Edited version of your private ruling

Authorisation Number: 1012063721039

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Ruling

Subject: Income tax: Interest and decline in value

Question 1

Can you claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the ongoing interest expense in relation to the small electricity generation unit (SEGU)?

Answer

Yes.

Question 2

Can you claim a deduction under section 40-25 of the ITAA 1997 for the decline in value of the SEGU?

Answer

Yes.

Question 3

If the termination value of the SEGU is less than its adjustable value just before the SEGU became inoperable, can you claim a deduction for the difference between these amounts under subsection 40-285(2) of the ITAA 1997?

Answer

Yes.

Question 4

Can you claim a deduction for the cost of dismantling the SEGU?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You entered into a contract to purchase an SEGU for the purpose of generating electricity to sell into the national electricity grid.

The site was inspected by the supplier who suggested that you remove a number of trees to optimise the efficiency of the SEGU. You removed the trees as instructed.

The supplier represented to you that the SEGU would generate a certain amount of power over a number of years and estimated that a certain amount would have been received by you annually.

The SEGU was recently installed and commissioned.

The SEGU did not live up to expectation and only generated a small amount of electricity.

You requested that the supplier either:

§ remove the SEGU and refund your money

§ replace the SEGU with an equivalent solar system

§ repair all existing defects in the existing SEGU so that it operated in accordance with quoted capacity.

There was a considerable amount of correspondence regarding the issues, and the supplier eventually issued a notice that it was placed into liquidation and that there were safety concerns.

A defect notice was issued on the SEGU.

The provisional liquidators report noted that warranty claims are likely to exceed the net assets of the company. You will include any amounts received from the liquidation or scrap dealers in your assessable income.

The property on which the SEGU is located is used for business and private residential purposes.

The SEGU feeds directly in to the grid and is not used as a domestic off-set.

The eligibility for the feed-in tariff is not linked to the consumption of electricity.

None of the electricity is consumed domestically.

The feed-in tariff rate for the SEGU is 60c/kW hour.

The payment is based on all of the electricity generated by the SEGU.

The feed-in tariff payment would have been made by direct payment to you.

You obtained a loan to pay for the SEGU and you are paying interest on this loan. You will not be paying the loan out early following the dismantling of the SEGU as you can not afford to do so.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 40-25

Income Tax Assessment Act 1997 Section 40-30

Income Tax Assessment Act 1997 Subsection 40-45(2)

Income Tax Assessment Act 1997 Paragraph 40-190(2)(b)

Income Tax Assessment Act 1997 Subsection 40-285(2)

Income Tax Assessment Act 1997 Paragraph 40-295(1)(b)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(a)

Income Tax Assessment Act 1997 Subsection 43-10(1)

Income Tax Assessment Act 1997 Subsection 995-1(1)

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 of the ITAA 1936 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

Question 1

Interest 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 can not deduct a loss or outgoing that is capital, private or domestic in nature.

Under section 8-1 of the ITAA 1997 you can deduct interest expenses you incurred in financing the acquisition and installation of the SEGU if you incur the expense in deriving assessable income from the system.

You can not deduct interest expenses relating to a private residence (such as in relation to a home loan) on which the system is fixed. Expenses associated with your home are usually of a private or domestic nature and do not qualify as deductions for taxation purposes.

Taxation Ruling TR 95/33 considers the deductibility and apportionment of losses and outgoings where expenses are incurred for dual purposes. TR 95/33 states that if an outgoing produces an amount of assessable income greater than the amount of the outgoing, there would normally be no need to examine the taxpayer's motives and intentions when determining the deductibility of the expenditure.

However, if the outgoing produces no assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure to determine whether the outgoing is wholly deductible. This may, depending on the circumstances of the particular case, include an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing.

If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective (for example, to derive exempt income or the obtaining of a tax deduction), then the outgoing must be apportioned between the pursuit of assessable income and the other objective: see Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613.

The Commissioner's view on whether interest deductions are allowable after the cessation of the relevant income producing activity is outlined in Taxation Ruling TR 2004/4.

Paragraph 10 of TR 2004/4 states that where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and the relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing the assessable income if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period.

Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgement about the nexus between the outgoing and the income earning activities.

Where the taxpayer has the legal power to repay the loan and hence avoid ongoing liabilities, the nexus will continue until a time at which it can be inferred that:

§ the taxpayer has kept the loan on foot for reasons unassociated with the former income earning activities, or

§ the taxpayer has made a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred,

the nexus between the outgoings of interest and the relevant income earning activities will be broken.

Assessable income

Under section 6-5 of the ITAA 1997 assessable income is made up of ordinary income and statutory income. There are no specific legislative provisions relating to money or credits received from electricity suppliers, therefore it is not statutory income.

Under subsection 6-5(1) of the ITAA 1997 ordinary income means 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 you 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 (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. However, receipts that indicate the arrangement is private or domestic in nature are not likely to be ordinary income.

In this instance, it needs to be determined whether any payments or credits received in return for transfer of electricity to the grid are income because of the nature and the circumstances of the receipt. In determining whether any receipts are 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. Some guidance in the context of rental properties is contained in Taxation Ruling IT 2167, which outlines the circumstances when amounts received will be considered income and when they will be considered to be in the nature of family or domestic arrangements.

A SEGU is considered to be property and receipts in connection with it are potentially assessable income. In determining whether or not the payments are assessable income the following are important:

§ the size of the SEGU

§ the terms of the arrangement with the electricity retailer and in particular whether the SEGU:

o is configured into the electricity system of the home - the SEGU first supplies electricity to the home to satisfy household electricity consumption before exporting excess electricity to the grid (referred to as a 'net' scheme), or

o exports all electricity to the grid (referred to as a 'gross' scheme).

§ the feed-in tariff payments and whether they are considered to represent a return on your investment in the SEGU

§ 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 on.

Application to your situation

The relevant factors to be considered in your case are:

§ You would have received a direct payment based on all of the electricity generated by the SEGU.

§ The feed-in tariff rate is 60 cents per kW hour.

§ The SEGU feeds directly in to the grid and is not used as a domestic off-set, that is, none of the electricity is consumed domestically.

§ The estimated annual payment which you would have received.

Based on your factual circumstances, it is considered that the regular payments which would have been received by you would have been in the nature of ordinary income. The scheme is not of a private or domestic nature and there was a realistic opportunity for you to profit from the arrangement.

Consequently, the payments which would have been received by you for your electricity generated and sold to the electricity grid would be considered to be assessable income. As a result, any expenditure, including interest, incurred in producing the receipts from the sale of the electricity generated to the electricity grid is deductible.

There does not appear to be a dual purpose in this case which would require apportionment of any interest expenses.

There is also no indication in this case that the loan in relation to the SEGU is to be kept on foot for reasons unassociated with the former income earning activity or for an ongoing commercial advantage. You will not be paying the loan out early following the dismantling of the SEGU as you can not afford to do so.

Any interest expenses incurred following the cessation of the income earning activity would therefore also continue to be deductible as the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period, that is, the erection of the SEGU for the purpose of gaining or producing assessable income.

The interest expense in relation to the SEGU is therefore deductible under section 8-1 of the ITAA 1997.

Question 2

Under Division 40 of the ITAA 1997, you may be entitled to a deduction equal to the decline in value of a depreciating asset that is used during the income year for a taxable purpose (section 40-25 of the ITAA 1997).

This Division applies to an improvement to land, or a fixture on land, whether the improvement or fixture is removable or not, as if it were an asset separate from the land (subsection 40-30(3) of the ITAA 1997).

Section 40-30 of the ITAA 1997 defines a depreciating asset as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. If the asset is used for only part of the year, any deduction should be apportioned on a pro-rata basis.

Subsection 40-45(2) of the ITAA 1997 prevents deductions that are available as capital works from being deductible under Division 40 of the ITAA 1997. The deductibility of expenditure incurred in relation to capital works is determined under Division 43 of the ITAA 1997.

Subsection 43-10(1) of the ITAA 1997 allows you to deduct capital expenditure incurred in constructing capital works, including buildings and structural improvements.

Application to your circumstances

The SEGU would decline in value over time and is considered to be a depreciating asset under subsection 40-30(3) of the ITAA 1997. It is not a building or structural improvement for the purposes of Division 43 of the ITAA 1997. Taxation Ruling TR 2011/2 provides an effective life for the SEGU.

A taxable purpose includes the purpose of producing assessable income (subsection 40-25(7) of the ITAA 1997). Something is done for the purpose of producing assessable income if it is done for the purpose of gaining or producing assessable income or in carrying on a business for the purpose of gaining or producing assessable income (subsection 995-1(1) of the ITAA 1997). We have determined above that the SEGU was erected for the purpose of gaining or producing assessable income.

The SEGU is therefore a depreciating asset which was used for a taxable purpose. You will therefore be able to claim a deduction under section 40-25 of the ITAA 1997 for the decline in value of the SEGU.

Question 3

Subsection 40-285(2) of the ITAA 1997 provides that you can deduct an amount if:

(a) a balancing adjustment event occurs for a depreciating asset you held and:

(i) whose decline in value you worked out under Subdivision 40-B of the ITAA 1997, or

(ii) whose decline in value you would have worked out under that Subdivision if you had used the asset, and

(b) the asset's termination value is less than its adjustable value just before the event occurred.

Paragraph 40-295(1)(b) of the ITAA 1997 provides that a balancing adjustment event occurs for a depreciating asset if you stop using it, or having it installed ready for use, for any purpose and you expect never to use it, or have it installed ready for use, again.

In your case, the SEGU has been used to generate an amount of electricity and you consider that the SEGU could become inoperable and be dismantled. If this were to occur, a balancing adjustment event under paragraph 40-295(1)(b) of the ITAA 1997 would happen.

In view of the above determination for question 2, you would be working out the decline in value of the SEGU under Subdivision 40-B of the ITAA 1997. You will therefore be able to deduct an amount under subsection 40-285(2) of the ITAA 1997 if the termination value of the SEGU is less than its adjustable value just before the event occurred. The amount you can deduct is the difference between those amounts, and you can deduct it for the income year in which the balancing adjustment occurred.

Question 4

The cost of dismantling the SEGU is an expense of a capital nature. As discussed above for question 1, you can not deduct a loss or outgoing of a capital nature under section 8-1 of the ITAA 1997. Such an expense is also not deductible under the blackhole expenditure provisions in Subdivision 40-I of the ITAA 1997 as paragraph 40-880(5)(a) of the ITAA 1997 provides that no amount is deductible to the extent that it forms part of the cost of a depreciating asset that you hold, used to hold or will hold (see Note below in this regard).

As there is no other provision in the ITAA which would allow you to deduct the cost of the dismantling of the SEGU, you will not be able to claim a deduction for this cost.

Note

The cost of a depreciating asset consists of two elements. Paragraph 40-190(2)(b) of the ITAA 1997 provides that the second element of cost includes expenditure you incur that is reasonably attributable to a balancing adjustment event occurring for the asset.

As the cost of dismantling the SEGU can be reasonably attributable to the balancing adjustment event discussed above in question 3, the cost of the dismantling would be included in the second element of the cost of the SEGU.

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