Australia's military will be given the full authority to target all terrorists, removing a number of legal blockages.
A 400-member Australian Defence Force air traffic group is conducting air strikes over the Islamic State group's strongholds in Iraq and Syria and a similar number of ADF personnel are training and assisting Iraqi ground forces.
However, when Malcolm Turnbull visited Iraq in January the chief of the defence force Mark Binskin advised him of a legal anomaly which meant the ADF was not empowered to be as effective as it could be.
He was told the ADF's targeting base in Iraq and Syria was restricted, and could not operate as freely as Australia's coalition partners.
The prime minister told parliament on Thursday the government would change the commonwealth criminal code to bring domestic laws in line with international law.
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"This means that ADF personnel will be supported by our domestic laws," Mr Turnbull said.
"They will be able to target Daesh (IS) at its core - joining with our coalition partners to target and kill a broader range of Daesh combatants - which is consistent with international law."
It was a "reasonable and conventional approach" adopted by the armed forces of Australia's key allies across the world.
Mr Turnbull said Australians could not pretend that IS-related terrorism was "merely a distant problem".
"Daesh is the most immediate security challenge that directly affects us all - our military and police, our communities, our youth and it is therefore my focus today," he said.
The first objective should be to expel IS from its occupied territories and destroy "all of its pretensions to statehood".
On a positive note, Mr Turnbull said the tide had turned in the Middle East fight against IS.
"Far from sweeping across Europe to stable their horses in the Vatican, Daesh is now on the defensive, losing territory, resources and lives."
When Mosul and Raqqa were liberated, the coalition against it could start talking about the final destruction of IS's so-called caliphate.
In the past year, 40 Islamist terrorist attacks against western targets resulted in over 700 deaths, many of which were inspired by IS.
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There were also many casualties in attacks against Muslims in Africa and Middle East.
Air Chief Marshal Binskin said there was the possibility within existing law "where a domestic court may take a narrower interpretation of Australia's obligations under international law and potentially prosecute an ADF member".
Opposition Leader Bill Shorten, who was briefed on the decision on Thursday, said Labor would take a "constructive approach".
"The principle of targeting all members of Daesh is a sound principle and of course we will need to see how the law and the drafting works," he told parliament.
While the ADF was able to target "Mad Max style vehicles" used by terrorists in Iraq, as well as infrastructure and headquarter positions, there was legal ambiguity when it came to "the factories where they make this equipment, where they cache their supplies, where they get the fuel trucks and the logistical element".
"It is important that we ... make sure that our ADF, by some quirk of domestic law anomaly, should not be subjected to legal repercussions merely because we didn't deal with the issue and update our laws," Mr Shorten said.
PM warns of likely new terror attacks
Australians are likely to fall victim to deadly terrorism attacks in south-east Asia as networks of extremists are galvanised and attracting new recruits, the prime minister has warned.
"Indonesia, Malaysia, the Philippines and Bangladesh have suffered terrorist attacks over the past year. Many are expecting further attacks," Malcolm Turnbull told parliament.
But Australian politicians could not close their eyes to the threat of "lone wolf" attacks on home soil, the prime minister said, adding he would soon receive a report on how best to thwart these.
Islamic State were sending extremists to countries to carry out attacks, and were also attempting to recruit and radicalise people with no prior history with terrorist organisations, Mr Turnbull said.
While those who had carried out the Martin Place siege, the Endeavour Hills stabbing and the murder of police official Curtis Cheng might be dead that didn't lessen the threat, he said.
"There are still people outside our country, and some within it, who hate the freedoms that we enjoy and would seek to threaten them and undermine them with violence," Mr Turnbull said.
"Some of these lone-actors and small groups are not deeply engaged with the Islamist ideology but are nonetheless, due to a range of reasons, including mental illness, susceptible to being radicalised rapidly."
The federal government has been actively reassuring Australia's regional neighbours it would work with them to strengthen co-operation and mitigate risks.
