New BTR tax relief: what does it mean for investment funds?

By Anthony Bradica and Jim Koutsokostas

A measure to encourage investment and construction in the build‑to‑rent (BTR) sector was announced in the 2023-24 Federal Budget. The Government has now released Exposure Draft legislation on the measures announced in the Budget that applies to eligible new BTR projects where construction commenced after 7.30pm (AEST) on 9 May 2023.

Until now, there has been little in the way of material tax concessions or incentives for BTR as an asset class. The measures will make it more attractive for investment funds that otherwise qualify as managed investment trusts (MITs) or attribution managed investment trusts (AMITs) to hold residential properties for rent and provide concessional returns to investors.

The proposed new measures:

• increase the rate for the capital works tax deduction from 2.5 per cent to 4 per cent per year; and
• reduce the final withholding tax rate on eligible fund payments from managed investment trust investments from 30 per cent to 15 per cent.

The consultation period ends on 22 April 2024.

Key features of the new regime

Active BTR development

In order to qualify for the concessions, the BTR development must be an ‘active BTR development’, which requires all of the following conditions to be met:

• 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. This can apply to new developments, as well as alterations and structural improvements that re-purpose an existing building into BTR (for example, the conversion of a warehouse to BTR apartments).
  • Properties earmarked as ‘build-to-sell’ can qualify if they are converted to BTR during construction.
  • A dwelling must consist of some form of residential accommodation, typically apartments and houses, provided the asset is considered ‘taxable Australian real property’, and is not commercial residential premises (for example, a motel or hotel).
  • The rules allow the rental conditions to still be met where one or more dwellings are not tenanted temporarily – for example, where the dwelling has suffered water or fire damage and is under repair.
• All the dwellings in the BTR development (and common areas that are part of the development) must continue to be directly owned together by a single entity, at any one time, for at least 15 years – known as the ‘compliance period’ – from the date when the buildings are first made available for rent.
  • The regime allows the owner to sell the entire development to another owner and for the concessions to continue to be available to the new owner provided the other conditions for eligibility remain.
• Dwellings in the BTR development must be offered for lease terms of at least three years throughout the 15-year period (although the tenant can request a shorter term).
• At least 10 per cent of the dwellings in the BTR development must be offered as affordable tenancies throughout the 15-year period. Relevantly:
  • As a general rule, a dwelling qualifies as an affordable dwelling if it is available for rent, or rented, at a discount of more than 25% to market rent for comparable dwellings.
  • If a BTR has dwellings of different amenity, the rules require 10 per cent of each dwelling type to be made available as affordable dwellings. This is to prevent a BTR owner from allocating only the lowest standard dwellings in a development as affordable dwellings (that is, lowest total floorspace, least number of bedrooms, least number of bathrooms, etc).
  • The Minister can make a determination imposing additional requirements, relating to the income of the tenant or prospective tenant, that must be satisfied for a dwelling to be considered an affordable dwelling. These determinations are expected to be updated periodically as wages change over time. Presumably, allowances will be made for difference in wages between the States and Territories.

Accelerated capital works deductions

• Amendments will be made to the capital works deductions rules in Division 43 to allow for accelerated deductions relating to the cost of capital works in respect of active BTR developments. The deductions apply at the rate of 4 per cent on the capital cost of the works and can be deducted once construction has been completed. The accelerated deductions are available even after the 15-year compliance period has ended.
• The change will allow an even greater scope for annual tax deferred distributions to be made by investment funds holding an active BTR development than is currently the case.

Reduced withholding tax rates for MITs and AMITs

• Currently, as a general rule, the tax law allows a MIT or AMIT that is a withholding MIT^[1] to cap the tax rate on certain ‘fund payments’^[2] made to foreign residents of an information exchange country to 15 per cent.
• However, fund payments to a foreign resident that represent rental income from a BTR development that does not constitute, broadly, affordable housing, is taxed at 30 per cent, as it is treated as non-concessional MIT income under the existing rules.
• Under the new BTR regime, the concessional 15 per cent withholding tax rate will apply to rental income derived from the lease of a dwelling that is part of an active BTR development. Unlike the accelerated capital works deductions, the concessional 15 per cent withholding tax rate only applies for the duration of the compliance period.

Reporting in respect of a BTR development

• There is a new reporting regime that impacts owners of an active BTR development. Within 28 days after the occurrence of the relevant event, the owner of the BTR development must report certain key events, such as the commencement of an active BTR development, a change in ownership of the development, or ceasing to qualify as an active BTR development.
• Trustees of withholding MITs that are seeking to rely on the concessional 15 per cent withholding tax rate for distributions of net rent received in respect of an active BTR development will also need to notify the Commissioner of Taxation, prior to making a fund payment, as well as any time one of the specified key events occurs during that year.

Failure to maintain the conditions to be an active BTR development

• The regime includes an integrity measure – the BTR misuse tax – that aims to neutralise the tax benefits claimed by entities where the BTR development ceases to be an active BTR development during the 15-year compliance period.
• The BTR misuse amount is the sum of the BTR capital works deduction amount and 10 times the BTR withholding amount. That amount is then subject to a tax rate of 1.5 per cent with a further 8 per cent uplift to reflect interest and costs associated with the shortfall.
• The imposition of the tax on an investment fund will be enforced through an extension of the amendment period for the trust’s tax returns. Depending on the terms of the fund’s trust deed, that impost may be taxed to the trustee or its unitholders, and former unitholders. The tax is not deductible.