This article was number 7 in The Cove's Top 10 Articles of 2022.
Tax-free pay for reservists creates a distortion in remuneration, contributes to animosity between service categories (SERCATs), and is undermining the implementation of the Total Workforce System (TWS). Except for providing a sales pitch in Defence recruiting advertisements, tax-free pay for Reserve service provides little measurable benefit to the ADF or its people. Removing it will provide for a more coherent, consistent, and effective remuneration framework across Defence.
Removing the tax-free status of income for reserve service is highly contentious. It was last attempted in 1983, when Paul Keating was Treasurer. It was aborted due to a backlash from service personnel. However, since then a lot of changes have been made in relation to Defence remuneration arrangements.
Calculating reserve salaries
In 1983 reserve daily rates of pay were calculated from the equivalent rank and trade of regular forces’ (SERCAT 7) annual salary divided by 365, being the number of days regular forces were considered to serve each year. Daily rates of pay for Army reservists were discounted by 20% to account for a work-value deficiency between reserve and regular forces (Navy and Air Force reserve personnel were almost all former regular forces). In the late 1990s and early 2000s, Army introduced Common Induction Training which removed the work-value deficiency and so the discounted daily rates were phased out.
Except for the removal of discounted rates and small changes to various allowances, the calculation and tax-free status of reserve remuneration has not changed in over forty years.
Changes affecting the value of reserve remuneration
Since 1983, a range of changes made by the Australian Government and Defence have diminished the relative value of reserve remuneration. The tax-free status of reserve remuneration has masked the deleterious impact of these changes.
1. Superannuation
In 1992 the Australian Government introduced compulsory employer contributions for superannuation. The employer contribution is legislated at 10.5% (rising to 12% in 2025) but Defence pays 15.4% to regular forces personnel. The legislation that requires employers to contribute to superannuation provides that no superannuation is to be paid in relation to tax-free income from reserve service. Superannuation is not paid to reservists, nor is it included in the annual salary divided by 365 to calculate reserve daily rates of pay.
2. 10 day fortnight for Defence
SERCAT 6 was introduced by Defence to allow permanent part-time service under the TWS. The Defence Force Remuneration Tribunal (DFRT) accepted that the pro rata calculation of entitlements for SERCAT 6 members should be based on a 10-day fortnight. This recognises that SERCAT 7 service does not consist of 365 days’ work (which is the basis of the calculation used for reserve daily rates of pay).
The 10-day fortnight is also recognised in the ADF Pay and Conditions Manual. It specifies that reserve personnel (SERCAT 3 to 5) required to quarantine or isolate as a result of Defence service shall be paid no more than 10 days in any two-week period. Thus, a SERCAT 5 member completing 14 days COVID-19 hotel quarantine due to Defence service will only be paid for 10 days.
3. Reserve call out legislation
The 2020 call out of reserve personnel for the Black Summer bushfire response demonstrated the merit of the TWS. However, it highlighted shortcomings in administrative arrangements, particularly in relation to processing reserve personnel onto Continuous Full Time Service (CFTS). To overcome this administrative burden, the Defence Act 1903 was amended at the end of 2020 to allow the Government to call out reserve personnel without moving them onto CFTS and associated conditions of service.
4. Reduction in marginal income tax rates
In 1983 the highest marginal income tax rate was 60 cents in the dollar for taxable income greater than $35,788. Legislated changes to marginal income tax rates commencing from 2024 will see the highest rate reducing to 45 cents in the dollar, but that will only apply to taxable income greater than $200,000 per annum, with 30 cents in the dollar applying to income between $120,000 and $200,000.
Combined effect of changes
The combined effect of changes in relation to Defence remuneration have diminished the value of the tax-free benefit of reserve remuneration. Two examples are useful to highlight the effect:
Example 1: Major Smith is called out in response to a catastrophic flood. Major Smith works for the next three months in a headquarters with other SERCAT 5, 6 and 7 personnel. As a SERCAT 5 Major, Major Smith’s total net daily remuneration is $349.83. The total net daily remuneration of an equivalent SERCAT 7 Major in the headquarters is $497.61 (net of tax and superannuation, pro-rated using the 230 workdays per year accepted by DFRT). Because Major Smith has been forced to take unpaid leave from his civilian employment, there is no benefit from the tax-free status of his pay from reserve service.
Example 2: Private Jones transferred from SERCAT 7 to SERCAT 5 with a suite of qualifications in demand in Army. However, it is not long before an upcoming Army field training weekend clashes with Private Jones’s new civilian job as a shop assistant. The shop assistant work requires Private Jones to work four hours Friday night, eight hours Saturday and eight hours Sunday. The Army training weekend requires Private Jones to commence duty at 7pm Friday night working through to 4pm on the Sunday. Despite being paid only low-skilled award wages, Private Jones will earn more as a casual level 1 shop assistant ($722.64, plus superannuation) than attending the Army training weekend ($456.20). Adjusting for tax and superannuation, Private Jones must choose between earning $456.20 with Army or $560.05 as a shop assistant (both calculated using a total taxable income of $90,000 per annum).
The case for taxing reserve salaries
Perpetuation of the tax-free status of reserve remuneration has created a distortion that prevents direct comparison of remuneration between the SERCATs for identical work. Successive decisions in relation to Defence remuneration have diminished the relative value of reserve remuneration. Reserve remuneration has fallen behind that of regular force equivalents. More worrying though is reserve remuneration becoming uncompetitive with even low-skilled award wages.
The shortfall in reserve remuneration is not sufficiently offset by its tax-free status, except possibly for the very highest paid income earners who choose to serve and are not required to take unpaid leave from their civilian work. However, individuals with high levels of taxable income have a range of personal choices to reduce the tax they pay through salary sacrifice, negative gearing, and work-related expense deductions.
To unlock the benefits of the TWS, Defence needs a competitive (and fair) remuneration package. This will assist with attraction and retention, and it will reduce the administration associated with transitioning members between SERCATs. A good place to start is removing the tax-free status of reserve salaries, providing superannuation and using a 10-day fortnight (230 days per year) to calculate daily rates of pay.
The tax-free status of reserve remuneration creates inequities and animosity between the SERCATs. Some are required to pay tax, others are not. Some have a 5-day week used to calculate the pro-rata entitlements while others have their entitlements determined on a 7-day week pro-rata calculation. Personal income tax should be just that – a matter for personal consideration; Defence should not presume the tax-free status of reserve remuneration provides a net benefit to a workforce with vastly differing tax arrangements. Attributing a tax-free status to part of Defence’s workforce is out of step with contemporary remuneration arrangements in Australia.
I will say though, in my reserve experience, the vast majority of members are students (receiving government allowances) or professionals who don’t really need the money who chose to serve and for personal satisfaction, mateship and patriotism.
Changing to a taxed model would disadvantage those students by lowering or deleting their student support payments and deter those already making good money outside defence from continuing to serve only to see large portions of their earnings swallowed up by their tax rate which has been set outside defence.
This has further impacts on those who pay child support, HECS, and other legislated obligations.
I think the issue warrants further investigation to ensure the remuneration is fair but it is my anecdotal belief that if this change were made tomorrow, you would see a resignation rate of 50% or more from SERCAT 5 as a result.
These SERCAT 5 members can apply themselves more at their full time work, seek an “easy” part time job or undertake casual work for employers that demand far less from their employees to make up the loss of income from defence.
Great article, thanks again,
Blair
When I filled SERCAT 7 gaps in an important shift-work role, it became clear to me I was earning less than the minimum wage - and certainly far less than my peers. Needless to say, it remind very hard to convince reservists to sacrifice other work to do jobs like this where the pay is comparably woeful.
In this particular role, Full-timers were paid on a schedule of four 12hr shifts (day, day, night, night) and then received five (paid) days off in the cycle. As a Reservist, I filled one or more or all of these shifts in the cycle but could receive only one attendance pay per ‘shift’, despite the work falling across two days in the case of a Night Shift. Further, i was not paid for the rest day or any of the period afterwards like those who had worked the same shifts as I just had. In addition, i was ineligible for HDA in the role despite being a rank below my peers doing the same job, due to the restrictive HDA rules for reservists requiring continuous days for activation, and not contemplating reservists working multiple roles for different ADF employers.
The TWS has some sensible elements but it’s time for a serious re-think on how reservists are paid.
But if you do not give up civilian income then then each dollar earned tax fee could be worth a lot more.
One of the best ways to increase reserve participation would be the complete opposite - ie. A reduction in taxation of civilian income
Won't these changes see a demographic change in Army Reserve spots too? By taxing the income, those on the upper end of the tax brackets will be less incentivised to take on work than those with less well paying civ jobs. Is taxing reserve pay worth a possible brain drain?
I consider that we need equality in service to ensure our debate remains about rank alone. Remembering that the comparator identified is to those with a single income; we want people to serve as a second job and we want to have those people equal to those with whom they serve be they regular or reserve (assuming same rank and skills).
Adoption of taxation of the Sercat 5 workforce just increased the level of difficulty for recruiting markedly.
There are a few things I believe that also should be addressed.
1. Reserve pay, whilst tax free, does not include superannuation payments as stated. When civilian employment is sacrificed for Reserve Service, the loss of compounding returns puts Reserve personnel at a economic disadvantage come retirement.
2. Reserve pay does not include the 25% casual loading added to casual remuneration to compensate for the lack of sick and annual leave.
3. The incremented pay scale for hours worked also puts Reserve personnel at a disadvantage. The 1, 2, 3 and 6 hour blocks means personnel can end up in the unfair position of working 5 hours, but still only being paid for 3. Adding in a 4 and 5 hour block should be seriously considered.
4. For Reserve personnel who may be on a very low yearly income, I.E a university student earning $15,000 p.a, the benefits of tax free pay are in actuality drawbacks. This is due to the $18,000 tax free threshold, meaning that they would pay no tax anyway. Someone in this position would be far better off working a full taxing job as they would receive 100% of their wage.
The addressal of these considerations would go a long way to rebalancing the perceived unfairness of the current pay system and help to boost attendance.
From my personal experience, I take more than a 50% sacrifice to my pay when I forego my civilian employment (Outdoor Guide and Instructor) for Reserve Service (RAE Corporal). This is whilst working away from home and similar hours, when compared to a field training exercise. Every time I consider undertaking Reserve Service, I have to also consider the knock on effects of severely reduced income and personal time, and sometimes it's not worth it.
I would also suggest that we need to be careful about casual loading. What happens when we work shifts as part of headquarters? Are we saying we moved to an ADF award? I’m not quite sure that is the solution for the remuneration in the ADF.
We do need a solution to entry level comparative pay. Ian’s example of tgg he e student or casual retail workers is excellent.
Referencing three. I totally agree that the pay system needs to allow for people to claim the actual hours that they’ve worked up to a full day. Many of us work 1 or more hours at least every day. These need paying.
Well presented arguments.