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.
In other words almost every SSO, many of whom are early career and still dragging significant HELP debts that completely negate the salary sacrifice option you’re recommending to offset the income vis a vis fringe benefits. That train left long ago and education debts have only grown since that time.
Your proposed solution only works for young non-professional early career workers in enlisted roles at lower ranks. You have given no evidence that your examples represent the rule rather than the exception. This is extremely important. If you’re wrong, it’ll gut the Senior ranks and we will end up with a Russian style system of reservists, bereft of NCOs and SSOs.
Additionally, if your seeking to make reserve defence income taxable income, wouldn’t it be equitable to expect the full dental benefits as per full time to offset for the lack of competitiveness of the full time wage compared to civilian alternatives. Not a chance that would fly.
I counter argue that this proposal would gut the army reserve which is already hurting for numbers and struggling to retain in a time where they are seeking growth.
Looking for proof? Post this article into the local signal chat of any enlisted level platoon or section forum and see how well it goes down there.
I know this to be true, because that’s where I came across it myself.
Moreover this was attempted in the mid 80s, resulting in a mass exodus of Reservists, and a huge tax liability placed on the Federal Government when the Reservists that remained taxed all they could against their Reserve time.
I also highly doubt that a Reserve Major is having to take unpaid leave to parade. I have no doubt that he would have at least negotiated some sort of Reserve Leave as part of his employment package.
As it stands, my 6hr pay rate as a SERCAT 3 is roughly my daily after tax daily pay amount for my current job. Should that be taxed it would lose a significant amount again, to which I would struggle to justify parading.
If a SERCAT 5 member worked side by side with the SERCAT 7 member, doing exactly the same job, over the same number of days, with the same weekends off, at the end of the year he is assessed against a 365 day working year, so gets told you only accrued 230 out of 365 days service, that’s only 2/3rds of a year accrued, despite working the exact same hours as his SERCAT 7 counterpart
In your MAJ Smith example, they will have no employer superannuation contributions for 3 months, from either Defence or their civilian employer. They will need to make the choice on whether to make extra member contributions from their Defence pay into their civilian super fund.
SERCAT 5 do not accumulate leave - sick, annual or long service. This is a big part of any conditions of service. Outside of call outs and continuous service periods, if a reservist is sick, for say a regular Tuesday night, there is no sick leave therefore they don't get paid. For callouts, such as your Maj Smith example they will not accrue annual or long service leave as a SERCAT 5.
While I've never found tax-free pay creating animosity between peers at different SERCATs, I agree that restructuring pay across SERCATs has merit and deserves more analysis.
I think the "idea" of tax-free pay provides an incentive to enlist, particularly for students and people early in their civi careers where getting extra cash is more appealing. However, it doesn't incentivise service nor does it aid in a smooth transition to SERVOP/SERCAT options. As you've also pointed out, there are a number of other benefits to paying tax & I'd certainly be willing to consider a taxed rate if it also included the ability to claim expenses, receive superannuation, etc
The calculation of daily rates, absence of paid leave for days worked, absence of Super Contribution Guarantee and illness provisions ( eg the SECAT 7 in the shift-work example above would be paid if too ill to attend work, the SECRT 5/3 would not) are all glaring shortfalls in the calculation of Reserve pay.
Do we ‘civilianise’ and use an hourly rate of pay, and if so what rate? Is it some calculation based on the SERCAT 7 rate, and then add a 25% loading for Reserve (to compensate for the annual leave and sick leave - and let’s not get started on the continued misuse of short term absence from duty for a full day)? The government Super Guarantee Contributions would still apply, as could/would member contributions.
But then we come to the real question - what is the daily/hourly rate for SERCAT7? And dow e look to very that bad on proficiency/effectiveness ( and how is that calculated?)
Is 10 days per fortnight correct - it poses some questions:
1. Does this figure suggests that the Defence work week is 10 days
1a. Why is it 10 days paid for 14 days isolation when the daily rate was calculated based on 1/365 days? Does this suggest that daily rate should 10/14 of the annual pay?
1b. If we use 10/14 instead of 365 days to calculate the daily rate for Reserve pay, are we not overly advantaging Reserves so do work so 20 days on exercise/flood assists etc compared to there SERCAT 7 peers?
1c. Do policy makers believe that most SERCAT 7 don’t work weekends they are still 12/13 public holidays and 20 days (+5 ERL) that SERCAT 7 are paid for?
2. Should we use the 118 hours per fortnight as per the payslips? This agains suggests 7 day week at 8 hours per day - which is too few hours for most members when in the field, and too many hours when in barracks. Surely the DFRT must have some views on average daily/weekly hours.
2a. How do this figure treat BRL, ERL, public holidays, and Short Term Absence from Duty?
I don’t envy policy makers in determining this rate, however I am sure that they have huge amounts of data upon which to base it - transparency and openness in the data and calculations is required (and would be available as they would have been presented to whomever set the policy).
There are then secondary questions such as effectiveness. Not withstanding LTCOL McNabs assertion that the work value issue has been addressed via CIT, I am not so sure. Are there roles where a minimum number of hours are required to maintain the level of proficiency for which the rate of pay is calculated?
For example, is someone who is working ‘out of their civilian trade’, who is parading for 1 day per week (say 20-30 days across they year) is as effective and/or efficient as a SERCAT 7 member, or Reserve who parades every weekend. A plant operator in the mines who is plant operator in the Army may would possibly be more efficient than the SERCAT 7 member; a shop assistant doing 20 days per annum in an infantry unit would be far less proficient than say a soldier at 6 RAR.
Finally, at the risk of waning interest (too late!), we get to the recruitment and retention aspects, particularly as it relates to the pay tax status. Arguments such as attracting students who may lose support payments need to be considered, as taxing pay and losing benefits becomes a trade off of time/benefit that is more difficult for them than for most of us. However the discussions on HECS, child support (and Medicare levies and a few others) should not be used to support the retention of tax free status - they are legitimate obligations that should apply to all citizens.
Regardless of our category, I believe, and hope, that most of us volunteered to do this job for reasons other than money, but that is one critical aspect that needs to be considered when determining how much time we spend away from our families, or indeed, in risky environments. At some stage the question will be is it with it?