benefits to compensate for their pay reduction.

For example, you can offer your employee a reduction of working hours or you can increase their annual leave entitlements.

Performance-based pay reduction

If you want to reduce an employee’s pay based on their performance, you can do so by following these steps:

Implement a performance management policy
Undertake a performance review

Redundancy pay

You can also make an employee redundant. For a redundancy pay to be legal it needs to meet one of the two requirements outlined in section 119 of the Fair Work Act. These are:

You are providing your employee with redundancy pay because the position the employee was performing is no longer needed by your business
You can also make an employee redundant if you have become bankrupt or insolvent

The amount of redundancy pay you have to pay an employee is outlined in s 119(2) of the Fair Work Act. You must pay employees based on the amount of time they worked for you continuously before their termination.

For example, if your employee has worked for one to two years, you must pay them for four weeks of their regular working hours. Whereas if your employee has worked for you for a minimum of ten years you’re required to pay them for 12 weeks of their regular working hours.

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Key factors to consider before reducing an employee’s pay

Terms of the Employment Contract

Before you reduce your employee’s pay, you must first review their employment contract. Their employment contract will outline the employee’s pay or salary, any benefits, and how often payroll occurs.

By reviewing an employee’s contract you can avoid a breach of contract.

Annual performance review or review of pay

You can use an annual performance review to justify reducing your employee’s pay if they’re not performing adequately. Therefore, when hiring a new employee, you should include a review of pay or an annual performance review in their employment contract.

These are important terms to include when creating an employment agreement for a new employee to ensure your rights as an employer are not limited in the future.

Four circumstances where you’re legally permitted to reduce an employee’s pay

Section 324 of the Fair Work Act 2009(Cth) outlines the four circumstances under which you can reduce your employee’s pay. These include:

When the employee authorises the pay reduction in writing and the reduction primarily benefits them
When the employee authorises the pay reduction according to their enterprise agreement
When the reduction is authorised under or by a Fair Work Commission (FWC) order or Modern Award
When the reduction is authorised under or by a law of the Commonwealth, a State, a Territory, or an order of a court

1. Pay reduction is authorised in writing and by the employee and primarily benefits them

Although it might seem strange that an employee would agree to a pay reduction, many small businesses often offer a pay reduction in exchange for job security.

It’s important to note that any variation in the amount of the deduction must be authorised in writing by the employee. This must specify the amount of the deduction and may be withdrawn in writing by the employee at any time.

Example 1: Global Financial Crisis( GFC)

During the GFC, a variety of measures were taken by businesses to retain employees. These included the following:

Reduced pay through a reduction in an employee’s salary or their rate of pay
Flexible working arrangements
Reduced working hours

Example 2: Coronavirus(COVID-19)

The measures used by employers during the GFC are now also being used during the COVID-19 pandemic due to the negative impact it has had on the economy.

Example 3:

Kiara runs an event management company. Due to COVID-19, virtual events have been unable to generate the same revenue as in-person events. Consequently, she can’t afford to pay her employees for their regular hours, and she must reduce their working hours. Her employee Rafael agrees to work fewer hours in exchange for job security and has provided written consent for this reduction in working hours. Therefore, Kiara can now reduce the number of hours Rafael works.

2. Authorised by an employee in accordance with their Enterprise Agreement

Enterprise agreements are agreements made between employers and employees. They are used to outline employment terms and conditions. Enterprise agreements must be approved by the FWC in order to be compliant with the Fair Work Act. Employers can use their registered agreements instead of awards under the National Employment Standards(NES).

Example

Rodney runs a construction company. In January 2020, he entered into an Enterprise Agreement with his employees that included terms regarding pay reductions. In June 2020, Rodney reduced his employees’ salaries instead of making them redundant to reward them for their loyalty. Rodney can make this pay cut under his registered agreement with the FWC instead of following the terms of the Construction Award.

3. Authorised by a Modern Award

Modern awards are documents that outline minimum employment conditions and terms in addition to the NES. Modern awards outline employee rights, including their working hours, pay rates, and penalty rates.

An employee’s award depends on the industry they work in and their specific role. Before you reduce an employee’s pay you must determine whether your employee is covered by an industry award. The type of award your employee is under will determine your ability to alter their pay.

You must ensure that the remuneration you give an employee does not fall below the modern award.

Example

James’ restaurant has been hit hard by COVID-19. In order to keep his business afloat, he decides that he will reduce the pay of all his employees.

George, his employee, is 22 years old and has agreed to cut back to two days of work on the weekend. Despite the agreement, James must pay George an hourly rate of $24.36, which is his minimum wage under the 2021 Australian Restaurant Award.

4. Authorised under or by a law of the Commonwealth, a State, a Territory, or an order of a court

It is perfectly legal for an employer to reduce an employee’s pay under limited circumstances, including:

Income tax deductions
Superannuation
Salary sacrifice payments
Deductions authorised by employees such as insurance premiums, union dues, and loan installments

Example

Samantha has just started her first full-time job at 21 years old. She is financially responsible and asks her employer to salary sacrifice an additional 5% of her income into her Superannuation. Therefore, her employer is now authorised to “reduce” her pay as long as they oblige her to deposit additional funds into her Super account before tax.

Restrictions to Consider

The following restrictions still apply even if you and your employee agree to reduce their wage:

National Employment Standards (NES)

Under the Fair Work Act 2009 (Cth), employment contracts can’t remove employee entitlements that are provided for employees in the National Employment Standards (NES). These include:

Annual leave
Sick leave
Parental leave
Penalty rates for working on public holidays

Minimum Wage

The reduction can’t fall below the minimum pay rate. As of 1 July 2022, The Fair Work Commission has increased the national minimum wage to $812.60 per week or $21.38 per hour for full or part-time workers. Casual employees are awarded an additional 25% and therefore their minimum wage is $26.725 an hour.

An employee’s minimum wage can also vary depending on the following factors:

Age
Experience
Position in your business

Frequently Asked Questions (FAQs)

According to Professionals Australia, employees can do the following if you reduce their pay without their consent:

Accept the pay reduction
Make a request for payment of their full salary
Request redundancy pay
Try negotiating an alternative change

What can happen if you illegally reduce an employee’s pay?

If you illegally reduce an employee the following can occur:

Reducing an employee’s pay can be a breach of contract if the employee had not agreed to the pay reduction
An illegal pay reduction can constitute a form of constructive dismissal. This may lead to unfair dismissal claim
You may potentially breach an employee’s minimum entitlements that are provided to them by NES
Individuals who contravene an NES minimum entitlement can be fined $13,000 or more, whereas your company could be fined $66,000 or more according to the Fair Work Ombudsman

Is it possible for a reduction in pay to constitute a dismissal?

It is possible that an employee’s demotion could constitute a dismissal if they’re demoted to a position that significantly reduces their pay or the tasks they perform.

In the 2006 case Petkoski v Wiredex Pty Ltd the Australian Industrial Relations Commission decided pursuant to the Workplace Relations Act 1996 (Cth) that an employee’s hourly rate of pay being reduced to $18 an hour from $20.95 was significant. Consequently, the demotion was held to be a dismissal.

Conclusion

Knowing how to reduce an employee’s pay legally is crucial to ensure you avoid legal trouble, retain your employees, and avoid unfair dismissal claims being brought against you.

You should hire a lawyer for legal advice if you’re still unsure what to do for your business and its employees.