The Australian government has, nearly 12 months after announcing them, released draft legislation to implement two key income tax incentives for build-to-rent (BTR) projects: 

• Extending the 15% withholding tax for foreign investors in a managed investment trust (MIT) to BTR rental income from 1 July 2024 (Reduced WHT); and 
• Accelerated capital works deductions (4% per annum versus 2.5%) on construction expenditure incurred since 9 May 2023, allowing earlier “tax deferred” returns of capital (Accelerated Depreciation).

Implementing these measures is a positive foundation for BTR - facilitating the delivery of BTR projects is critical to addressing some of the housing shortages in Australia. They remove some of the tax barriers to BTR projects. Importantly the measures begin to reduce the tax distortions between BTR projects and other commercial or industrial real estate developments. The Reduced WHT is particularly important to attract foreign capital to the BTR sector - and the important role of foreign capital is evidenced by a majority of the significant BTR projects announced involving foreign capital partners. The draft measures also address some key issues we flagged in our previous BTR series (see Part 2 and Part 3). 

However, there are unfortunately still a number of issues arising from the draft legislation that may undermine these positive foundations and other tax barriers and issues that remain unaddressed.

SUMMARY OF THE QUALIFYING REQUIREMENTS

The Reduced WHT is proposed to apply to distributions by an MIT of rental income from Active BTR Developments from 1 July 2024. Accelerated Depreciation is proposed to apply from Active BTR Developments with capital works begun after 9 May 2023.

In summary, a development is an Active BTR Development where:

• It consists of at least 50 residential dwellings (in a single building, or when aggregated with other buildings on the same or “adjacent” land) in Australia (and an Active BTR Development will automatically expand if additional dwellings in the building begin to meet the remaining requirements);
• Every one of the dwellings in the project is at all times either (a) available to the public for a lease, or leased as a result of being made available to the public for lease, where the offer for lease was for a term of three years or more (although the tenant can choose to accept a shorter term); or (b) temporarily unable to satisfy (a) due to extensions, alterations, improvements or repairs;
• The dwellings are not part of “commercial residential premises” (e.g. boarding house, hotels);
• All of the dwellings and their “common areas” (areas, facilities, or amenities intended for the use of any dwellings) are owned by a single entity;
• Of the dwellings, 10% or more are “affordable dwellings” (proposed as >75% market rent and leased to a person or household meeting with income less than the relevant income limit); 
• Every one of the non-affordable dwellings must have a corresponding “affordable dwelling” that is the same size and has the same amenities (i.e. there must be an “affordable” version of every dwelling of a particular size and amenity in the development); and
• All of these conditions must be satisfied for a continuous period of 15 years (although where the development expands, the 15-year period for the additional dwellings runs from that expansion without affecting the original 15-year period).

Importantly, if those conditions cease to be met at any time in that 15-year period, the entity owning the development is liable for “Build to Rent Misuse Tax”. That “claws back” the full amount of any Accelerated Depreciation and Reduced WHT benefit across the life of the development (plus an interest component).

There are also additional reporting requirements imposed, including on becoming, ceasing to become or making a payment of rental income from an Active BTR Development.

SOME OF THE FOUNDATIONS ARE STRONG

The draft legislation does, in some respect, contain important elements:

• The ability for the Active BTR Development to be sold to another entity (i.e. for the single owner to change), as well as the freedom for underlying investors to enter and exit. Given the long-term requirement, this allows different investors’ capital allocation and risk appetites to be catered for, unlocking greater supply. For example, it allows investors with higher risk but shorter tenor appetites to get the development to operating status, and then for more patient but lower risk appetite capital to take it over. Unfortunately, as set out below, this flexibility is then somewhat undermined.
• Flexibility for a single Active BTR Development to be spread across multiple buildings and “adjacent land”. This allows mixed-used developments that not only allow better management of returns and risks but also are more appealing (by allowing complementary tenancies like supermarkets, cafes etc.).
• Allowing existing buildings (e.g. lower-grade offices, hotels, industrial space) to be converted to BTR with capital works on the conversion qualifying for Accelerated Depreciation (as well as rental income from such conversions qualifying for Reduced WHT).

WHERE ARE THE POTENTIAL CRACKS IN THE FOUNDATIONS?

Unfortunately, there remain some serious challenges with the draft legislation:

WHAT FEATURES HAVE BEEN LEFT OUT OF THE PLANS?

In addition to potential cracks in the foundation, a number of the tax barriers to BTR have not been addressed at all, leaving a development with missing features. Some of these are in the control of the federal government and some require cooperation with the states. All remain barriers that need to be addressed to make BTR successful (particularly because many of the same barriers do not exist for commercial and industrial real estate developments). Some of the key issues are as follows:

• The draft legislation makes clear that a BTR development is not, and cannot, be “commercial residential premises”, and otherwise does not address any GST issues. In short, that means BTR developers cannot claim GST input tax credits on their costs of acquiring and constructing the development (whereas such credits are available to “build-to-sell” developers). It adds 10% to the effective cost of the BTR development, and where margins can be tight anyway, can be a real barrier to feasibility. Even allowing the input tax credits to be claimed back upfront and then repaid over the 15-year timeframe (or earlier, if sold) would materially assist cash flows and reduce the upfront GST burden;
• Whilst the federal rules have many things in common with state-based concessions for duty and land tax (including generally the minimum number of dwellings and three-year lease terms being offered), there remain differences across the jurisdictions that can be difficult to navigate;
• No clarity has been provided that a BTR project is an “eligible investment business” for the purposes of the “trading trust” rules (which is a precondition for MIT eligibility). Whilst the minimum holding period of 15 years should surely mean the primary purpose is to derive rent, the historical views treating residential property development as a trading-type activity remain as a cloud of unnecessary uncertainty. This is particularly so where the plan may be for a developer to sell the Active BTR Development. It would have been easy to specifically allow an Active BTR Development as an eligible investment business; and
• There has been no specific measure to deal with how an Active BTR Development can provide ancillary services (which are not “eligible investment businesses”) which overseas experience suggests can make BTR a more attractive proposition for tenants. Whilst there appears to be no restriction on outsourcing (unlike some state tax concessions), this requires a more complex structure (whereas it would have been better to allow any income from those ancillary services to be included in the rental income).

WHERE DO WE GO FROM HERE?

The draft legislation has been going through the process of consultation, and it is hoped that some or all of the above issues will be addressed. To achieve this, a version of this article has been submitted to treasury as part of the consultation process on the draft legislation. Otherwise, what is a promising start may not actually see BTR projects delivered to address housing shortages. The government needs to decide whether it really wants to BTR to be successful, and if so, adopt a more realistic approach.