Misuse and lose: incentivising MIT investments in the BTR sector…but at a cost?

On 9 April 2024, the Federal Government released for consultation exposure draft legislation – the Treasury Laws Amendment Bill 2024: Build to rent developments (Exposure Draft) - which seeks to implement certain tax incentives in the build-to-rent (BTR) sector, first introduced in its ‘A Better Future for the Federation’ plan (see our previous alert here).

The proposed reforms, which (if enacted in its current form) will commence from 1 July 2024, seek to improve the commercial feasibility of foreign investment into the Australia BTR housing sector by:

• reducing the withholding tax (WHT) rate for ‘withholding managed investment trusts’ (MITs) from 30% to 15% for rental income from ‘active BTR developments’; and
• increasing the capital works deduction rate from 2.5% to 4% for active BTR developments.

As part of the Exposure Draft, the Federal Government is also seeking to introduce a new non-deductible ‘misuse tax’ (previously unannounced), which applies as a percentage of all tax concessions claimed if the development ceases to be an active BTR development at any time during the 15-year compliance period.

What you need to know

• The amendments are set to apply to capital works which begun after 9 May 2023 (i.e., the concessions will not apply to existing builds, who will continue to be subject to the non-concessional regime).
• The concessions will only apply to rent (but not capital gains) derived from ‘active build to rent developments’ that satisfy the relevant eligibility requirements throughout a 15-year compliance period.
• If the development ceases to be an ‘active build to rent development’ at any time during that 15-year period, the misuse tax will apply to the tax benefit gained since the compliance period began – i.e., the misuse tax is effectively retrospective.
• There is at least some uncertainty regarding how the requirement for dwellings and common areas to be ‘owned by a single entity’ applies. It is suggested that this requirement take on the meaning of ownership under section 118-130, which may mean that there is a look through for certain types of trust structures, including bare trust and nominee style arrangements.
• While these concessions are likely to be welcomed by industry, the continuous 15-year compliance period may be considered unduly onerous particularly when viewed in light of the misuse tax, which takes into account deductions claimed in the years where the development was ‘active’. This means that there may be limitations in the ability of subsequent purchasers to re-purpose a particular site even if it was originally genuinely intended and used for a BTR purpose.
• Compliance involves a number of notification requirements both for the asset holder and the MIT making distributions to foreign residents (to the extent they are different entities).

We discuss these key points in more detail below.

Further details

Key aspects of the Exposure Draft

The key aspects of the Exposure Draft are as follows:

Implications and practical challenges of the Exposure Draft

As flagged in our previous alert, while these changes are undoubtedly helpful and likely welcomed by industry, there remain a number of other Australian tax and duty considerations that may challenge investors (foreign or domestic) making BTR investments, including:

• stamp duty costs and other state-based foreign surcharges;
• the availability of input tax credits; and
• land tax liabilities and any attached premiums.

Additionally, there are some unanswered queries in relation to the specifics of certain mechanisms introduced under the Exposure Draft, which KWM expect to be resolved (to the extent possible) in subsequent Drafts. These include:

• 15-year limit: it is unclear why the MIT withholding rate concession only applies within the 15-year compliance period, i.e., no concessions are available after that period. This may limit the incentives for foreign investors to plan for such long-term investments, which would appear to be in line with the relevant policy objectives.
• Rental income only: the concessions only apply to fund payments to foreign residents in respect of rental income, i.e., any capital gains will not be subject to any concessional WHT rate (either during or after the 15-year period).
• No grandfathering for existing BTR investments: early investors in BTR investments (i.e., prior to 9 May 2023) will not be able to access any of these concessions. In addition to disadvantaging their early investment, the difference in tax concessions available may cause valuation-related and other administrative issues, particularly where ‘pre and post’ 9 May 2023 investments are held by the same investor group.
• The tests involved are stringent: 100% compliance must be maintained over 15 years, and there is no safe harbour or de minimis threshold (i.e., 1 non-compliant dwelling de-activates all concessions). There is also no way to ‘re-qualify’ once it ceases to be eligible – the entire development appears to be ineligible going forward for the relevant concessions, and all historic tax benefits must be paid back.  This latter requirement will be a significant practical challenge where upstream investors have changed over time, and ‘new’ investors may need to fund tax liabilities from periods before their investment. Following the final draft, investors and managers will need to consider the appropriate allocation of ‘misuse tax’ risk.
• Different owners and withholders: the Exposure Draft appears to facilitate scenarios in which the BTR development owner and the MIT making fund payments to foreign residents are different entities (a common structure). Part of that facilitation however is that the liability to pay for ‘withholding misuse’ will fall on the withholding MIT, which could have issues with obtaining funding in the 21 day period before the amounts are due.  Further to the point above, this practical issue may be accentuated where the risk relates to periods before ‘new’ investors may have entered the fund. 
• Single owner requirement: Treasury notes that the change (since the 2023 Budget announcement) with respect to the single ownership retention period (from 10 years to 15 years) reflects requirements in states and territories also applying a 15-year period in relation to certain BTR concessions. While this change is beneficial with respect to the longer term availability of the concessional MIT withholding rate, it may be considered unduly onerous particularly in terms of calculating misuse amounts.
• Clarity requirement on ownership reporting: as noted above, it should be clarified whether the single ownership requirement allows for underlying investors to change so long as, at all times, the BTR development is held by a single entity. Whilst the ‘single owner’ provisions only require that ‘dwellings are owned by a single entity’, it appears given the relevant reporting requirements that the provision would look through to underlying investors, in order to ensure consistency with the proposed notification requirements. 
• Affordable dwelling requirement: the requirement for 10% or more of the dwellings to be ‘affordable dwellings’ could create a significant compliance cost for developers, particularly to determine the relevant ‘market rate’ that applies. We suspect that the market rent will need to be determined throughout the 15-year compliance period.  However, it is unclear whether this is to be determined by reference to certain time periods (e.g., monthly, quarterly or annual).  

MITs and property investments

The proposed BTR amendments now sit among a number of complex provisions that provide for differing income tax outcomes or consequences where a MIT invests in certain property assets.  These include:

Consultation process

Treasury released the Exposure Draft together with Explanatory Materials and a Policy Fact Sheet. Submissions on the Exposure Draft were due by 22 April 2024.