Edited version of private ruling

Authorisation Number: 1011837750318

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Income - solar power - small business entity

Question 1:

Are payments you receive from your electricity 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 interest and maintenance, deductible under section 8-1 of the ITAA 1997?

Answer:

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

Question 3:

Does the solar system qualify as a depreciating asset that can be allocated to the general small business pool under section 328-185 of the ITAA 1997 and allow a deduction to be claimed under Division 328 of the ITAA 1997?

Answer:

Yes, to the extent that the solar system is used for a taxable purpose.

This ruling applies for the following periods:

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

You are a sole trader. You purchased a photovoltaic solar system. The system has been installed on the roof of one of the buildings on the property. You carry on your activities on the property including primary production. There is also a residential building that is tenanted.

The system will feed electricity produced by the solar panels into the electricity grid in return for the electricity retailer paying you a feed-in tariff.

You are eligible to participate in a gross solar feed-in tariff scheme (the scheme).

Under the scheme, your electricity retailer will be required to buy all electricity that the system generates at a gross feed-in tariff rate per kilowatt hour generated. You will enter into a contract under which you will be paid for the electricity generated by your electricity retailer.

You will receive the credits/payments from the electricity provider for the electricity generated from the solar panels.

You plan to declare the income that the solar system generates and then claim deductions for the business use of the electricity.

The system is an eligible small generation unit (SGU) for the purposes of the Renewable Energy (Electricity) Act 2000 (REE Act).

The REE Act supports the Federal Government's Renewable Energy Target (RET) scheme which was established to encourage additional electricity generation from renewable energy sources.

Upon ownership and installation of a SGU a statutory right arises under the REE Act entitling you to create Renewable Energy Certificates (RECs).

As provided for under the RET scheme, you are able to enter into an agreement with the installer of the solar system, who is an agent for the purposes of the REE Act, and assign your right to create RECs to the installer in return for a financial benefit. The financial benefit is effectively the reduction in the amount you would pay for the purchase and installation of the solar system. The reduction reflects the value of the right to create RECs that you may assign to the installer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Subsection 6-5(4)

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 8-5

Income Tax Assessment Act 1997 Section 328-175

Income Tax Assessment Act 1997 Section 328-185

Income Tax Assessment Act 1997 Subsection 25-10(3)

Income Tax Assessment Act 1997 Section 40-25

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 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 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

Summary

Based on the configuration of the system you will install, the arrangement with your energy retailer for the feed-in tariff payments, and the fact that the property is used for business use, the arrangement is other than private or domestic in nature. That being so;

· the payments/credits received for the generation of electricity from the solar system are ordinary assessable income under section 6-5 of the ITAA 1997

· the costs that are incurred in relation to the generation of electricity from the solar system are deductible under section 8-1 of the ITAA 1997 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 under the simplified depreciation rules because the solar system is used to produce assessable income and you are a small business entity, and

· the value of the right granted to you to create 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 under section 6-5 of the ITAA 1997 and statutory income under section 6-10 of the ITAA 1997. Section 6-10 of the ITAA 1997 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) of the ITAA 1997 defines ordinary income as income 'according to ordinary concepts'. Under subsection 6-5(2) of the ITAA 1997, the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources during the income year.

Under subsection 6-5(4) of the ITAA 1997 in working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

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 ,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 as a result of employing that asset, therefore, are potentially assessable income to the owner. Consequently, it needs to be determined whether the payments or credits received in return for transfer of electricity to the grid are income because they represent a financial return from the investment in the solar system.

The factual circumstances, and in particular whether the receipts represent activity which is more than private or domestic in nature, need to be considered in determining whether or not the receipts are income. The following are important:

· the terms of the arrangement with the electricity retailer in particular any requirement on the retailer to buy all electricity generated from the system

· 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 of the ITAA 1997. Under section 8-1 of the ITAA 1997 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 section 8-5 of the ITAA 1997 allows you to deduct. Examples of specific deductions include repairs under section 25-10 of the ITAA 1997 and deductions for depreciating assets under section 40-25 of the ITAA 1997.

Interest

Under section 8-1 of the ITAA 1997 you can deduct interest expenses you incurred in financing the acquisition and installation of the solar system on your private residence as you incur the expense in deriving assessable income from the system.

Repairs and Maintenance

Under section 25-10 of the ITAA 1997 you can deduct expenditure you incur for repairs and maintenance to the solar system as you incur the expense in deriving assessable income from the system.

A repair involves restoring the efficiency of function of the property being repaired without changing its character. A repair may improve to some extent the condition the property was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10 of the ITAA 1997. In addition, under subsection 25-10(3) of the ITAA 1997 expenditure incurred for repairs is not deductible if it is of a capital nature. For further information see Taxation Ruling TR 97/23 Income Tax: deductions for repairs.

Decline in value - Division 40 of the ITAA 1997

For assets that are capital in nature, you cannot claim deductions under section 8-1 of the ITAA 1997. Instead, under the capital allowances system you may be able to claim a deduction for the decline in value of the cost of a capital asset used in gaining your assessable income.

Under section 40-25 of the ITAA 1997 you can deduct an amount equal to the decline in value for an income year 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.

A solar system, also known as a photovoltaic 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.

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 on residential property is 20 years.

Simplified depreciation rules

If you are a small business entity, you can choose to deduct amounts for most of your depreciating assets on a diminishing value basis using a pool that is treated as a single depreciating asset. Such a choice would be instead of making a claim under Division 40 of the ITAA 1997 as detailed above.

Broadly, a pool is made up of the costs of the depreciating assets that are allocated to it or, in some cases, a proportion of those costs.

The pool rate is 30% for most depreciating assets, and 5% for depreciating assets that have an effective life of 25 years or more.

Section 328-175 of the ITAA 1997 allows small business entities to choose to calculate deductions and some amounts of assessable income under Subdivision 328-D of the ITAA 1997 instead of Division 40 of the ITAA 1997 in relation to depreciating assets that they hold and they use or have installed ready for use during or before that income year.

Depreciating assets costing more than $1,000 with an effective life of less than 25 years, can be allocated to the general small business pool, section 328-185 of the ITAA 1997. For assets allocated to the general small business pool, the depreciation rate is 30%.

In calculating a deduction using this method you must also take into account your taxable purpose proportion. That is, the small business entity must make a reasonable estimate for that year of the proportion they will use the asset for a taxable purpose. The asset's cost does not include any amount that can be claimed as a GST credit.

See the enclosed information on the Simplified depreciation rules.

Assessable recoupments

Under Subdivision 20-A of the ITAA 1997, 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 (that is, expense) in respect of installing and owning that system.

Under the 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 of the ITAA 1997 (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 of the ITAA 1997 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 (i.e. $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 required.

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 feed-in tariff scheme and as described in your ruling application, the electricity company credits or pays a premium feed-in tariff to the electricity account holder for all electricity generated and contributed to the electricity grid. The electricity account holder then buys back electricity from the company according to their consumption. Payment for the electricity generated is separate and not related to the amount of electricity consumed. The rate paid by the electricity account holder for electricity consumed is the same as that available to any other electricity account holder.

In your case, you will receive a payment provided under an arrangement between yourself and the relevant electricity company. The payment will be made under a gross metering tariff scheme. You will receive the payment as a direct credit to your electricity account. The value of electricity that you will produce and be paid for is not related to the amount of electricity that is used for business and private purposes. You expect to receive payments/credits regularly, generally quarterly.

Having regard to all of the facts, it is considered that your solar system installation amounts to an arrangement which is not private or domestic in nature because:

The solar system will be installed on a property which is currently used to derive assessable income.

The electricity retailer will pay a premium feed in tariff per kilowatt hour for any excess electricity that you generate.

The arrangement is commercial in nature; an agreement has been created.

There is a realistic opportunity to profit from the arrangement even if no profit is actually made in any particular period

As the payments received for the electricity generated are assessable income the expenditure incurred in producing the income from the sale of the electricity generated to the electricity grid would be deductible.

You may be entitled to deductions for the operating expense of the solar system installation, such as:

decline in value of the solar system based on 20 year effective life under Division 40 of the ITAA 1997 or under the simplified depreciation rules for small business in Subdivision 328-D of the ITAA 1997

· interest on the borrowings to acquire the solar system, and

· repairs and maintenance of the solar system.

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 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.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).