Assessability of income: retention benefit paid to ADF member while serving overseas on eligible duty

Is a retention benefit paid under the Military Superannuation and Benefits Act 1991 (MSBA 1991) to a resident taxpayer serving overseas as part of a military operation included in the taxpayer's assessable income under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. A retention benefit paid under the MSBA 1991 to a resident taxpayer serving overseas as part of a military operation is not included in the taxpayer's assessable income under subsection 6-5(2) of the ITAA 1997 as the income is exempt under section 23AD of the Income Tax Assessment Act 1936 (ITAA 1936).

The taxpayer is a resident of Australia for tax purposes.

The taxpayer is a member of the Australian Defence Force (ADF).

The taxpayer served overseas as part of a military operation.

The Chief of the Defence Force issued a certificate declaring that ADF members deployed on the military operation were on eligible duty for the purposes of section 23AD of the ITAA 1936.

The taxpayer received a retention benefit under the MSBA 1991.

The taxpayer received the retention benefit while serving overseas on eligible duty.

Subsection 6-5(2) of the ITAA 1997 provides that the income of an Australian resident includes ordinary income derived from all sources, whether in or out of Australia, during the year of income.

A retention bonus is an additional reward payment derived by a taxpayer in the capacity as an employee ( Dean & Anor v. Federal Commissioner of Taxation (1997) 78 FCR 140; (1997) 37 ATR 52; 97 ATC 4762 ( Dean's Case )). A retention benefit paid under the MSBA 1991 is therefore ordinary income for the purposes of subsection 6-5(2) of the ITAA 1997.

Subsection 6-15(2) of the ITAA 1997 provides that if an amount is exempt income then it is not assessable income.

Section 11-15 of the ITAA 1997 lists those provisions dealing with income which may be exempt. Included in this list is section 23AD of the ITAA 1936 which deals with pay and allowances received by ADF members performing certain overseas duty.

Subsection 23AD(1) of the ITAA 1936 provides that the pay and allowances earned by a person serving as a member of the Defence Force are exempt from tax if: (a) they are earned while there is in force a certificate in writing issued by the Chief of the Defence Force to the effect that the person is on eligible duty with a specified organisation in a specified area outside Australia; and (b) the eligible duty is not as, or under, an attaché at an Australian embassy or legation.

Subsection 23AD(2) of the ITAA 1936 provides that the regulations may declare that duty with a specified organisation, in a specified area outside Australia and after a specified day, is eligible duty for the purposes of the exemption.

The retention benefit will fall for consideration under section 23AD of the ITAA 1936 if it falls within the meaning of the term 'pay and allowances'.

The term 'pay and allowances' is not defined in section 23AD of the ITAA 1936 or elsewhere, but it may reasonably be construed to refer to salary, wages, bonuses and allowances received by an ADF member in their capacity of an employee.

Dean's Case provides authority for the proposition that a retention bonus is salary and wages for tax purposes. In that case, it was decided that a retention bonus was 'in substance and reality' an additional reward for services provided, and was received by the taxpayer in their capacity as an employee. In addition, it was found that the retention bonus was 'principally for the labour' of the taxpayer and therefore were within the definition of 'salary or wages' for tax purposes.

As such, we accept that as a retention benefit is salary and wages, it falls within the term 'pay and allowances' for the purposes of section 23AD of the ITAA 1936.

A retention bonus is derived at the time it is received ((1958) 9 TBRD Case J20; 7 CTBR (NS) Case 130; and (1958) 9 TBRD Case J60; 8 CTBR (NS) Case 50 ). The fact that the receipt may have to be repaid if certain events subsequently occur does not affect the character of the receipt (Case A59 69 ATC 334; 15 CTBR (NS) Case 34).

Therefore, the retention benefit is earned by the taxpayer at the time it is received.

While it will usually be the case that section 23AD of the ITAA 1936 will apply to the pay and allowances earned by an ADF member from eligible duty, there is no requirement in section 23AD of the ITAA 1936 that the pay and allowances be connected to that eligible duty.

Rather, section 23AD of the ITAA 1936 only requires that the pay and allowances are earned by an ADF member while there is a certificate in place declaring that the member is on eligible duty.

At the time the taxpayer received the retention benefit, the relevant certificate was in place declaring that ADF members deployed overseas as part of the particular military operation were on eligible duty. Further, Regulation 7A of the Income Tax Regulations 1936 (the 1936 Regulations) had been amended to reflect the fact that duty with that overseas deployment was eligible duty for the purposes of subsection 23AD(2) of the ITAA 1936.

Therefore, the retention benefit received by the taxpayer while serving overseas on eligible duty will be exempt under section 23AD of the ITAA 1936 and will not be assessable under subsection 6-5(2) of the ITAA 1997.