Edited version of private ruling

Authorisation Number: 1011659307333

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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 of the ITAA 1997?

Answer

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

Question 3

If the payments are assessable income under section 6-5 of the ITAA 1997 is the income assessable to the person who enters into the feed-in payment contract rather than the owner of the premises?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on:

1 July 2010

Relevant facts

You are considering acquiring and installing a specific size photovoltaic system ('solar system') on the roof of your private residence.

The legal title to these premises is held by you and your spouse as joint tenants.

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

Under the scheme, your electricity retailer will be required to buy all electricity that the solar system generates at a gross feed-in tariff rate per kilowatt hour. You will enter into a contract in your name only under which you will be paid per kilowatt hour for electricity generated by the network provider through your electricity retailer. Your retailer will pay you an additional payment per kilowatt hour for electricity generated.

You will receive this as a separate payment as a direct payment either by cheque or direct deposit into a bank account from your energy retailer.

The frequency of the payment will depend on your arrangement with your electricity retailer, but it is expected that you will be paid quarterly. The scheme will operate for a number of years.

You have provided an estimate of the payment you expect to receive from your electricity retailer through the feed-in tariff rate. Your eligibility for the feed-in tariff is not linked to your consumption of electricity.

You have provided an estimate of the amount of electricity that you would consume for your personal use per year. You are billed for your electricity consumption in the usual way.

The electricity account is held in your name only.

You will purchase the solar system in your name.

The solar system you intend to purchase 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 intend 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 will pay for the purchase and installation of the solar system. The reduction reflects the value of the right to create RECs that you will assign to the installer.

You have provided an estimate of the balance of the cost of the solar system after assigning your rights to create RECs to the installer.

You state that you will be borrowing all of the balance of the purchase price.

You have not provided any contractual documents in relation to the scheme.

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 8-1

Income Tax Assessment Act 1997 Section 8-5

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

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

Income Tax Assessment Act 1997 Section 20-30

Income Tax Assessment Act 1997 Section 20-40

Income Tax Assessment Act 1997 Section 25-10

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

Income Tax Assessment Act 1997 Section 40-25

Reasons for decision

Summary

Based on the configuration of the solar system you intend to install, the arrangement with your energy supplier/retailer and your estimated feed-in tariff payments, the arrangement is other than private or domestic in nature. That being so;

· the payments you would receive for the generation of electricity from the solar system are ordinary assessable income under section 6-5 of the ITAA 1997

· the costs you would incur 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 would be able to claim deductions in respect of the decline in value of the capital cost of the system because the solar system would be used to produce assessable income, 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.

As the owner of the solar system asset, any income generated from it would be assessable to you.

Potential capital gains tax and goods and services tax consequences may also apply.

Detailed reasoning

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. 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.

In this instance, it needs to be determined whether the 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 the receipts are income, the factual circumstances, and in particular whether the receipts indicate an activity that is more than private or domestic in nature, needs 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 solar system is considered to be property and receipts received in connection with it are potentially assessable income. In determining whether or not the payments are assessable income 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 also be included in your assessable income. This is explained further 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 the decline in value of 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 where you incur the expense in deriving assessable income from the system.

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

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

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 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 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.

You must reduce your 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.

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.

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.

The cost of the solar system is, generally, amounts you are taken to have paid to hold the solar system, such as the purchase price including its installation and connection costs. It is worked out as at the time you begin to hold the solar system, that is, when it is installed and ready for use. It 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 of the ITAA 1997, certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable. Recoupment of a loss or outgoing is defined in subsection 20-25(1) of the ITAA 1997 to include a grant in respect of a loss or outgoing, that is, expenditure.

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 the right to another person, for example the installer of the system, or you may create the certificates and sell them on the market. You have advised you intend to assign the rights to the installer. This will result in a reduction in the amount you need to pay for the solar system and this reduction is considered to be a financial benefit.

You will gain a financial benefit when you assign your right to create the RECs to another entity (eg the installer of the system). The financial benefit is effectively the reduction in the amount you pay for the purchase and installation of the solar system. The reduction reflects the value of the right to create certificates that you assign to the installer. As a result, the right to create RECs arising under the REE Act is taken to constitute a grant for the purposes of Subdivision 20-A of the ITAA 1997.

For your grant to be a recoupment it must be 'in respect of' the loss or outgoing. The meaning of 'in respect of' has not been considered in the context of section 20-25 of the ITAA 1997. However a number of judicial decisions have considered the meaning of the phrase in other areas of the tax law.

In FC of T v. Scully 2000 ATC 4111; (2000) 43 ATR 718, consideration of the words 'in respect of' highlighted the importance of the context in which the phrase appears and resulted in the requirement that there be some 'discernible rational link' between the two subject matters. J & G Knowles & Associates Pty Ltd v. Federal Commissioner of Taxation (2000) 96 FCR 402; 2000 ATC 4151; (2000) 44 ATR 22 also supported this interpretation, stating that 'in respect of' requires 'a nexus, some discernible and rational link', which is sufficient for the purposes of the particular legislation.

In this case your right to create RECs, is dependent on ownership and installation of a qualifying solar system. You incur an outgoing to own and install the solar system. Upon ownership and installation of the solar system you are granted the right to create RECs. The entitlement to the grant is therefore a result of the outgoing to acquire and install the solar system. In this case, the required discernable, rational, material link is present between the grant and the outgoing. The grant is therefore in respect of the loss or outgoing for the solar system for the purposes of paragraph 20-25(1)(b) of the ITAA 1997.

As the right to create certificates is a grant in respect of the outgoing for the solar system under paragraph 20-25(1)(b) of the ITAA 1997, there is a recoupment of a loss or outgoing under section 20-25 of the ITAA 1997.

For the recoupment of the loss or outgoing to be an assessable recoupment under subsection 20-20(2) of the ITAA 1997, the amount you receive must be by way of insurance or indemnity.

In this instance, the recoupment is clearly not received by way of insurance.

However, relevant case law makes it clear that an amount received 'by way of indemnity' would include a receipt pursuant to an obligation, including under a statute, to make good or compensate for a loss which arises after the obligation comes into existence. As the granting of the right to create RECs satisfies a statutory obligation arising under the REE Act to partially compensate you for the costs to own and install the solar system, the value of the rights granted is considered to be an amount received by way of indemnity.

As you can deduct an amount for the loss or outgoing of the solar system under Division 40 of the ITAA 1997, the recoupment, being the right to create certificates, will be an assessable recoupment under subsection 20-20(2) of the ITAA 1997.

Because the cost of your solar system is deductible under Division 40 of the ITAA 1997 over several income years, section 20-40 of the ITAA 1997 applies so that the total assessable recoupment to be included in assessable income in a particular year is limited to the total amount of the loss or outgoing that can be deducted under Division 40 in that year. Any part of the assessable recoupment that is not included in assessable income in the year it is received because of this limit is assessable in later income years to the extent that further amounts are deductible under Division 40 in those years.

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.

Who the income is assessable to

In a self assessment environment, income derived from an asset should be returned by taxpayers according to who has the beneficial entitlement to the income, unless there is evidence to the contrary. The entire solar system is considered to be a single depreciating asset. You are the legal owner of the system. As you intend to enter into the contract with your electricity retailer to use the system to generate receipts, any resultant income generated from the system would be assessable to you.

Application to your situation

Under the gross feed-in tariff scheme as described in your ruling application, the electricity company credits or pays a premium feed-in tariff to the householder for all electricity generated and contributed to the electricity grid. The householder 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 householder for electricity consumed is the same as that available to any other householder.

In your case, you have stated that you will receive a payment provided under an arrangement between yourself and the relevant electricity company. You will receive the payment directly either by cheque or direct deposit to your bank account. The value of electricity that you will produce and be paid for is not related to the amount of electricity you consume. You expect to receive payments regularly, generally quarterly.

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.

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 installation and operating expenses of the solar system, such as for:

· interest on the borrowings to acquire the solar system;

· repairs and maintenance of the solar system ; and

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

You stated that the purchase price of the solar system installation is reduced because you will assign your right to create RECs to the installer. The grant of the right to you to create the certificates is an assessable recoupment. This 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. Depending on the original cost of the solar system and the amount of the decline in value deductions, the assessable recoupment will reduce such allowable deductions over a number of years.

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