Build-to-rent measures: exposure draft legislation released

After a wait of almost 12 months, on 9 April 2024, the Treasury published the exposure draft legislation to implement the build-to-rent (BTR) income tax concessions previously announced in the 2023-24 Budget. We highlight below the main features of the proposed measures.

The proposed BTR income tax concessions

Amidst a housing crisis in Australia generally, and a rental crisis more specifically, the proposed rules are intended to provide incentives to invest in new BTR developments by introducing two income tax concessions:

• an increase in the Division 43 capital works deduction rate from 2.5% to 4%; and
  
  
• a reduction in the managed investment trust (MIT) withholding rate on fund payments consisting of rental income from eligible BTR investments (but not gains on disposal of such investments) from 30% to 15%. This concession only applies to fund payments sourced from rental income during the 15-year compliance period (see below), meaning that any fund payments sourced from rental income derived after the end of that period would be subject to the 30% withholding tax rate.

The proposed new rules are set out in two draft Bills, the Treasury Laws Amendment Bill 2024: Build to rent developments (the Main Bill) and the Capital Works (Build to Rent Misuse Tax) Bill 2024 (the Imposition Bill). The new rules are proposed to commence on the first 1 January, 1 April, 1 July or 1 October to occur after the day the Imposition Bill receives Royal Assent, and commencement of the Main Bill is conditional on the commencement of the Imposition Bill.

Eligibility criteria

To access one or both of these concessions, a BTR development must meet each of the following conditions:

• capital works on the development began after 7.30pm (AEST) on 9 May 2023 (i.e. Budget night 2023 when the initial announcements were made). This means that early investors in BTR developments will not be able to access the concessions resulting in different outcomes for different developments;
  

• the development consists of 50 or more residential dwellings made available for rent to the general public;

• an eligible BTR development includes alterations or improvements that re-purpose an existing building into BTR (e.g. a conversion of a warehouse into apartments) and can be part of a building;

• all of the dwellings in the BTR development (and the relevant common areas) continue to be directly owned together by a single entity, at any one time, for at least 15 years (a change from the original Budget announcement which contemplated a minimum 10-year ownership period);

• the BTR development, together with the common areas, may be sold by the original entity to another entity during the 15-year period, and will still qualify, provided that it continues to be owned by a single entity for the balance of the 15 years. The 15-year period does not reset if the BTR development is sold to another entity;

• dwellings in the BTR development must be offered for lease to the public for a period of three years or more, unless a prospective tenant subsequently requests (and the lessor accepts) a shorter lease.
  
  An exception applies where a BTR development temporarily does not satisfy this requirement due to the construction of an extension, alteration or improvement, or the making of repairs. In such a case, the development is deemed to continue to meet this condition; and

• at least 10% of the dwellings are available as affordable tenancies.
  
  Dwellings will be ‘affordable dwellings’ if they are made available for rent, or rented, at 74.9% or less of comparable market rents and any requirements determined by the Minister by legislative instrument are met (see below for more detail). Where a BTR development has different types of dwellings with different sizes and amenities, the owner of the BTR development must make at least one of each apartment or dwelling types available as affordable dwelling. This requirement is aimed to prevent a BTR owner from allocating only the lowest standard dwellings in a development as affordable dwellings.

Minister’s determination – income of a tenant or prospective tenant

For the purposes of the ‘affordable dwellings’ condition above, the Minister will be able to, by legislative instrument, determine requirements relating to the income of the tenant or prospective tenant. The Policy Fact Sheet included in the legislative package indicates that the following limits would apply, on a before-tax basis (based on annualised average weekly earnings as calculated by the Australian Bureau of Statistics):

• single adult - $122,179
  
  
• couple, no dependant - $132,361
  
  
• family, one or more adults with one or more dependants - $142,542.

The Policy Fact Sheet states that in applying these thresholds, the BTR development owner would be required to assess ‘initial and ongoing tenant eligibility’, including obtaining evidence of the tenant’s gross income for each year of tenancy and lodging a form in respect of each tenant to the Australian Taxation Office (ATO).

Reporting to the ATO

Under the proposed rules, the Commissioner of Taxation (Commissioner) must be notified within 28 days of any of the following occurring:

• the BTR development commences to be an ‘active BTR development’ (that is, becomes eligible for one or both concessions);
  
  
• an active BTR development is expanded during the minimum period of ownership / operation;
  
  
• there is a change in the direct ownership interest in an active BTR development; or
  
  
• a BTR development ceases to be an active BTR development.

In addition, a trustee of a MIT which makes a fund payment consisting of rental income from an active BTR development will be required to notify the Commissioner about the fund payment.

What if a development stops meeting BTR eligibility conditions during the 15-year period?

If a development ceases to meet the BTR conditions before the end of the 15-year ownership period (‘the BTR compliance period’), then:

• if the increased 4% capital works deductions were previously claimed, the BTR development will now be treated as having been subject to the 2.5% deduction rate for the time when the concession was claimed (so that the BTR development is depreciated over 40 years instead of 25);
  
  
• the ‘BTR misuse tax’ will apply to neutralise any tax benefits claimed by entities under each tax concession (as relevant). The tax will be imposed at the rate of 1.5% on the sum of:
  
  
  • the entity’s BTR capital works deduction amount. This amount is roughly equal to the accelerated capital works tax benefit (calculated at the corporate tax rate for companies, and at 45% for any other taxpayers), plus 8%; and
    
    
  • 10 times the BTR withholding amount (for MIT fund payments). This amount is broadly the sum of the fund payments from the relevant BTR investment for which the BTR concession was previously claimed, plus 8%; and
    
    
• there will be no time limit on the Commissioner amending assessments where a BTR development has ceased to qualify for the concessions during the relevant 15-year period (including assessments to impose the BTR misuse tax). If the Commissioner makes an assessment of BTR misuse tax, the tax is payable within 21 days of the date of the notice of assessment (or amended assessment). In addition, general interest charge would apply if the amount assessed is not paid by the due date.

Insights and implications

• As currently drafted, the MIT withholding tax concession only covers fund payments attributable to rental income from eligible BTR developments. This is different from the tax treatment of other asset classes where the concessional MIT withholding rate is also available to capital gains derived from dealings in the underlying assets (e.g. investments in commercial property and other assets), and may place investments in BTR developments at a disadvantage when compared to other types of investments.

• While there is some flexibility around the types of developments that qualify - for example, the BTR development may be a part of a building (and the proposed new rules permit the concession to apply on a pro rata basis), or may consist of two or more buildings located on the same or adjacent land - the requirement for all dwellings and the relevant common areas to be owned by a single entity would mean that a single BTR development cannot be co-owned (e.g.by two or more parties as tenants in common). This requirement may limit the ability to sell or transfer title to the affordable housing component to a community housing provider (CHP), which can be either a requirement or an option under a development consent where the planning authority seeks to achieve an affordable or social housing outcome.

• The proposed new rules do not appear to place any restrictions on ownership (1) at the landowning entity level or (2) of other non-dwelling components of the BTR developments in a mixed-use setting, such as retail or community areas. These areas may be subdivided from the dwelling components and owned by a different entity.

• Under the proposed new rules, investors in BTR developments will be required to continually monitor compliance with all the relevant conditions, including the tenants meeting annual income thresholds (which would be monitored by requiring each tenant to submit a form each year). It is unclear how the rules would operate where, for example, a BTR development has become non-compliant due to circumstances outside the investor’s control (e.g. a tenant’s income exceeding the threshold for a particular year) and without the investor’s knowledge. This is one aspect of the proposed rules that should be followed closely during the consultation period as we expect that it may be considered by investors unreasonable that in such circumstances, a BTR development may not qualify for the concessions where an inadvertent or temporary failure of the BTR conditions did not result from the investor’s actions.

• The proposed income tax amendments are part of a suite of measures to achieve the intended policy outcome of increased housing supply. The States have led the charge in the provision of tax concessions for the BTR asset class, with most jurisdictions now providing land tax relief for BTR developments and the proposed eligibility criteria for income tax concessions would appear to have been borrowed from the eligibility criteria for land tax concessions (although there is of course no uniformity between the States, or indeed, with income tax).
  
  At this stage however, any stamp duty concession is limited to the non-application of foreign surcharge for the construction of a BTR development (but not for the acquisition of an operating BTR property) and there appears to be little progress on any proposal to amend the GST legislation to allow input tax credits for BTR providers.
  
  Consultation concluded on 22 April 2024 – no doubt the focus will be on making BTR and attractive asset class for investors whilst achieving the desired policy outcomes.