Edited version of private ruling

Authorisation Number: 1011769123983

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Ruling

Subject: Income - solar feed-in tariff scheme

Question 1

Are payments you receive from your electricity retailer and provider (through your retailer) for the generation of electricity from a solar system assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are the costs associated with the solar system, such as depreciation and maintenance, deductible under section 8-1 or 8-5 of the ITAA 1997?

Answer

Yes, to the extent they are not capital or private or domestic in nature.

This ruling applies for the following period:

1 July 2010 to 30 June 2011.

1 July 2011 to 30 June 2012.

1 July 2012 to 30 June 2013.

1 July 2013 to 30 June 2014.

1 July 2014 to 30 June 2015.

1 July 2015 to 30 June 2016.

1 July 2016 to 30 June 2017.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it.

You and your spouse jointly own a residential property. The property is used for private residential purposes although your child uses part of an external structure to produce some income.

You installed a 2.5 kilowatt system on your home. The system has generated enough power to cover your electricity bills since then. You have been on a net metering system with your supplier and this type of metering allows some solar input to reduce your grid consumption without allowing you to determine how much usage has been altered.

The annual average power you have produced since installation has been greater than your household usage and therefore the grid-linked income you have generated has been slightly more than your usage costs.

In response to the state government's feed-in tariff you have increased the system by installing X kilowatts of extra capacity on a ground mounted system near the house.

You will now have a system of less than 10 kilowatts. You will be paid for all of the electricity that the system generates as you are now operating under a gross system. You will receive XX cents per kilowatt. You expect that the payment will be credited directly to your bank account periodically.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Section 6-10,

Income Tax Assessment Act 1997 Section 8-1,

Income Tax Assessment Act 1997 Section 8-5,

Income Tax Assessment Act 1997 Section 25-10 and

Income Tax Assessment Act 1997 Section 40-25.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Unless otherwise stated, all legislative references in the following Reasons For Decision relate to the Income Tax Assessment Act 1997 (ITAA 1997).

Summary

Based on the configuration of the solar system you have installed, the arrangement with your energy supplier/retailer and your estimated feed-in tariff payments, the arrangement is not private or domestic in nature. As a consequence:

· the payments you receive for the generation of electricity from the solar system are ordinary assessable income under section 6-5

· the costs you incur in relation to the generation of electricity from the solar system are deductible under section 8-1 to the extent that they are not capital or private or domestic in nature

· you are able to claim deductions in respect of the decline in value of the capital cost of the system because the solar system is used to produce assessable income, and

· the value of the right granted to you to create renewable energy certificates

(RECs) is an assessable recoupment and must also be included in your assessable income.

Potential capital gains tax and goods and services tax consequences may also apply but have not been addressed in this ruling.

Detailed reasoning

Assessable income

Assessable income is made up of ordinary income and statutory income. Section 6-10 provides that assessable income includes statutory income which constitutes amounts made assessable by specific statutory provisions. There are no specific legislative provisions relating to money or credits received from electricity suppliers therefore such amounts are not statutory income.

Subsection 6-5(1) defines ordinary income as income 'according to ordinary concepts'. Under subsection 6-5(2), the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources during the income year.

The tax legislation does not provide specific guidance on the meaning of income according to ordinary concepts. However, a substantial body of case law exists which identifies likely characteristics.

In determining whether an amount is ordinary income, the courts have established the following principles:

· what receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as a statute dictates otherwise

· whether the payment received is income depends upon a close examination of all relevant circumstances; and

· whether the payment received is income is an objective test.

Relevant factors in determining whether an amount is ordinary income include:

· whether the payment is the product of any employment, services rendered, or any business

· the quality or character of the payment in the hands of the recipient

· the form of the receipt, that is, whether it is received as a lump sum or periodically; and

· the motive of the person making the payment, but noting that this latter factor is rarely decisive, as a mix of motives may exist.

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1, the Full High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The whole of the circumstances must be considered.

Amounts that are periodical, regular or recurrent, relied upon by the recipient for their regular expenditure and paid to them for that purpose are likely to be ordinary income. In addition, receipts from property or investments that are on commercial terms and/or that indicate an intention to make a profit from an activity, are also likely to be ordinary income.

A solar system is considered to be the property of its owner. Receipts received in connection with it, therefore, are potentially assessable income. Consequently, it needs to be determined, in light of the nature and the circumstances of the receipt, whether the payments or credits received in return for transfer of electricity to the grid are income.

In determining whether or not the payments are assessable income, the factual circumstances, and in particular whether the receipts indicate an activity that is more than private or domestic in nature, need to be considered. The following are important:

· the terms of the arrangement with the electricity retailer and in particular any requirement on the retailer to buy all electricity that is generated from the system (as occurs under a gross feed in tariff scheme)

· the feed-in tariff payments and whether they are considered to represent a return on your investment in the solar system

· whether there is a realistic opportunity for you to profit from the arrangement, and

· the regularity of payments / credits received from the feed-in tariffs such that they can be relied upon.

Amounts that you receive as a recoupment of a deductible expense (that is the financial benefit arising from the RECs which offset the cost of the system) may potentially also be included in your assessable income. That issue will be discussed in greater detail below.

Deductions

The general provision that determines the deductibility of expenses is section 8-1. Under section 8-1 you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income. However you cannot deduct a loss or outgoing that is capital, private or domestic in nature.

Other provisions in the ITAA 1997 contain specific deductions which are made allowable by section 8-5. Examples of specific deductions include repairs under section 25-10 and deductions for the decline in value of depreciating assets under section 40-25.

Repairs and Maintenance

Under section 25-10 you can deduct expenditure you incur in respect of repairs and maintenance to the solar system. That is because the expense is incurred in deriving assessable income from the system.

Under subsection 25-10(3) expenditure incurred for repairs is not deductible if it is of a capital nature. For further information regarding the deductibility of repairs see Taxation Ruling TR 97/23 Income tax: deductions for repairs.

Decline in value

For assets that are capital in nature, you cannot claim deductions under section 8-1. Instead, under the capital allowances system you may be able to claim deductions for the decline in value of the cost of a capital asset used in gaining your assessable income. You can deduct the decline in value of the capital cost of your solar system where it is used in gaining your assessable income.

Under section 40-25, each income year you can deduct an amount equal to the decline in value of a depreciating asset that you hold. A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time that it is used. Where it is used in producing assessable income a solar system would fall into that category.

You must reduce any applicable deduction by the part of the asset's decline in value that is attributable to your use of the asset for a purpose other than a taxable purpose. The purpose of producing assessable income is a taxable purpose but private usage is not.

A solar system comprises modules of photovoltaic cells, a roof mounting frame, various fixings, electrical wiring and conduits and inverters. The entire solar system is considered to be a single depreciating asset and would be depreciated accordingly.

Taxation Ruling TR 2010/2 Income tax: effective life of depreciating assets provides a table listing the effective life of depreciating assets. In accordance with TR 2010/2 the effective life of solar power generating system assets that are on residential property is twenty years.

Generally speaking, the cost of a solar system is those amounts which you are taken to have paid to hold the solar system, such as the purchase price and its associated installation and connection costs. It is worked out as at the time that you begin to hold the solar system; in other words, when it is installed and ready for use. The cost also generally includes amounts you pay over time to maintain its condition.

For more information on determining the decline in value of your solar system, you should refer to the Guide to depreciating assets 2009-10.

Assessable recoupments

Under Subdivision 20-A, your assessable income may include an amount which you receive by way of insurance, indemnity or other recoupment if it is for a deductible expense and it is not otherwise assessable income. This provision needs to be considered where your solar system produces assessable income and you incur a loss or outgoing (i.e. expense) in respect of installing and owning that system.

Under the Renewable Energy (Electricity) Act 2000 (REE Act), if you install an eligible solar system on your private residence, you have a statutory right to create RECs after the system is installed. You can assign that right to another person, for example the installer of the system, or you may create the RECs and sell them on the market.

Assigning the right to create RECs to another entity (such as the installer) is considered to result in a financial benefit to you. Effectively, the financial benefit is the reduction in the amount which you would otherwise pay for the purchase and installation of the solar system. In effect that reduction is the price discount which the installer offers you in return for surrendering the RECs to them.

The RECs are effectively a financial incentive given to you to purchase the system. The amounts received in respect of the RECs are considered to be an indemnity (and therefore a recoupment) as they satisfy a statutory obligation under the REE Act to partially compensate you for the cost to install and own the solar system. Where you can deduct an amount for the decline in value of the solar system under Division 40 (as outlined above) the recouped amount in respect of the RECs is an assessable recoupment.

Where the cost of the solar system is deductible under Division 40 over several income years, the total assessable recoupment included in a particular year is the amount of the deduction for the loss or outgoing in that year. Any part of the assessable recoupment that is not included in assessable income in the year it is received is assessable in later income years until it has been fully accounted for.

By way of clarification, consider the following example:

On 1 July 2009, a taxpayer installed on the roof of his private residence a 10 kilowatt solar system costing $60,000. He received the right to create RECs to the value of $12,000. He assigned them to the installer, resulting in a reduction in the price paid for the solar system to $48,000.

The taxpayer claims the decline in value of his solar system using the prime cost method and an effective life of twenty years. He can claim a deduction for decline in value of the system of $3,000 for the 2009-10 income year and each of the following 19 income years (being $60,000 /20).

He received the right to RECs to the value of $12,000 and that is considered to be an assessable recoupment. As his deduction for decline in value of the system is $3,000 each year, he will include an assessable recoupment of $3,000 each year in his assessable income for the first four income years. The total value of the RECs will then be fully recouped. In subsequent years, the deduction can still be claimed but with no off-setting recoupment.

Taxation Determination TD 2006/31 deals with recoupments for rebates received for the purchase of a depreciating asset for use in a rental property. It provides further guidance on how the recoupment provisions operate in relation to depreciating assets. In addition ATO ID 2010/218 discusses when the right to create RECs is an assessable recoupment, again in the context of rental properties.

Application to your situation

Under the gross feed-in tariff scheme operating in your state and as described in your ruling application, the electricity company credits or pays a premium feed-in tariff to you for all electricity generated and contributed to the electricity grid. You then separately buy electricity from the company according to your consumption. Payment for the electricity generated is distinct from and unrelated to the amount of electricity consumed. The rate paid by you for electricity consumed is the same as that applied to any other householder in your state.

In your case, you have stated that you will receive a payment provided under an arrangement between yourself and the relevant electricity company. You have already received a payment by cheque and expect further regular payments by cheque. The value of electricity that you will produce and be paid for is not related to the amount of electricity you consume.

Based on your factual situation, it is considered that all of the payments received for your electricity generated and sold to the electricity company are assessable income because:

· The electricity retailer is required to buy all electricity that is generated from the system under the gross feed in tariff scheme.

The feed-in tariff payments are considered to represent a return on your investment in the solar system.

There is a realistic opportunity for you to profit from the arrangement.

The payments from the feed-in tariffs are received regularly and can be relied upon, including to meet regular household electricity expenditure.

The arrangement is not of a private or domestic nature because the solar system does not provide electricity to your private residence. Instead, all electricity produced is exported back to the grid. You then buy back electricity to meet your own electricity needs.

As the payments received for the electricity generated to the electricity grid are assessable income, the expenditure incurred in producing the income from the sale of the electricity would be deductible. You may be entitled to deductions for the installation and operating expenses of the solar system, such as for:

· repairs and maintenance of the solar system; and

· decline in value of the solar system based on 20 year effective life.

In cases where the purchase price of the solar system installation was reduced because you assigned to the installer your right to create RECs, the grant of the right to create the certificates is an assessable recoupment. That is because it is considered to be a grant in respect of a loss or outgoing and you can deduct an amount for that loss or outgoing.

The amount by which the cost of the system is reduced because of the assignment is the value of the assessable recoupment. The amount of the assessable recoupment is applied to reverse the effect of a deduction for decline in value of the full cost of the solar system. The assessable recoupment will reduce such allowable deductions for a certain number of years, that period being determined by the original cost of the system and the annual amount of the deductions.

Please note that this ruling does not consider the issues relating to any potential capital gains tax or goods and services tax consequences.

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