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.
The ongoing transition from the CMF to the ARes was also in play. For many older hands it was simply time to go.
But, the first round of Tax Returns from ARes members was the killer blow.
Few outside the Reserves had any idea of the dollars many members were spending to enhance there equipment. I've still got the Wilderness Equipment Mk6 SAS Pack and Gore Tex Bivvi I bought back then. Neither were cheap.
Paying Tax at half rate open the doors to claiming "Allowable Work Expenses" at half rate. I chose not to make a claim, but many at WAUR did - aided by those studying or working in Finance.
When the bean counters in Finance factored that in Net Revenue to the Commonwealth was marginal, at best.
Its always what don't see that gets you in the end.
If an ARA member gets $235 for day, an ARes member gets $235 for day. If ARA member gets superannuation, so too ARes (pro-rata). If ARes needs dental, go to RAP and offset cost by amount of service days rendered. If ARA members support any weekend training, offer 2 x days as RDO. Both ARA and ARes should receive same allowances (e.g. separation, field) if on same tasking for same time period.
Service life provides many inherent benefits. And for most 'pay' is not the deciding factor. No matter change, I would prioritise service as much as able: conditions are key to retention. Simply better acknowledging ARes members' AQF civilian qualifications, treating them as equals in team, and speaking to members appropriately is incentive enough to keep good personnel.
As an ARes soldier, I already benefit from 'geographical stability' which is a non-negotiable for me (at present) as a caregiver; however, I experienced significant back-lash from employers IRT ARes service due its perception in popular opinion (considered hobby). I routinely take unpaid leave, and have even lost role on return. A standard is needed IRT Defence Leave, especially when supporting DACC/DFACA tasks.
This piece presents a well-crafted and insightful argument for reconsidering the tax-free status of reserve salaries in the Australian Defence Force (ADF). The thorough historical context you provide gives readers a strong understanding of how reserve remuneration has evolved and why change is necessary. The use of specific, relatable examples, like those of Major Smith and Private Jones, is particularly effective in illustrating the practical implications of the current system.
Your comprehensive approach, considering various factors like superannuation, marginal tax rates, and Defence policies, adds depth and credibility to your argument. The analysis is clear and logically structured, making it easy to follow your reasoning.
Moreover, your proposal to remove the tax-free status and align reserve salaries with regular forces is both practical and forward-thinking, however, is likely to receive backlash from the reservist community as taxing that earned income is likely to put members into higher tax brackets and under minds the tax free incentive.
Your writing is persuasive and well-balanced, presenting a strong case for reform while remaining respectful of different perspectives. Overall, this is a compelling piece that effectively communicates the need for change and offers a well-reasoned solution to improve fairness and consistency within the ADF.