Build to Rent Income Tax concessions released

13 minute read  11.06.2024 Hamish Wallace, Adrian Varrasso, Jason Hawe, Pooja Tandon

Following Treasury consultation and industry feedback on exposure draft materials, the legislation for the new build-to-rent federal tax concessions has been introduced into Parliament.

Key takeouts

  • The reduced MIT withholding tax rate will now apply to capital gains derived on disposals of BTR developments and membership interests in entities holding a BTR development, as well as rental income.
    A new feature, not previously included in the exposure draft material, creates a fundamental problem for investors wanting to invest in a project via a head trust / sub trust arrangement.
  • The Commissioner will have a discretionary power to treat qualifying conditions as being met despite temporary non compliance, provided that non compliance arises due to events outside the control of the BTR owner.

On 5 June 2024, the proposed build to rent (BTR) Federal tax concessions were formally introduced into Parliament via the Treasury Laws Amendment (Responsible Buy Now Pay Later and Other Measures) Bill 2024 (BTR Bill) and the Capital Works (Build to Rent Misuse Tax) Bill 2024 (Misuse Tax Bill), and accompanying Explanatory Memorandum (EM).

This follows previous consultation by Treasury, including on an earlier exposure draft package released on 9 April 2024 (Exposure Draft material), on which we provided commentary.

Critically, the managed investment trust (MIT) withholding concession now extends to capital gains as well as rental income derived from qualifying BTR developments. We discuss below some of the key features of the legislation and how these differ from the Exposure Draft material.

BTR concessions

Consistent with previous announcements and the Exposure Draft material, the BTR Bill proposes to implement the following incentives for eligible BTR developments (BTR concessions):

  • a reduction in the MIT withholding tax rate on fund payments (i.e. rental income from an active BTR development) from 30% to 15% (MIT withholding concession); and
  • an increase in the rate for capital works deductions from 2.5% to 4% per year (accelerated capital works concession).

Critically, and following consultation feedback, the MIT withholding concession has now been extended to capture fund payments representing capital gains derived from the disposal of an active BTR development or a membership interest in an entity that holds a BTR development. This is a welcome change and rectifies what would have been a critical flaw in the concessions.

Qualifying requirements

The headline eligibility criteria for a development to qualify as an active BTR development remains largely unchanged:

  • the BTR development’s construction commenced after 7:30PM (AEST) on 9 May 2023;
  • the BTR development consists of 50 or more dwellings made available for rent to the general public;
  • all of the dwellings in the BTR development (and common areas that are part of the development) continue to be directly owned together by a single entity, at any one time, for at least 15 years;
  • dwellings in the BTR development must be offered for lease terms of at least 3 years throughout the 15 year period (although the tenant can request a shorter term); and
  • at least 10% of the dwellings in the BTR development must be offered as affordable tenancies throughout the 15 year period.

However, changes have been made to the rules underpinning the affordable tenancies requirement. We discuss these further below.

The BTR Bill: Key observations

Capital gains on BTR developments

The concessionary 15% MIT withholding rate will now apply to:

  • rental income derived under a lease of a BTR dwelling;
  • capital gains derived from the disposal of a BTR dwelling; and
  • capital gains derived from the disposal of a membership interest the value of which is referable to a BTR dwelling (e.g. a unit in a unit trust that indirectly holds the BTR development).

In respect of the disposal of membership interests, there is a formula that apportions the capital gain from the disposal of a membership interest in the entity on the basis of the value of the interest in the BTR dwelling as a proportion of the overall value of the membership interest.

This is a welcome change noting that the drafting proposed in the previous Exposure Draft material meant that fund payments representing capital gains would not have qualified for the MIT withholding concession.

However, the drafting in new subsection 12-450(5) raises uncertainty about whether all of a capital gain derived from the disposal of an entire BTR development would qualify for the 15% rate.

The words in the draft legislation refer to a capital gain from a CGT event in relation to a ‘dwelling’, rather than, for example, a ‘BTR development’. Where an entire BTR development is sold, there is a question about whether any gain or value attributable to something other than a specifically identifiable ‘dwelling’ (e.g. common property) would qualify for the 15% rate. If this is the intention behind the drafting, this imports significant valuation complexity in determining what elements of a sales price reflect specific dwellings. Unfortunately, the EM does not clarify this uncertainty.

Restrictions on 15% rate

A feature of the legislation that was not previously flagged as part of the Exposure Draft materials is restrictions that apply to accessing the 15% MIT withholding concession where income and capital gains flow through a trust structure.

Of particular concern is the proposed amendments to section 12-385 of Schedule 1 to the Taxation Administration Act 1953 (Cth). These amendments appear to create a significant issue for investors wanting to invest in a project via a head trust / sub trust structure, being a commonplace investment structure.

Where a fund payment made by a MIT is attributable to a payment from another entity (e.g. an intermediary trust), which relevantly includes the BTR development owner, then the 15% MIT withholding rate appears to only be available where the trustee of the MIT, all intermediary trusts (if any) and the BTR development owner are the same.

This will be a fundamental problem for investors wanting to invest in a project via their own Australian withholding MIT, given different investors are unlikely to be using the same trustee.

The EM justifies this requirement on the basis that it supports the administration of the tax concession, in particular, the BTR misuse tax. Presumably, the reason for this is so the Commissioner only has to assess a single entity for misuse tax where a development ceases to meet the qualifying conditions.

The way in which the misuse tax provisions are drafted indicates that:

  • the trustee of the ‘single entity’ trust that will be required to hold the direct interest in the BTR development will be the entity issued an assessment of misuse tax in respect of accelerated capital works deductions; and
  • the trustee of any investor’s ultimate upstream holding MIT will be the entity issued an assessment of misuse tax in respect of any fund payments from which the reduced 15% tax rate has been applied.

Accordingly, to impose misuse tax in respect of non-compliance, the Commissioner would need to have issued two different assessments to each trustee. This new restriction seems to be an attempt to address this issue by forcing use of a single trustee entity for each trust referred to in the above scenario. If this requirement is included in the final legislation, it will have a significant adverse impact on investment decisions.

Access to MIT withholding concession no longer limited to 15 years

Another welcome change in the BTR Bill as introduced is that the MIT withholding concession is no longer limited to the 15 year BTR compliance period. Provided that a BTR development continues to meet the qualifying criteria, then it appears the MIT withholding concession will continue to be available.

Choice to 'opt in'

The revised drafting in the BTR Bill now incorporates a requirement that an owner of a BTR development (i.e. the single entity that owns the dwellings) make a choice that the development become an active BTR development to access the relevant tax concessions once all qualifying conditions are met.

The choice needs to be made in the approved form and given to the Commissioner. The choice can specify a prospective date from which the BTR development will become ‘active’ (being the date the 15 year compliance period starts). If no date is specified or the date specified is prior to the notice being received by the Commissioner, the BTR development will only become ‘active’ from the date the Commissioner receives notice of the choice.

Investors and developers will need to keep this requirement in mind and ensure notice is given to the Commissioner as soon as the qualifying conditions are met in order to commence the 15 year compliance period.

Further, although the date nominated from which the development becomes ‘active’ can be a future date, the development needs to meet all of the qualifying criteria prior to an owner being able to make the choice. That is, an owner cannot make a choice indicating a future date on the expectation that the conditions will be met by that date.

Affordable dwellings – market rent requirement

The market rent requirement under the BTR Bill has changed slightly as compared to the requirement in the Exposure Draft material.

The new requirement is that for affordable dwellings, the rent payable under the lease for the dwelling must be 74.9% or less of the market value of the right to occupy the dwelling under that lease. The EM clarifies that the market value of the right to occupy means the rent otherwise payable for a comparable dwelling in an open market.

The EM sets out factors that are considered relevant in determining whether another dwelling is a comparable dwelling. These include:

  • general physical condition, including the number of rooms, floor area and the standard of the facilities available (for example, heating, cooling, cooking etc.);
  • the existence and condition of inclusions (such as carpets, drapes, blinds etc.); and
  • location and setting (for example, whether or not the dwelling is in an inner or outer suburb of a city or regional area, how far it is located from community amenities, whether it is affected by industrial noise and pollution etc.).

The EM also indicates that the market rent requirement should be evaluated at the time a lease is entered into and indicates that a re-evaluation would generally not need to occur during the period of a lease. However, the EM flags that a re-evaluation exercise may be required where, for example, there is an ‘unreasonable’ rent increase (there is no guidance on what ‘unreasonable’ means in this context).

We observe that the market rent requirement is no longer linked to a dwelling of an equivalent size and standard located in the same development. It is based on the concept of market rent in an open market. Given the evidentiary burden sits with the taxpayer, the practical consequence is that a BTR operator will need to determine an appropriate open market and obtain a valuation supporting that rent payable for a particular lease meets the 74.9% market value requirement. This will add to compliance costs.

The comments in the EM about this requirement being evaluated at the time the lease is entered into are helpful and appear to address the concerns we raised in our submission to Treasury on the Exposure Draft material about conditions not being met where rental values fluctuate within the term of an existing lease.

Affordable dwellings – comparable to non affordable dwellings

The Exposure Draft material contained a requirement that any dwellings in a BTR development that are not affordable dwellings must be the same size and have the same amenities as at least one of the affordable dwellings. The concept of 'amenities' previously referred to in the provisions was not defined and left considerable uncertainty for operators and investors about the features captured by that definition.

The updated drafting in the BTR Bill now requires that for each affordable dwelling (the test dwelling), the number of comparable non-affordable dwellings must be greater than or equal to the number of comparable affordable dwellings. The number of comparable non-affordable dwellings refers to non-affordable dwellings that have the same number of bedrooms and a floor area that is at least equal to but not greater than 110% of the test dwelling.

Similarly, the number of comparable affordable dwellings refers to affordable dwellings (including the test dwelling) that have the same number of bedrooms and a floor area that is at least equal to but not greater than 110% of the test dwelling.

The features of the comparability condition is therefore now limited to only the number of bedrooms and the floor area. The concept of 'amenities' is no longer present which removes the significant uncertainty that arose as a result of the previous drafting.

Accordable dwellings – number of dwellings

The BTR Bill also clarifies that where 10% of the total number of dwellings results in a fractional number, an owner rounds down to determine how many dwellings must meet the affordable dwelling requirements.

Affordable dwellings – income threshold requirements

The BTR Bill still contemplates the existence of income based thresholds for tenants of affordable dwellings. The Government still intends to capture these in a separate Legislative Instrument which has not yet been released.

Commissioner's discretion to treat eligibility conditions as being met

The drafting of the provisions means that where a BTR development has commenced being an active BTR development, if one of the qualifying criteria cease to be met (even if non compliance is temporary), then access to the BTR concessions is lost permanently and the BTR development can no longer requalify. This also exposes an operator and investors to the misuse tax.

Given the lack of control and degree of subjectivity associated with some of the requirements around affordable dwellings, this appears to be an unduly harsh outcome.

It seems the Government has sought to address this concern to some extent by incorporating a discretionary power of the Commissioner to effectively ignore temporary non-compliance with particular conditions that arise due to circumstances outside of the control of the BTR development owner.

Specifically, the BTR Bill enables the Commissioner to exercise their discretion to treat the three year lease requirement or the affordable dwelling requirement as being met at all times during a period if the Commissioner is satisfied:

  • that non-compliance was due to events outside the control of the owner of the BTR development;
  • the owner took all reasonable steps to ensure the non-compliance is rectified; and
  • the non-compliance has been rectified by the time the determination is made (i.e. the qualifying conditions are met / non-compliance has ceased) and the owner intends to continue to meet the requirements for the remainder of the 15 year compliance period.

An application for a determination needs to be made to the Commissioner in the approved form.

Although this addition to the provisions provides some ability to rectify non-compliance, it requires an application to, and exercise of discretion by, the Commissioner. This rectification process will no doubt take time and is not as satisfactory as a de minimis or safe harbour provision, against which a taxpayer can self-assess. This has been an approach taken in relation to other concessionary MIT regimes (e.g. 2% safe harbour for non-trading income under the eligible investment business provisions; clean building MITs have a 180 day rectification period).

The inability to seek the exercise of the Commissioner's discretion until after the issue has been rectified also creates unnecessary administrative costs both for taxpayers and the Commissioner.

For example, if a BTR development ceases to meet a qualifying condition, such as a condition relating to affordable stock, then notice must be given to the Commissioner within 28 days. The Commissioner may then issue an assessment for misuse tax while the taxpayer is taking reasonable steps to address the issue. Following the receipt of an assessment for misuse tax, the taxpayer may then be able to address the non-compliance and make a subsequent application to the Commissioner for the exercise of discretion. Where the Commissioner exercises the relevant discretion to treat the conditions as being met, it seems the taxpayer would then have to object to the misuse tax assessment or make a further application to seek an amendment of that assessment. This example demonstrates the considerable administrative work that could be involved in such a scenario.

Single ownership rule remains

The single ownership rule which requires that the BTR development be held by a single entity remains. This essentially prevents investors from holding a direct interest in a BTR development as a tenant in common. That being said, the phrase single entity is not defined within the provisions. This suggests a taxpayer should have regard to the existing definition of entity in section 960-100 of the Income Tax Assessment Act 1997 (Cth) and then determine whether that entity is a 'single' entity.

Relevantly, a partnership is included as an entity for this purpose, noting that partnership includes both a general law partnership and a tax law partnership (persons in joint receipt of income).

While we suspect that this may not be the Government's intention, one view is that the provisions allow multiple entities who have formed a partnership to hold an interest in a BTR development as a tenant in common. This would not extend to entities that have formed a joint venture given a non-entity joint venture is specifically excluded from the definition of entity in section 960-100.

Existing assets

It seems Treasury has not taken on board requests to expand the BTR concessions to a number of existing operating or under construction BTR projects in Australia as the conditions still require that construction commence after 7:30 PM, by legal time in the ACT, on 9 May 2023.

Adjacent land

For the purposes of the BTR concessions, the reference to the term building as used in the provisions (which is relevant in determining what constitutes a BTR development) includes a reference to other buildings that are on the same or adjacent land. This means that a BTR development may consist of multiple buildings on the same or adjacent land where, taken on an aggregated basis, a number of dwellings would meet the qualification requirements.

Unfortunately, the Government has not clarified the concept of same or adjacent land as used in the BTR Bill. While the EM references 'two towers on one plot of land' as an example of where multiple buildings could, together, form a single BTR development, the concept of one plot of land provides no more certainty than the concept of same or adjacent land. The lack of any meaningful guidance or examples in the EM about how this concept is to be interpreted is disappointing.

Specific reporting

The reporting obligations contained in the BTR Bill as introduced to Parliament reflect the position contained in the Exposure Draft material, as summarised in our earlier article.

Misuse tax

The calculation and assessment of misuse tax also remains largely unchanged from the Exposure Draft material. The misuse tax is roughly equal to the accelerated depreciation and reduced MIT withholding rate benefits obtained, increased by 8%. The misuse tax continues to be non deductible and subject to the general interest charge.

Given the BTR concessions can now be claimed beyond the 15 year compliance period, misuse tax will only be imposed in respect of non-compliance during the 15 year compliance period. Failure to comply with the requirements after the 15 year compliance period has ended will not result in misuse tax being imposed in respect of BTR concessions claimed throughout the 15 year compliance period.

Please contact your MinterEllison Tax specialist to discuss the measures proposed in the BTR Bill and Misuse Tax Bill further and how they may be relevant to your organisation.