Some Thoughts on the Build-to-Rent Bill

By James Pettigrew, Ryan Leslie, Graeme Cooper, Jinny Chaimungkalanont

The government has introduced the Treasury Laws Amendment (Responsible Buy Now Pay Later and Other Measures) Bill 2024 into Parliament. It includes the tax concessions for residential build-to-rent projects announced by the Prime Minister in April 2023.

Background

The proposal for income tax concessions for build-to-rent (‘BTR’) residential projects was announced by the Prime Minister in April 2023 and confirmed in the May 2023 Budget.  It represented a substantial retreat from measures enacted in 2019 which insisted that all ‘MIT residential housing income’ must suffer withholding tax at the rate of 30% in the hands of foreign investors.  But is worth noting, despite the fanfare, this is not expected to be a generous concession – Treasury estimated in the Budget the cost to revenue would be $20m pa in 2026-27.

The 2023 proposal comprised two measures:

• reducing the withholding tax rate for fund payments from withholding MITs [‘MITWT’] attributable to income from residential BTR projects from 30% to 15%, and
• increasing the rate for deducting the construction costs of capital works for residential BTR projects from 2.5% to 4%.

An Exposure Draft of the measures was released by Treasury for consultation in April 2024.  The ED revealed highly detailed and very prescriptive eligibility conditions and announced an accompanying ‘misuse tax’ where a building ceased to qualify within 15 years of completion. Our Tax Insight on Treasury’s Exposure Draft is available here.

The Bill

The Treasury Laws Amendment (Responsible Buy Now Pay Later and Other Measures) Bill 2024 [‘Bill’] and the accompanying Explanatory Memorandum [‘EM’] retain most of the features seen in the Exposure Draft, with a few revisions.  A separate Bill, the Capital Works (Build to Rent Misuse Tax) Bill 2024, will formally impose a ‘misuse tax’ where there has been a failure to meet requirements for the tax concessions. Exposure to ‘misuse tax’ lasts during the 15-year compliance period, generally commencing on the day on which the development became an active BTR development.

What hasn’t changed

Many key requirements seen in the Exposure Draft remain unchanged:

• construction of the building (or major refurbishment of an existing building) must have commenced after 9 May 2023. Treasury was apparently unpersuaded by the argument that bringing existing buildings into the BTR regime was both cheap and productive;
• the development must include at least 50 residential dwellings located in Australia.  ‘Commercial residential premises …’ such as hotels and serviced apartments, and developments on land outside Australia, are excluded at this point;
• because it is likely building projects will involve mixed uses (residential units, shops, car parks, gyms, and so on), some attention is devoted to stating when shared ‘common areas’ in a building will qualify for the concession, and when they must be segregated. This will remain a difficult area and is discussed in more detail below;
• it is not necessary that dwellings are all currently occupied; it is sufficient if they are ‘available … to be tenanted’, but there are specific provisions dealing with periods when dwellings are both unoccupied and not currently ‘available’, typically because of repairs or renovations;
• dwellings must be offered for rent to ‘the public’. According to the EM, retirement villages and student accommodation are excluded at this point on the basis that they are offered only to a segment of the public;
• all dwellings and common areas must be owned by a single entity for at least 15 years, although a single owner can sell the development to another single owner during that time;
• occupancy of dwellings must be by way of ‘lease’, and lease terms must be at least 3 years, unless the tenant requests a shorter term;
• at least 10% of the dwellings must be ‘affordable housing’ – that is, the rent is less than 75% of the market rent for a comparable dwelling;
• another requirement to be ‘affordable housing’ based on the income of the tenant will appear shortly;
• the development must continue to satisfy the eligibility criteria for 15 years from the time dwellings are first offered for rent, to enjoy ongoing capital allowance benefits;
• the development must continue to satisfy the eligibility criteria in perpetuity to enjoy the reduced MITWT benefits;
• income and gains from the development can continue to enjoy the reduced MITWT rate indefinitely, but the project must continue to satisfy the eligibility requirements at the relevant time;
• ‘misuse tax’ will be assessed by the ATO if a development ceases to meet the requirements within 15-year compliance period; and
• specific and highly detailed reporting and notification obligations must be met.

These requirements are discussed in more detail in our earlier Tax Insight.

Ensuring ongoing compliance with these requirements throughout the 15-year compliance period remains an important compliance burden.  Some of the requirements are ‘set-and-forget’: for example, according to the EM, whether the rent is less than 75% of market rent is assessed at the time the lease is entered and need not be revisited, in most cases.  But it is clear other requirements, such as those which depend on a tenant’s income levels, will need constant monitoring.

There is still no attempt to address GST issues. Perhaps more understandably, discrepancies with various State tax measures still remain.

What has changed

(a) MIT withholding tax

There has been some movement on two aspects of the reduced MIT withholding rate.

First, the good news.  One of the more significant, and welcome, changes relates to fund payments which contain a capital gain, typically on the sale of the property or an interest in a ‘dwelling-rich’ entity.  The Exposure Draft had applied the reduced rate only to amounts ‘attributable to a payment of rental income under a lease …’  But the Bill says that the reduced rate will now also apply to:

• a capital gain arising from a CGT event that happens in relation to a build-to-rent dwelling owned and sold by the MIT, and
• part of a capital gain arising from a CGT event in relation to a membership interest in another entity [sub-trust] owned by the MIT. The EM is silent on the matter, but the drafting seems capable of applying to the two different scenarios:
  • the trustee of sub-trust has sold the dwelling and the capital gain flows through to the MIT; and
  • the MIT is selling its stake in a sub-trust which currently holds a build-to-rent dwelling.

The gain on sale of the interest in the sub-trust is pro-rated based on the value of the dwelling compared to the values of other assets held by the sub-trust, which makes sense in the second scenario if the sub-trust holds multiple buildings, some of which are BTR and others which are not. But the drafting is more prescriptive than this, requiring pro-rating of the gain on the sale by the sub-trust of a single building. Apparently, it is necessary to apportion between the value of dwelling and the values of the rest of the building. Just how the trustee of the MIT will know how much of the gain arises from the sale of the dwellings when an entire building has been sold, is not explored.  And there is simply no way the trustee of a MIT could do this apportionment when there has been no sale by the trustee of the sub-trust.

There is definitely bad news.  The ability to flow income and gains through a chain of trusts is seriously constrained by a new provision, which did not appear in the Exposure Draft, but was inserted into the Bill.  The 15% rate is delivered by a provision which says that qualifying rent and capital gains will not be ‘MIT residential housing income.’  But the new provision removes that benefit if there is a chain of trusts and the lower tier trust and the paying trust do not share the same trustee. 

Having the same trustee for multiple trusts rarely happens for widely-held managed funds.  Rather, having a separate trustee is a practical way of ensuring each trustee is meeting its obligation under trust law not to blend the assets of different trusts.  So not only does this structure rarely happen, the practice shouldn’t be encouraged. 

According to the EM, ‘this carve-out from the concessional 15 per cent rate of tax is to support the administration of the tax concession, in particular the BTR misuse tax’ an explanation which obscures more than it reveals. Hopefully the Senate will fix this.

(b) Measuring comparability

It has always been a requirement of the regime that at least 10% of the dwellings in a BTR project must be ‘affordable housing’ and there were two key tests for deciding whether a dwelling qualified:

• first, the rent charged for the dwelling must be less than 75% of the market rent for a comparable dwelling – this is a comparison with similar dwellings being offered in the market;
• second, there must be at least one dwelling in the building of the same size and with the same amenities – this is a comparison of the affordable dwelling with other dwellings in the same development.

The justification for the second requirement was to ‘prevent a BTR owner from allocating only the lowest standard dwellings in a development as affordable dwellings.’  The explanatory material which accompanied Exposure Draft said the effect of the requirement was that an owner must offer at least one from every class of unit as an affordable dwelling – in effect, if there is to be a luxury penthouse, an affordable penthouse must also be offered.

The Bill has turned drafting of this second requirement on its head.  The requirement is now, if a dwelling is to count as an ‘affordable dwelling’ the owner must offer at least one other non-affordable dwelling (with the same number of bedrooms and similar floor space in the building). In effect, all the penthouses can be luxury accommodation if the owner wishes, but if the owner does wish to count an ‘affordable’ penthouse toward the 10% affordable housing test, then at least one non-affordable penthouse must be offered. This should ensure a mix of affordable and non-affordable dwellings in each class if it is being offered as affordable housing.

(c) Leasing to low-income tenants

There was no express requirement in the Exposure Draft that a dwelling must be leased to a low-income tenant.  Instead, there was a place marker: ‘the Minister may, by legislative instrument, determine requirements relating to the income of the tenant or prospective tenant …’  A ‘Policy Fact Sheet’ released with the Exposure Draft, indicated that affordable housing would have to be leased to a tenant whose (sole or family) income was less than a nominated percentage of annualised average weekly total earnings, and owners would ‘be required to assess initial and ongoing tenant eligibility.’ 

The Bill does not advance this matter, but the place marker survives. Regulations will undoubtedly appear once the Bill has been passed.  A dedicated provision ensures meeting this income requirement will not breach another requirement: that the dwellings must be offered to ‘the public’, not just a segment of the public.

Some of the oddities in the Bill

The Bill also contains the usual number of imponderable provisions.

(a) Buildings, dwellings, common areas, and the rest

The Bill creates many demarcations which will mean apportionment headaches for BTR project developers.

The starting concept is a ‘building’, which is then subdivided into ‘part[s] of a building’, which are then subdivided into the parts of the building which are a ‘dwelling [and any] common areas for those dwellings’, which are then subdivided into the dwellings and common areas which are part of an ‘active build to rent development’ and those which are not.

There are demarcation problems right from the start. A ‘building’ is defined to include ‘any other buildings that are on the same or adjacent land’ which means an owner must decide whether its one new building is actually two buildings, or even more. There is no provision in the Bill which gives a way to answer that question. The EM seems to regard this provision as concessional – ‘if there are two towers on one plot of land and both are BTR … eligibility for the tax concessions can be met if the structures meet the eligibility criteria in aggregate.’ And combining the buildings in this way will make it easier to meet the 50 dwellings threshold.

The EM contemplates that a single ‘building’ might have both BTR and non-BTR areas within it, and a single building might have multiple BTR areas inside it. Dwelling is defined to mean a unit of residential accommodation in a building, but things like car spaces, visitor car spaces, a shared laundry, gyms, pools, open spaces will create demarcation problems: are they part of the dwelling, are they common areas, are they neither?  Are they even part of the ‘building’?  Only the ‘dwellings’ need to be offered under a lease; there are no requirements on how ‘common areas’ are made available.  But it seems ‘common areas’ can only be made available to residential occupants (and their guests) – a common area exists by reference to the ‘dwellings’ in the building. And so the EM says, a gym or pool which is accessible to the general public is not a ‘common area.’ Interestingly, the EM says construction expenditure on common areas shared between residential occupants does not need to be apportioned between BTR and non-BTR dwellings; on the other hand, if the facilities are also accessible to the general public, the construction expenditure will need to be apportioned.

The Bill contemplates that a BTR development might expand over time which implies a further demarcation: when is construction work a new BTR project, and when is it the expansion of an existing BTR project?  The owner has an option which route to choose in the notice it sends to the ATO. The drafters have removed one factor which might have influenced that choice: the compliance period for a dwelling added to an existing BTR development is 15-years, just as if the owner had elected to start a new BTR project for the new building. But there are other factors which might influence the decision: expanding an existing project might allow surplus affordable housing in one building to shield a deficiency in the other.

Finally, embedded in the drafting is a more fundamental problem: is a particular requirement applied to the building as a whole, or is it applied just to the portion of the building that is ‘dwelling’?  Sometimes, the answer to that question is obvious. For example,

• the 50-dwelling requirement is applied to the building as a whole: the ‘dwellings … of a building’ are in a ‘build to rent development’ from the first day on which ‘a building has 50 or more dwellings …’;
• the requirement to offer a 3-year lease applies discretely to ‘each of the dwellings.’

But sometimes, the building v. dwelling issue is not obvious. For example, the affordability requirement is expressed as ‘10% of the number of the dwellings’ which must mean, ‘10% of the number of the dwellings in the building.’  But if that is correct, it would cause problems in other requirements: it would mean that none of the dwellings in the building could be commercial residential premises, rather than, none of the dwellings which are being put forward as eligible are commercial residential premises.

(b)Failure, death, forgiveness and redemption

The Bill has a lot of detail about what is required to qualify for the concessions, and the penalties for failing to meet those requirements. But there is little about the possibility of redemption for a BTR project after a failure has been uncovered, punishments suffered, and the failure rectified.

The closest approximation to a rule about failures is the new discretion which allows the ATO to overlook non-compliance, where the owner begs forgiveness in the approved form. But the owner cannot appeal to the ATO unless it meets very strict requirements: the failure was because of events ‘outside the control of the entity’, the owner took ‘all reasonable steps’ to remedy the failure promptly and the project is now complying again. The EM gives some unremarkable examples of events ‘outside the control of the entity’: damage from a fire or flood means the dwelling isn’t available for rent, the tenant gets a pay rise and doesn’t tell the owner, or the tenant gets a pay rise and refuses to leave ‘because of a lack of alternative accommodation.’

But if the ATO is unwilling to overlook past indiscretions, it seems the only option is to re-notify the ATO about the project, which will restart the 15-year compliance period which seems unnecessary.

(c) Using a dwelling to produce assessable income

The Bill has curious provisions which are triggered when a dwelling is used to produce assessable income. They work differently between different time periods.

During the 15-year compliance period, the requirement is that the premises must be ‘residential premises’ and not be ‘commercial residential premises.’  A dwelling will be ‘residential premises’ if it is occupied as a residence, even if it used in part to produce assessable income, up to the point it becomes ‘commercial residential premises’ such as a hotel or serviced apartment (but apparently not Airbnb, according to the ATO).

But after the compliance period has expired, one of the requirements to continue enjoying the 4% building allowance and reduced MITWT is ‘no other entity is [currently] using … any part of the eligible development, for the purpose of producing assessable income …’ and never has. There is an exception which says the prohibition is not triggered if the ‘other entity’ is using the development to produce ‘assessable income by providing management services.’

There are many curious aspects to this rule.  First, it is odd to conceive of a building manager as ‘using’ the building in any meaningful sense. The manager is providing a service, and it will ‘use’ its own staff and equipment and other assets in that process.  But it is odd to assert a building manager is somehow using the building as well.

But if this notion of ‘use’ is really intended, then it seems the owner will be immunised only if the building manager is earning income just from ‘management services.’ Management services are provided to an owner, so if the building manager also offers services to tenants (such as parcel collection, dog walking, cleaning or other add-on services), the owner may be in some difficulty, especially if the manager charges a separate fee. Just what happens if these services are not separately priced (ie, the manager charges the owner a higher management fee which is passed on to tenant in the form of higher rent), is not obvious, but the higher rent will make it less likely the building offers ‘affordable housing.’

In the same vein, the owner’s position is now dependent on what the tenant is doing in the dwelling. A tenant who decides to turn the second bedroom into an Airbnb (which will generate assessable income even if it is not ‘commercial residential premises’), or operate a mail-order business from the kitchen can apparently extinguish the landlord’s entitlement.

(d) Misuse tax

A new Div 44 ITAA 1997 and the Capital Works (Build to Rent Misuse Tax) Bill 2024, will assess and impose the ‘misuse tax’ where there has been a failure to meet the requirements for either or both of the tax concessions.  Exposure to misuse tax for over-claiming building allowance and for under-paying MITWT is limited to the 15-year compliance period.

This tax is the penalty for non-compliance but rather than allow the existing punishments for non-compliance to operate in the usual way, a separate tax is being imposed. The obvious question is, why?  No explanation is given, but one likely explanation is to avoid the need to amend the assessments of multiple unitholders or pursue foreign investors.  Another possible explanation – that this route offers a way to bypass the time limits on amending income tax assessments – turns out not to be the case because s. 170(10AA) ITAA 1936 is being amended in the Bill to allow the ATO to amend income tax assessments at any time to deny excess deductions claimed under Div 43.

At first glance, the misuse tax process works largely as expected. To take the simplest example, a taxpayer which has constructed a building and claims incorrectly that it qualifies as a BTR project, is liable to pay an amount of ‘misuse tax’ equal to the income tax saved (computed at the corporate rate or top personal marginal rate) by deducting at 4% instead of 2.5%, plus a penalty of 8%.  And the portion of a fund payment incorrectly taxed at 15% triggers an amount of top-up ‘misuse tax’ equal to a further 15%, plus a penalty of 8%.  And because ‘misuse tax’ is collecting an amount equivalent to a tax saving, neither amount is deductible.

But there are some oddities. Using the top personal marginal rate to calculate the tax saving (and thus the misuse tax) in cases where the building is owned by someone other than a company may make sense in the unlikely scenario that the owner is an individual; it makes no sense where the owner is a superannuation fund.  Given that industry and retail superannuation funds are exactly the kind of entities this measure is meant to attract, using the top personal rate is a distinct punishment.

A related problem will arise for any tax-exempt entities, such as housing charities, which invest indirectly into BTR projects. Charities will not be protected from suffering the cost of ‘misuse tax’ imposed on the trustees of trusts into which they invest.

The legislation is drafted so that these two liabilities accumulate, but there is no interaction between the two steps.  That is, the legislation does not adjust the amount of a fund payment if the amount of building allowance (used as the basis for deciding the ‘net income of the trust’) is excessive. Instead, the portion of the original fund payment which was taxed at 15%, is subject to an extra 15% tax.  An alternative approach might have concluded the portion of the fund payment which represents the net income of the trust must be bigger, since the net income is bigger.

Another issue lurking behind this process is, what happens from an income tax perspective?  There is nothing in the Bill which switches off the usual income tax rules where misuse tax has been triggered. If the owner’s taxable income was understated and the ATO says the shortfall was not reasonably arguable, the ATO presumably issues an amended assessment adding the shortfall into taxable income or net income and the owner (or unitholders) must pay additional income tax, plus a 25% penalty and shortfall interest.  It seems to be assumed that the ATO won’t ‘double dip’, but the amendment to s. 170(10AA) has been put into the Act precisely to allow the ATO to amend income tax assessments in perpetuity.

Even if the ATO does not ‘double dip’ during the 15-year compliance period, the next question is whether there will be a switch over from misuse tax back to income tax exposures for BTR projects. Exposure to misuse tax (for both over-claiming building allowance and for under-paying MITWT) is limited to the 15-year compliance period. But the provisions switch off access to the concessions in year 16+ if the project has ceased to comply with the BTR requirements.  At this point, presumably, the ATO will insist that income tax penalties are now to be applied if the 4% rate and reduced MITWT are being incorrectly claimed.

There are some machinery provisions in the Bill about assessing and collecting this tax, but the details are scant. The ATO will explicitly issue assessments of misuse tax, although in reality, these assessments will be triggered by self-reporting non-compliance. Assessments can be challenged in the same way as income tax assessments for up to 4 years. Misuse tax is not made payable for the year of non-compliance. Instead, the liability arises in the year of assessment and so it seems shortfall interest charge cannot arise. According to the EM, the one-off 8% uplift is meant to capture both, ‘interest and costs associated with the tax shortfall.’

But, there is no rule which identifies the taxpayer of misuse tax – the taxpayer is simply ‘you’.  Where the owner is a company (which means only the capital allowance concession is involved), the reference to ‘you’ in the charging provisions is unfortunate but probably inconsequential. But in the case of a trust, both concessions are in play, and the provisions seem to be drafted to refer to the trustee rather than unitholder – misuse tax is calculated by reference to ‘each fund payment you make …’

(e) Sales of BTR structures

One of the requirements for enjoying the tax concessions is that ‘all of the dwellings and common areas for the dwellings are owned by a single entity.’  The EM says this does not prevent sale by one single owner to another single owner. Interestingly, the EM also seems to bless construction by, and sales to, a consortium of owners, if they acquire ‘via a single entity.’  It remains to be seen whether the ATO will agree that indirect sales by consortium owners are permissible.

Nor is there anything in the rules which limits sales to transactions between BTR owners.  That is, nothing on the face of the Bill would appear to prevent build-to-sell developers selling to BTR owners, who then claim the benefits of the regime.  The EM contemplates that ‘a new building … commenced as a build-to-sell development [can be] converted to a BTR development during construction ...’ but this concession does not advance matters very far: apparently a permitted change can only happen ‘during construction’ and the passage just permits changing use, it says nothing about changing owners. It is not obvious that there should be such a restriction, but the question is worth asking.

Conclusion

As the previous discussion has showed, the Bill is complex, demands a lot of judgment calls and will require ongoing oversight. But the Bill is still a work in progress and hopefully some of the more obscure and unnecessarily complex provisions in the Bill will be improved in the Senate.

But at the end of the day, the very modest price tag probably suggests this regime is not, and was never planned to, bring about seismic change in the supply of affordable housing.