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.
Interesting article. I take it you would also be in favour of members that don’t pay Medicare to start contributing? There is also the point that the same members also get private health cover paid for by the state. Having served for over 30 years we use to get a reduction for days served. Now we get the bonus. Which the fulltime members scoffed at. I’m more than happy to forgo the bonus for no Medicare and free private heath cover without an out of pocket ex pence. Is also disappointing I cannot transfer any of the long service I have acquired over the years to my Civil employment. I was told by the department that manages his process I have to be on CFTS to carry out the process. I would hate to calculate all the lost entitlements I’ve missed out on for completing 30 years military service. May bethe full timers need to be educated on what reservists miss out on. If you applied the same rules to the full time members there would be an uprising. Like most reservist it was never about the money. However I don’t work for free as for the full time members.
Whilst some of your arguments are not entirely without merit, there are numerous fatal flaws
1) if we are to have an army which is almost 50% ARes, you need to offer an incentive. Having worked in ADFRU, people all too frequently underestimate the drawing power of tax-free pay!l. Sadly, your article is rather dismissive of this element. Absent that incentive, will reservists be given free medical? Dental? Waiver of Medicare levy? Leave entitlements? Family benefits? Penalty rates for work >8 hours?
2) will SERCAT 3 be offered similar entitlements? Or will they be a separate class of reservist (thereby undermining the whole concept of the TWF system?)
3) Superannuation is also a mess.
Ultimately, govt will find it significantly cheaper to have tax free pay and less entitlements than taxed pay with full entitlements. Sadly, we must be reminded that Defence spending is not exactly the flavour of the month in Canberra at present,
so increases in expenditure on personnel for less outcome are highly undesirable.
If the tax and pay rates are the same across all categories of service, entitlements must also be the same. If not, there will be a significant drop-off in recruitment & retention in a time when we are trying to almost double the intake. For these reasons, I cannot see any government supporting your thesis.
I served in both types: ARA and ARes; and understand both sides of the arguments. However .... when I was in the Reserves I also had times where I got casual civilian work over a weekend where I earnt approx $2.5K (after tax). Was always amused when the ARA Cadre Staff then cracked the sh1t's claiming: "Sir, we only put this weekend's training on for YOUR benefit, and then you don't even bother showing up". 🤣🤣. No amount of explaining could convince them that time in uniform from 3pm Friday all the way through to 6pm Sunday .... for a couple of hundred dollars .... was an illogical argument.
Appears nothing has changed ....
I served in both types: ARA and ARes; and understand both sides of the arguments. However .... when I was in the Reserves I also had times where I got casual civilian work over a weekend where I earnt approx $2.5K (after tax). Was always amused when the ARA Cadre Staff then cracked the sh1t's claiming: "Sir, we only put this weekend's training on for YOUR benefit, and then you don't even bother showing up". 🤣🤣. No amount of explaining could convince them that time in uniform from 3pm Friday all the way through to 6pm Sunday .... for a couple of hundred dollars .... was an illogical argument.
Appears nothing has changed ....
Respect is a core ADF value, but when you pay people different rates for doing the same job, it upsets pers and erodes trust. The method on how a day is calculated needs consistent and simplified. Further, the entire conditions of service package should be reviewed, as financial factors are often not the driver for part-time service. The SERCAT 5 that get sick on COVID ASSIST or does 14 days on 7x 24 hrs shifts uses their civilian sick/annual leave for recovery – the SERCAT 7 doing the same job gets paid Defence leave. Key roles often struggle for staffing; work 12 hours and get paid for six, placing greater demand on SERCAT 7s. Many in Army were against using SERVOP C, for reserves that could commit to recent ops; far better to manage them as a casualised workforce to be hired/fired as needed. This situation makes pers reconsider the benefit of placing civilian careers at risk and compromising time with family.
Recent domestic ops relied heavily on the SERCAT 5 workforce. A significant portion of ARTS is expended on SERCAT 3s, with no readiness obligations, often on high salaries and many doing 100+days + transition to retirement on “special projects”. Many are ex ARA with critical skills and make up a large element of the reserve force. All units are short of SERCAT 5 and would value this asset, so this imbalance needs to be fixed. One option could be a transfer bonus for SERCAT 7s that transfer straight to SERCAT 5, and a “retention bonus” for SERCAT 5s that do 50+ days a year. In most roles, a SERCAT 5 cannot be effective doing 20 days a year so we should drop this false advertising.
In 1983 a newly elected Labor government introduced taxation of Australian Defence Force Reserve salaries. It removed an exemption from income tax from part-time members of the Reserve Defence Forces in two steps with 1 half of pay and allowances taxed from 1 December 1983 and the 2nd half of pay and allowances taxed from 1 December 1984. Quite the Christmas bonus from new Treasurer Paul Keating!
The Army Reserve voted with its feet. The unintended but perhaps predictable consequence of the decision to tax Reserve salaries saw Army Reserve strength decline from 33,277 (larger than the Regular Army at the time) to 23,145 by 1986. This was the despite the Labor government reversing the decision to tax Reserve salaries before 1985 after the immense backlash to the change. Reservists felt like their service wasn't valued and neither the Regular Army or Politicians had their interests at heart.
If stage 3 tax cuts go through anyone earning over $45k will have 30% as the marginal tax rate for Reserve pay and allowances. That is a 30% reduction in take home pay for every dollar you earn in Reserves. Once it is taxed, super also needs to be withdrawn from your gross salary. Unless Defence introduces a 16.4% pay increase at the same time, that's a further reduction in your take home pay. That is a huge change to push through on Reservists and a likely catalyst for a very large minority of our serving personnel to choose to do something else with their 'spare' time.
We need to retain more of our current Reserves and increase the number of Regular personnel transferring to the Reserves. Taxing Reserves will have the opposite outcome.
As a previous contributor on LinkedIn noted, this need not be binary. Why can’t we seek a situation where there is a choice? Taxed or not taxed.
Secondly, there are many, many awards in Australia. We’re not going to complete with every one on every detail.
We need to grow the force. Longer term members have worked our solutions. Albeit that there needs more equity in the system.
Ian’s most poignant example is the 18 yo with a choice between retail and military service. Maybe we create a bonus system for 18-25 yo if they do 50 days service in a year at an entry level. SERCAT 4?
The current conversation in the media about systems ignores our greatest asset; our people. Thank you Ian for your contribution to seeking ways to attract more Australians to service.
Our taxation system isn't set up to tax reserve pay because, as you identify, the Keating Experiment in 1987 failed because of the double tax on a second job.
However tax free pay has never meant superannuation free - and yet there's never been a challenge to Government as the only employer in Australia not eligible to pay its part-time workforce superannuation.
I see no solution here. Any Government will find it too difficult to sort out but until there's an outcome, the numbers will continue to fall.