Build to rent exposure draft legislation released

On 9 April 2024 Treasury released exposure draft legislation that aims to encourage investment in new build-to-rent (BTR) housing developments that were announced on 28 April 2023. The exposure draft is open for consultation for 14 days.

In summary:

• The draft legislation proposes two main tax concessions for eligible BTR developments:

1. 1. Increasing the capital works deduction rate from 2.5% to 4% per year. This allows investors to depreciate the construction costs of a BTR project over 25 years instead of 40 years and applies for the life of the project (provided certain conditions are met for 15 years).
   2. Reducing the withholding tax rate on fund payments from managed investment trusts (MITs) that invest in BTR from 30% to 15%, but only for a 15 year period once operations commence (and there may not be taxable income in early years in any event given depreciation and financing costs). The rules assume BTR projects can be held by managed investment trusts, which is not something the ATO has always accepted in the past. However, there is no concessional withholding rate on the distribution of any capital gain on disposal.

• The eligibility conditions are quite prescriptive. The requirements for 15 year single ownership, 3 year lease offers and 10% affordable housing across a mix of dwelling types set a high bar.
• The accompanying ‘misuse’ measures impose significant penalties in the event that the building ceases to be an active BTR development within 15 years.
• Finally, there are still GST and state tax issues with BTR that are yet to be addressed.

BTR Eligibility Criteria

To qualify for the BTR tax incentives, developments must meet the following conditions:

• Construction must have commenced after 7:30pm AEST on 9 May 2023;
• The development must include at least 50 dwellings offered for rent to the public;
• All dwellings and common areas must be owned by a single entity for at least 15 years;
• Dwellings must be offered for lease terms of at least 3 years (unless a shorter term is requested by the tenant); and
• At least 10% of the dwellings must be affordable housing (defined as dwellings rented for 74.9% or less of the market rent for comparable dwellings), and there must be a ‘matching’ affordable dwelling for each category of dwelling available (eg if a development includes 2 penthouses, one must be affordable housing)

BTR projects can include new builds as well as substantial renovations that convert existing buildings like warehouses into rental apartments.

Meeting the eligibility criteria in aggregate across multiple co-located buildings is permitted. For example, two towers on one plot of land could qualify as a single BTR development if they collectively meet the criteria, even if one tower falls short on its own.

The single ownership requirement may present issues where direct income from tenants is attributable to common areas. There is an additional requirement to access the lower MIT rate under the exposure draft that the relevant part of the fund payment by the MIT is attributable to rental income “under a lease of a dwelling”. Accordingly; in cases where an explicit licence over common areas is recognised, even if a separate licence fee is not provided for, there may be a need to consider if this portion of rental income would arise under a lease of the dwelling, instead of under a licence of separate common areas.

Maintaining Active BTR Status

The legislation introduces the concept of an "active BTR development". Once a development first meets all the eligibility criteria, it commences being an active BTR development and the 15-year compliance period begins. The development must continue to satisfy the eligibility criteria for the full 15 years to maintain its active status and the associated tax concessions.

Some allowances are made for temporary vacancies to renovate or repair dwellings. Adding new dwellings to an active BTR development is also permitted. The new dwellings are subject to a fresh 15-year compliance period while the pre-existing dwellings remain subject to the original compliance period.

If a BTR development ceases to be active within the 15 years (eg some dwellings are sold or offered only on short leases), the "BTR misuse tax" is triggered to claw back the tax benefits obtained to that point, plus an additional 8% penalty / interest component. The development is also treated as only ever being entitled to the standard 2.5% capital works deduction rate rather than the 4% BTR rate.

Affordable Housing Requirements

At least 10% of dwellings in a BTR development must be designated as affordable housing. These dwellings must be rented at 74.9% or less of the market rent for similar dwellings. The relevant market rent could potentially be determined by reference to external benchmarks. There will be potential for disagreements about market rent and then whether the rent of the affordable housing component is set at no more than 74.9% of market rent.

The affordable rental dwellings must be representative of the overall dwelling mix in the development. It is not permitted to only designate the smallest or least attractive apartments as affordable housing. At least one dwelling of each type (by floorspace, number of bedrooms, etc.) must be offered at an affordable rent.

Eligibility for affordable rental housing can be subject to tenant income requirements set by the Government to ensure the discounted rentals are targeted to low and moderate income earners.

It is not clear what happens if a tenant who is a low to moderate income earner, receives a salary increase which moves that person out of this bracket. There does not seem to be any concessional period for adjustment so owners may have to build in a buffer of safety.

MIT Withholding Tax Reduction

Under the existing law, passive rental income earned by MITs and attributed to foreign investors is generally subject to a 30% withholding tax. The draft legislation lowers this to a 15% concessional rate for MITs that derive rental income from investing in active BTR developments during the 15-year compliance period.

This concession makes Australian BTR projects more competitive with other international opportunities from the perspective of foreign institutions investing via MIT structures.

The 15% MIT rate applies only while a project maintains active BTR status. If active status ceases within 15 years, the BTR misuse tax applies to claw back the tax benefits obtained.

However, there is no concessional withholding rate on the distribution of any capital gain on disposal.

Administration and Integrity Measures

The draft legislation includes specific reporting and notification obligations for BTR proponents to support administration and integrity of the concessions.

Owners must notify the ATO within 28 days whenever:

• A development first commences being an active BTR development
• An active BTR development is expanded with additional dwellings
• Ownership of an active BTR development changes
• An active BTR development ceases to be active.

Trustees of MITs are also required to notify the ATO before paying any distributions to foreign investors that include concessional BTR rental income.

The BTR misuse tax is the main integrity measure to deter abuse of the concessions. If a development ceases to be an active BTR development within 15 years, the misuse tax applies to capture:

• the amount by which the accelerated 4% capital works deductions exceeded the standard 2.5% deductions, grossed up at the owner's marginal tax rate and subject to an uplift factor
• 10 times the amount of rental income distributions by MITs that benefited from the 15% concessional withholding tax rate instead of the 30% rate, also subject to an uplift factor.

The misuse tax is roughly calibrated to neutralise the tax benefits obtained, plus an additional amount representing interest on the tax shortfall. The ATO has powers to amend prior year assessments to give effect to the misuse tax if required. No tax deduction is allowed for misuse tax incurred.

Commencement and Transitional Arrangements

The BTR concessions only apply to developments that commence construction after 7:30pm AEST on 9 May 2023, the date the measures were announced. This start date requirement applies even if a development does not meet all the other eligibility criteria to be an active BTR development until a later income year.

The legislation package commences on the first 1 January, 1 April, 1 July or 1 October after it receives Royal Assent. All provisions of the primary Bill are conditional on the separate imposition Bill (which imposes the BTR misuse tax) also commencing.

State Taxes concessions for BTR Developments

Broadly speaking: 

• In addition to the duty normally payable when a person acquires land, an additional duty surcharge rate (of up to 8%) applies to a foreign acquirer of residential land, unless an exemption applies. An exemption from surcharge duty may apply for residential developers generally or for land that is developed into an eligible BTR. (No foreign surcharge duty applies in ACT or NT.)
• Land tax is generally payable by an owner of land (except in NT), calculated on the taxable value of land. A concession applies to reduce the taxable value by half for eligible BTR developments (generally during the operational phase and for a specified period only, eg 20 – 30 years).
• In addition to ordinary land tax, a surcharge land tax of up to 4% applies to land owned by a foreign person (other than in WA, SA and NT). An exemption may apply during the development phase of a BTR project, and in some cases for a specified period during the operational phase.

The requirements to access BTR concessions vary between the States and Territories (see our detailed note here), but at a high level some key features to qualify as an eligible BTR development include:

• a new development – being a new building or a conversion usually from a non-residential to residential use;
• a parcel held within a unified ownership structure (but can be co-owned);
• management of the BTR development must be provided by a single entity (eg management of the leases, common areas, facilities etc), including on-site management access for tenants. Affordable/social housing can be separately operated;
• a minimum number of self-contained dwellings (eg 50 or more);
• residential tenancy agreements offered to the public (ie not a subset such as student accommodation), meeting specified requirements including an offer of a fixed term lease of at least 3 years (but tenants may opt for a shorter term);
• required proportions of affordable/social housing; and
• required proportions of labour sourced from certain classes of workers.

Although there are broad similarities between the requirements from a state tax perspective with the requirements to access income tax concessions under the draft legislation, there remains key points of difference. In particular:

• it is generally possible to access state tax concessions where the BTR development is owned in a tenancy in common structure, provided that a single management entity is jointly engaged by both co-owners to manage the BTR development. However, this kind of structure would appear to be inconsistent with the “single entity” requirement under the draft legislation.
• for the States which require a fixed proportion of the BTR development be available for affordable housing, the relevant tests looks only to whether numerically there are sufficient dwellings available on an affordable housing basis. There is no additional requirement that each category of dwelling are available on an affordable housing basis.
• most of the States require that the first stage of a BTR development deliver at least 40 or 50 dwellings, otherwise the state tax concessions are not available. For example, if a BTR development delivers 35 dwellings (stage 1 occupancy certificate issued) and then subsequently delivers a further 50 dwellings (stage 2 occupancy certificate issued), concessions would only be available for the stage 2 dwellings. If this occurs in the reverse order, concessional status is available for all dwellings. This strict staging concept is not included in the draft legislation (rather concessional status is available once 50 dwellings are offered for rent to the public) so it is important to be aware of the difference for staged developments from a state taxes perspective.