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Ruling

Subject: Tax consequences of installing a solar system on a residential property.

Question 1

Would the generation of electricity from a solar system (the solar system) on your property amount to the carrying on of a business?

Answer

No.

Question 2

Would payments received from your electricity retailer for the generation of electricity from a solar system be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 3

Are the costs associated with the solar system, such as maintenance and depreciation, 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.

Question 4

Is the discount received on the purchase price of the solar system for the assignment of the Renewable Energy Certificates (RECs) considered assessable income?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You acquired a large solar system which you installed on your property. Due to the size of the system you installed a small number of solar panels on your house, and the remaining solar panels on the property (vacant land).

The State Government provides for a net feed-in tariff solar scheme (the scheme). Under the scheme, owners of eligible renewable energy systems are paid x cents per kilowatt hour for energy exported to the grid that is in excess of the household consumption at the time of generation.

Based on the latest electricity account you provided, you consumed xkWh of electricity. The system generated a net amount of xkWh of electricity.

On your latest electricity account the retailer added a net credit amount, after your electricity consumption expense (including other miscellaneous expenses) was subtracted from the electricity generated by the system.

This credit, and future credits for electricity generated, may be applied to offset your future electricity expenses. Alternatively you may be able to receive a separate direct payment either by cheque or direct deposit into a bank account from your energy retailer.

Based on the generation and consumption figures provided, you could receive a large amount of income per year from your electricity retailer through the feed-in tariff rate.

You are billed for your electricity consumption in the same manner as any other retail electricity customer in your state.

The solar 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 RECs.

As provided for under the RET scheme, the right to create RECs were assigned to the installer in return for a discount on the purchase price of the solar system. You received a large sum of money in return for assigning the right to create the RECs.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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 6-10

Income Tax Assessment Act 1997 section 20-25

Income Tax Assessment Act 1997 subsection 20-25(1)

Income Tax Assessment Act 1997 paragraph 20–25(1)(b)

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 section 20-40

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 section 40-25

Reasons for decision

Question 1

Summary

Based on the facts provided, you would not be considered to be carrying on a business by receiving payments or credits for the export of excess electricity generated from the solar system.

Detailed reasoning

Carrying on a business

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators to determine the matter, these indicators are summarised in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production. These indicators are applicable to business activity generally, relevant indicators include:

· the size, scale and permanency of the activity.

· whether there is repetition and regularity of the activity, and

· whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business.

Size, scale and permanency of the activity

The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business. However the size or scale of the activity is not a determinative test and a person may carry on a business though in a small way.

In your case the activity involves the installation and operation of the solar system. Once the solar system is installed no more work other than occasional maintenance is required to operate it. The size and scale of the operation is very small.

A smaller scale of activity usually detracts from the commercial purpose or character of the activities, for example the activity may more properly be described as the management of a capital investment rather than the carrying on of a business.

This factor alone is not conclusive. The smaller the scale of the activity the more important the other indicators become when deciding whether a taxpayer is carrying on a business.

Whether there is repetition and regularity of the activity

It is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business. TR 97/11 refers to Hope v. The Council of the City of Bathurst (1980) 144 CLR 1, 80 ATC 4386, (1980) 12 ATR 231 where 'the transactions were entered into on a continuous and repetitive basis', such that the taxpayer's activities 'manifested the essential characteristics required of a business'.

In your case the measurement of and payments for the electricity generation are the responsibility of the energy retailer. There is little repetition and regularity in terms of action required for the activity. This factor must be considered together with the other relevant indicators.

Whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

The activities of a taxpayer are more likely to be a business when carried on in a manner similar to that in which other participants in the same industry carry on their activities.

The factors below, set out at paragraph 64 of TR 97/11, are used to compare the characteristics of others engaged in the same type of business:

· the volume of sales, if there is a small number of sales it is less likely that a business is being carried on

· the types of customers the taxpayer sells their product to - wholesalers, retailers, the public at large, or friends or relatives - and the manner in which this marketing takes place

· the sort of expenses incurred by the taxpayer, and

· the amount invested in capital items.

Application to your situation

You expect to generate recurring receipts from the energy retailer. The major expense you will incur is the cost and installation of the system. There will be no significant operating costs.

You will have a single customer. There would be a contract agreement in place, however, you would not be required to meet or maintain a certain supply level, rather you would merely sell back the amount of electricity the system generates that is in excess of domestic requirements.

A business of electricity generation would usually be expected to produce and maintain certain amounts of electricity and meet certain levels of demand. It would also require a larger scale of production to ensure they were able to manage demand levels. It could not be said that your activity is alike to an ordinary business of solar electricity generation.

From a consideration of the factors above the activity would not amount to the carrying on of a business. The size and scale of the activity is small, there is little repetition and regularity in the activity and the activity when compared to an ordinary business of electricity generation could not be said to be similar. As a result you would not be considered to be carrying on a business by receiving payments for the export of electricity generated from a solar system.

Question 2, 3 and 4

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

· 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 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

· 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

· 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 at 4420; (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

· 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 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 2012/2 Income tax: effective life of depreciating assets provides a table listing the effective life of depreciating assets. In accordance with TR 2012/2 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 2011-12 which is available from www.ato.gov.au.

Apportionment of deductions for private and domestic usage

A net feed in tariff scheme is configured into the electricity system of the home - the solar system first supplies electricity to the home to satisfy household electricity consumption before exporting excess electricity to the grid. Where income received under a net feed in tariff scheme is assessable, any expenses incurred in generating the assessable income will need to be apportioned to take into account expenses incurred for electricity generated for private and domestic purposes. For example, one method to apportion will be to reduce the deduction by the percentage of electricity consumed by the household divided by total electricity generated by the system.

Assessable recoupment

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 (ie 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 (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 financial year and each of the following 19 financial 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 Interpretative Decision 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 scheme operating in your state you would receive credits whenever your electricity generation exceeds your household consumption at intervals during the day, as recorded by your meter. The credit will be applied to your electricity account. After a period, you may be able to make arrangements with the retailer to be paid out for any remaining credits on your account.

The scheme is connected with the electricity needs of the householder as:

· the solar system is configured into the electricity system of the home, and

· the solar system primarily supplies electricity to the home and satisfies the electricity consumption of the householder before exporting excess electricity to the grid.

However based on your factual circumstances, it is considered that the credits you would receive on your electricity account (or payment for credits) are ordinary income because:

the scheme is more than private or domestic nature, this being demonstrated by

· the size of the system you have chosen to install is quite sizeable and has a capacity in excess of the needs of a typical household

· the amount of electricity generated by the system being significantly greater than the domestic consumption requirements of your household. In particular:

· you expect to generate excess electricity from the solar system. Only a small portion will be used for personal consumption in your private residence, the excess will be transferred to the electricity grid

· the credits you would receive for excess electricity do more than offset the cost of your electricity and represent a return on investment for the system, and

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

Consequently, any credits (and payment of credits) received for the electricity generated by the solar system and sold to the electricity grid would be considered to be assessable income.

However, if there were a decrease in the size or scale of the activity in which you engaged in, or a decrease in the payments / credits received or the regularity of the payments, this might indicate the payments were not ordinary income and therefore not assessable.

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 to the extent it were not private or domestic in nature. 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

· decline in value of the solar system based on twenty year effective life or some other effective life you have determined for the solar system in accordance with TR 2012/2 and the Guide to depreciating assets 2012).

You would be required to apportion your deductions to take into account expenses incurred in generating electricity consumed by your household, as this will have a private and domestic character. For more information on deductions and apportionment you can refer to TaxPack 2012 and the Guide to depreciating assets 2012.

This ruling does not consider the issues relating to any potential capital gains tax or goods and services tax consequences.

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