UK forces in Afghanistan, Iraq and the Balkans will receive cash bonuses to pay off their tax bill, Defence Secretary Des Browne has announced.
UK soldiers on duty in Afghanistan
The £60m scheme would ensure everyone on dangerous operations for six months or more would be better off, he added.
He told MPs the £2,240 tax-free bonus would be backdated to April this year.
He said UK forces were "some of the best paid in the world" but that in many countries active troops did not pay taxes and the UK would follow suit.
'£500 better off'
The bonus represents almost £100 a week over six months.
Mr Browne said the lowest-paid personnel - privates and corporals - would be £500 better off than had their tax simply been returned.
It has already emerged that British troops wounded while fighting in Afghanistan and Iraq will receive an extra allowance of £10 a day while they are in overseas hospitals.
Chancellor Gordon Brown had freed up £60m, so the money would not come from operational budgets, he added.
Shadow foreign secretary Liam Fox welcomed the announcement of the bonus - but said the idea had come from his leader, David Cameron.
"I'm delighted that the government has responded so quickly to the initiative of the leader of the opposition," he said.
Mr Cameron later told the BBC he hoped the Conservatives' suggestion had had some impact.
"I went to see our troops in July, I got a very clear message from them about the anger at paying income tax.
"I raised these when I got back to the UK, I raised them consistently and I'm glad the government has listened."
The decision follows a campaign to stop soldiers paying tax on their earnings - something that American GIs do not do.
Earlier, Tony Blair said: "It's something that's obviously important because of the work that the troops are doing."
The prime minister told the BBC the payment was in recognition of the fact that British troops were going through a completely different experience to soldiers on the battlefield years ago.
The amount will be paid to anyone serving in what is called a hazardous operational area - currently about 15,000 troops.
General Patrick Cordingley, who commanded the desert rats in the first Gulf War against Iraq, said the decision was long overdue.
He said: "In the past I've always thought that this tax business when you're abroad on active service doesn't seem to make any sense.
"And in some instances they actually lose various allowances when they go to another theatre."
Mr Blair ordered a review of the complete support package available to armed forces personnel several weeks ago.
At-sea bonuses and separation allowances will also be extended to cover servicemen and women who are in hospital.
Troops are also set to benefit from additional travel expenses for families visiting them in hospital, free delivery of postal parcels over the Christmas period and improved access to broadband internet connections.