ATO clarifies its position for employers on superannuation and annual leave loading

Until recently, whether compulsory superannuation had to be paid in respect of annual leave loading was a confused issue. The ATO has now provided clarification in a recent announcement.

Annual leave loading

Annual leave loading is an entitlement contained within most modern awards and covers employees in industries such as building and construction, manufacturing, mining, horticultural, agricultural, hospitality, retail, administration, banking, finance, and insurance.

Annual leave loading is an additional payment of 17.5% (generally) provided to an employee on top of their base rate of pay during periods of annual leave. Annual leave loading was initially incorporated into modern awards to compensate employees who usually receive overtime and penalty rates during work periods for the shortfall in wages during periods of annual leave.

Through the review of modern awards and enterprise bargaining, the entitlement to annual leave loading has been extended to classifications of employees that would not generally perform work attracting overtime and penalty rates.

Superannuation and annual leave loading

Prior to February 2018, many employers followed the ATO website and calculated their superannuation contributions for employees on the basis that annual leave loading was excluded from the definition of ‘ordinary time earnings’.

The ATO has now clarified its position that annual leave loading will be classified as ordinary time earnings, unless an employer can provide evidence to show that the entitlement to annual leave loading is referrable to an employee’s lost opportunity to work overtime. This is consistent with the ATO’s public ruling SGR 2009/2.

On this basis, there is a risk that employers may be liable to a superannuation guarantee charge, as well as nominal interest, administrative fees, and penalties, for the underpaid superannuation contributions.

ATO’s compliance approach to previous quarters

The ATO has acknowledged that there is uncertainty around the treatment of annual leave loading. In addition, modern awards and enterprise agreements generally do not state the reason for the annual leave loading payment being made to the employee.

As such, the ATO has stated that it won’t scrutinise the purpose of annual leave loading payments made in historical quarters where:

• the employer self-assessed that annual leave loading payments were not ordinary time earnings because it was in relation to an employee’s loss of opportunity to work overtime; and
• there is no evidence to suggest the entitlement was for something other than overtime.

The ATO states that relying on historical opinions about the initial purpose of annual leave loading will not be sufficient to demonstrate that the annual leave loading is a lost opportunity to work overtime.

ATO compliance approach to future quarters

Moving forward, for annual leave loading to be excluded from calculations of ordinary time earnings, employers must, as soon as practicable, obtain written evidence that the entitlement is ‘demonstrably referrable’ to a lost opportunity to work overtime.

This evidence could include:

• wording in the relevant modern award or enterprise bargaining agreement clarifying the reason for the entitlement; or
• other written evidence, such as a documented policy, that clarifies the reason for the entitlement, and reflects the mutual understanding of both parties to the agreement that gives rise to the entitlement.

What do employers need to do?

Employers need to check whether an industrial instrument (modern award or enterprise bargaining agreement) applies to their employees and if their employees are entitled to receive annual leave loading under the industrial instrument.

If your employees are entitled to annual leave loading, employers need to obtain written evidence demonstrating that the entitlement to annual leave leading is linked to an employee’s loss of opportunity to earn overtime and penalty rates. If the employer cannot obtain this evidence, the annual leave loading will form part of an employee’s ordinary time earnings, and superannuation contributions will have to made in respect of those amounts.

If you are an employer and have any concerns about superannuation on annual leave loading payments to your employees, please contact our workplace relations team or our tax team on 07 3231 2444.