The Federal Government recently announced concessional tax changes in the build-to-rent (BTR) sector, which together propose to offer a significant incentive for further investment in BTR projects, particularly by foreign investors. The relevant announcement is part of the Federal Government’s initiative to increase the supply of rental housing in Australia as part of the Federal Government’s ‘A Better Future for the Federation’ plan.
The announced changes include:
- reducing the withholding tax rate for managed investment trusts (MITs) from 30% to 15% in respect of certain ‘new’ BTR investments after 1 July 2024; and
- increasing the depreciation rate from 2.5% to 4% for certain new BTR projects commencing construction after 9 May 2023.
The announcement promises to significantly increase the commercial feasibility of investments by foreign investors, and consortiums including offshore investors, into the Australian BTR housing sector. Prior to these changes, foreign investors, who typically invest via MITs, generally had to pay an additional 15% of withholding tax in respect of income attributable to BTR investments.
We expect further details on the measures to be provided in the 2023-24 Federal Budget, to be announced on 9 May 2023.
We will continue tracking the proposed changes closely - for assistance with how these changes may impact you and future BTR projects in Australia, please feel free to reach out to one of the authors or your KWM contact.
What you need to know
- The changes appear to only apply on a prospective basis to new projects (the MIT-withholding rate changes appear to only apply to buildings constructed after 1 July 2024, while the increase in the depreciation rate applies only to buildings for which construction commenced after 9 May 2023);
- The proposed MIT-withholding tax change aligns the tax treatment of BTR investments by MITs with other commercial investments;
- There remains a number of other tax considerations for BTR projects to consider, such as foreign surcharges, land tax, stamp duty costs, and the unavailability of GST credits for construction costs; and
- Further details are likely to come on 9 May 2023 in the 2023-24 Federal Budget announcements.
We discuss these key points in more detail below.
Further details
Current withholding implications for MITs
Under the MIT final withholding tax regime, fund payments (i.e. distributions of the MIT’s net income excluding dividends, interest, royalties and certain capital gains or losses) made to foreign residents by qualifying ‘withholding MITs’ are generally subject to a special withholding tax regime. Under that regime, the rate of withholding is generally 15% where there is an ‘information exchange agreement’ with the foreign investor’s jurisdiction, unless:
- the fund payments are attributable to a ‘clean building MIT’, in which case a 10% withholding rate applies;
- the fund payments are attributable to ‘non-concessional MIT income’, in which case a 30% rate applies; or
- the foreign investor is tax resident in a jurisdiction without an information exchange agreement with Australia, in which case a 30% rate applies to all fund payments to that investor.
Income from residential BTR projects (to the extent it is not attributable to commercial premises that are part of the BTR development) are currently treated as ‘MIT residential housing income’, which is a type of ‘non-concessional MIT income’.
The implication of the withholding rate changes
The reduced withholding tax rate provides a significant concession to MITs looking to invest in the residential BTR sector, and harmonises the treatment of BTR developments with many commercial real estate developments. In short, BTR projects are now more likely to be commercially feasible for foreign investors investing in BTR developments via MITs, or indeed investment consortiums that include foreign investors. For Australian real estate investors, this could also widen the pool of potential co-investors able to support these projects. Australian investors, even in ‘wholly-Australian’ BTR investments, should also consider these changes given their capacity to materially increase the valuations that foreign investors may now place on BTR investments.
While these changes will be extremely welcome to an industry that has advocated for similar amendments since the Federal Government introduced the withholding tax rate of 30% for residential housing income in 2018/19, the ‘devil will be in the detail’ regarding the specific changes proposed to be implemented.
A key detail to be confirmed will be how eligible BTR investments will be statutorily defined under Subdivision 12-H of the Taxation Administration Act 1953 (Cth). We note that when the Labor Party first proposed a similar reduction in MIT withholding tax as a pre-2020 election promise, it indicated at the time that eligible BTR investments would include those that “are a passive investment held primarily for the purpose of deriving rent”. This is a term already used in tax legislation (for example, in the definition of “eligible investment business” under section 102M of the Income Tax Assessment Act 1936 (Cth)). However, of course, further detail will be required regarding exactly how this concept may be applied.
The following items will also require further consultation:
- the extent to which any pre-existing and under construction BTR developments may qualify under the concept of ‘new’ BTR properties; and
- whether any further qualifications will be placed on the concept of an ‘eligible’ fund payment that was flagged in the relevant announcement.
Increased deduction rate
Under the ‘capital works’ regime, the deduction or ‘depreciation’ of capital works (e.g. buildings and structural improvements) may occur at the rate of 2.5% or 4% depending on the type of capital works, nature of their use and when construction commenced. Generally, the deduction rate for capital works expenditure has been 2.5% every year for up to 40 years.
While the specific details of how the reform will be implemented is unclear, we suspect based on the wording on the announcement that it will involve relevant amendments to Division 43 to include eligible BTR developments as a specie of capital works to which the 4% rate can apply. However, similar to the above, further consultation will be required on how eligible BTR investments will be statutorily defined in the relevant provisions.
Whilst not changing the cash flow and accounting income profile of relevant investments, the increased rate of depreciation to 4% should further improve the tax profile of BTR investments and further incentivise the development of BTR projects in Australia.
Other potential relief for BTR development
While these changes are undoubtedly helpful and will be welcome by industry, there remain a number of other Australian tax and duty considerations that continue to disincentivise investors (foreign or domestic) from making BTR investments. For example, any investor considering a BTR investment would need to consider that:
- stamp duty costs are generally higher for residential land as opposed to commercial land; and
- input tax credits may not be available in relation to the construction costs of the project.
Although not strictly a disincentive relative to other forms of real estate developments, an investor would also need to consider, for example, that:
- state-based foreign surcharges may apply where the MIT is regarded as a “foreign person”; and
- significant land tax liabilities may arise depending on the premium attached to the relevant land.
What next?
Given the significant political pressure on all levels of government to do more to incentivise BTR housing development, we will continue closely monitor the prospect of reforms to the above that may further encourage capital allocation to the BTR sector.
Look out for our 2023-24 Federal Budget Report on 9 May 2023 for any further details on these proposed changes.
