Edited version of private ruling

Authorisation Number: 1011676003047

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: Solar energy - assessable income - allowable deductions

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)?

Yes.

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

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

This ruling applies for the following periods:

1 July 2010 to 30 June 2011.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

You own a residential property in your name only that is located in New South Wales (NSW). You are an individual and there is no business use of the property.

A 7.5 kilowatt solar electricity system was installed onto the roof of the property and this was purchased also in your name only.

You signed over the rights to the renewable energy certificates (RECs) to the retailer/installer and the cost of the system included goods and services tax after credits for the RECs.

The system is connected to an energy supplier network and you are paid $0.66 for every kilowatt of energy that is generated. You pay a much lower rate for every kilowatt of energy that you use.

In correspondence to the ATO, you provided that the system is designed to generate a maximum of 7.562 kilowatt per hour. You estimated seven hours of sunlight in winter and 12 hours in summer.

You have received one payment as a cheque and this payment was less than the estimated figures however you stated that this was due to the unusually high rainfall and overcast weather.

You are in the process of building a garage/carport and have signed-up to have solar panels installed on the roof of the structure. The plan is to increase the current system.

You have given permission for us to use third party information.

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

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

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 other than private or domestic in nature. That being so:

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

· the value of the right granted to you to create renewable energy certificates (RECs) is an assessable recoupment and must also be included in your assessable income.

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

Potential capital gains tax (CGT) and goods and services tax (GST) 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 Proprietary Limited 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.

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 (NAT 1996).

Assessable recoupments

Under Subdivision 20-A of the ITAA 1997, your assessable income may include an amount 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) to install and own that system.

Under the Renewable Energy (Electricity) Act 2000 (REE Act), if you install an eligible solar system on your private residence, you have a statutory right to create RECs after the system is installed. You can assign the 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. The financial benefit is the reduction in the amount you paid for the purchase and installation of the solar system.

You incur a loss or outgoing when you acquire and install your solar system. 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.

The recouped amount is an assessable recoupment where you can deduct an amount for the loss or outgoing for the solar system being the decline in value deduction under Division 40 as outlined above.

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.

For example, on 1 July 2009 Wilma installed a 10 kilowatt solar system costing $60,000 on the roof of her private residence. She received the right to create RECs to the value of $12,000. She assigned these to the installer, reducing the price she paid for the solar system to $48,000.

Wilma claims decline in value of her solar system using the prime cost method and an effective life of 20 years. She can claim a deduction for decline in value of the system of $3,000 for the 2009-10 income year and each of the following 19 income years (being $60,000 x 100%/20). As Wilma received the right to RECs to the value of $12,000, this is considered to be an assessable recoupment. As her deduction for decline in value of the system is $3,000 each year, she will include an assessable recoupment of $3,000 each year in her assessable income for the first four income 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. In addition ATO ID 2010/218 deals with when the right to create RECs is an assessable recoupment, again in the context of rental properties.

Application to your situation

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

In your case, you have stated that you will receive a payment provided under an arrangement between yourself and the relevant electricity company. You have already received a payment by cheque and expect further regular payments by cheque.

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

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

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

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

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

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

As the payments received for the electricity generated 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:

· 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 was reduced because you assigned 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.