Thinking about investing in Australia? Here's how the Federal Budget 2023-24 affects you

Using managed investment trusts to attract foreign investment into housing and certain commercial property

In an apparent reversal of the trend from previous Governments of tightening and restricting the availability of the managed investment trust (MIT) regime, the Budget announces measures to broaden its availability to new build-to-rent projects, as well as data centres and warehouses that meet relevant energy efficiency standards.

Data centres and warehouses

The clean building MIT withholding tax concession will now extend to data centres and warehouses. This measure will also raise the minimum energy efficiency requirements for existing and new clean buildings to a 6-star rating from the Green Building Council Australia or a 6-star rating under the National Australian Built Environment Rating System (NABERS).

Key dates: To be eligible, construction of new build-to-rent projects or data centres and warehouses must have commenced after 7:30pm (AEST) on 9 May 2023 (Budget night), with the reduced withholding rate applying from 1 July 2025.

Build-to-rent

The Government is encouraging the expansion of Australia's housing supply by:

• increasing the rate for the capital works tax deduction (depreciation) from 2.5% to 4% per year (same as hotels); and
• reducing the final withholding tax rate on eligible fund payments from MIT investments from 30% to 15%.

Broadly, eligible build-to-rent projects have the following features:

• consist of 50 or more apartments or dwellings made available for rent to the general public
• retention under single ownership for at least 10 years before they can be sold, and
• landlords must offer a lease term of at least 3 years for each dwelling.

Several details will be confirmed after further consultation, including any minimum proportion of dwellings that must be affordable tenancies.

These measures, together with other recent State-based concessions for build to rent projects (including land tax and stamp duty surcharge exemptions), will continue to make the build-to-rent asset class more appealing for foreign investment.

However, one of the biggest impediments to build-to-rent projects is the inability to recover input tax credits on construction costs, which has not been changed with these rules.

Key dates: construction of new build-to-rent projects must have commenced after 7:30pm (AEST) on 9 May 2023 (Budget night). The reduced withholding rate will apply from 1 July 2024 for build-to-rent projects.

More schemes captured by Australia's general anti-avoidance rule

Australia's general anti-avoidance rule (Part IVA) will soon capture schemes that:

• reduce tax paid in Australia by accessing a lower withholding tax rate on income paid to foreign residents; and
• achieve an Australian income tax benefit, but have the dominant purpose of reducing foreign (not Australian) income tax.

Both measures will apply to income years commencing on or after 1 July 2024, regardless of whether the scheme was entered into before that date. Importantly, both amendments have a retrospective element, so taxpayers should carefully assess their risk.

The lower rate of withholding tax

The current definition of "tax benefit" for Part IVA purposes explicitly captures schemes designed to avoid liability to withholding tax altogether, but not those merely designed to access a lower rate of withholding tax. This will change.

Part IVA will only apply to cancel tax benefits where the dominant purpose of the taxpayer is to obtain a tax benefit. Accordingly, while the withholding rate for interest payments is 10% and the withholding rate for unfranked dividends is 30%, significant commercial factors are likely to drive taxpayers' choices between equity and debt, which may serve to reduce the likelihood of the dominant purpose test being met.

A more likely angle might be "schemes" designed to access the MIT concessions and lower income tax amounts withheld when making certain payments to non-resident members. We understand the ATO recently flagged its concern that some trusts are not eligible for MIT status, and this targeted amendment may give the ATO a legislative fallback for schemes that – while ticking all the eligibility boxes – are artificial or contrived in nature. Time will tell.

Schemes that reduce a foreign tax liability

A "scheme" that reduces Australian tax, where the dominant purposes was directed at reducing a foreign tax liability, has generally not been captured by Part IVA. It has always been a high-risk argument for taxpayers to run because in succeeding in Australia, the taxpayer may invite significant exposure in another jurisdiction.

Now, however, the ATO will be able to cancel Australian tax benefits associated with schemes designed to obtain a foreign tax benefit. Given the tightening of the rules, the need for taxpayers to present compelling, objective evidence of local and global commercial drivers for transactions is heightened. A strong foreign tax driver will not be enough to escape the operation of Part IVA in Australia. Further, relief is not available under Australia's tax treaties where Part IVA applies, raising the stakes significantly.

Pillar II: implementing the 15% global minimum tax

The 2023-2024 Federal Budget announced Australia's implementation of Pillar II of the OECD Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitisation of the Economy. In addition to the Income Inclusion Rule (IIR) and Undertaxed Profits Rule (UTPR), Australia will also implement a domestic 15% minimum tax for certain entities. The goal is to ensure that wherever the income is derived, it will be subject to a rate of tax at least 15%.

From income years beginning on or after 1 January 2024, the IIR will apply to top up Australian headquartered multinationals, or foreign multinationals located in jurisdictions that have not implemented an IIR where there is income within the group that has not been subject to tax at 15%.

Supplementing this, from income years beginning on or after 1 January 2025, the UTPR will apply where no IIR applies to the group and will deny deductions in Australia to ensure that the Australian income is subject to tax at least at 15%.

To ensure that Australia does not lose out on revenue as Pillar II is implemented around the world, Australia has followed the lead of others such as the United Kingdom, the European Union, Singapore and Hong Kong (to name a few), and is implementing a domestic 15% tax rate. Without such a rule, income adjustments for lower taxed Australian income could have been subject to the IIR in other jurisdictions, thus foregoing the opportunity for additional revenue.

The measures will apply to multinational groups with annual global revenue of EUR 750 million. Although full details are not yet available, it is intended that certain sectors to which the measures will have particularly adverse application will be carved out, such as investment funds, pension funds, government entities, international organisations and not-for-profits.

The domestic minimum tax gives rise to franking credits, but consistent with OECD guidance, the IIR will not give rise to franking credits. At this stage it is unclear how the foreign income tax offset rules will interact with the measures.

These are complex measures, not just from a domestic implementation perspective, but also regarding their interaction with other foreign tax systems. It will be essential that those affected are given enough time to consult on the rules to assist to identify any inadvertent consequences, and then to have sufficient time to prepare for implementation of the complex rules.