Edited version of private ruling

Authorisation Number: 1011680791049

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Ruling

Subject: Income - other - solar power

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 depreciation and maintenance, deductible under section 8-1 of the ITAA 1997?

Answer

Yes.

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?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You currently own a tenanted investment property.

You are considering installing a small scale photovoltaic solar system on the investment property.

When the system is installed you 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.

Once implemented, you intend to take control of the electricity account for the investment property. You would receive the payments from the electricity provider for the electricity generated from the solar panels and invoice the tenants for their domestic electricity consumption.

You would declare the payment for electricity from the tenant as income and claim the cost of the electricity consumed by the tenant as an expense in respect of the investment property.

You state your reasons for installing the solar system on your investment property is because your current primary residence is not suitable for an installation. The investment property has a large north facing roof and you want to use this property as a proxy to reduce your carbon emissions and also offer a similar benefit to your tenants.

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.

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(3)

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

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Subsection 116-20(1)

Income Tax Assessment Act 1997 Subsection 116-40(2)

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 a tenanted investment property, 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 may be an assessable recoupment.

As the owner of the asset and the person who enters into the contractual arrangement for payment, 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 ,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 that indicate the arrangement is other than private or domestic in nature, or an intention to make a profit from the 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 they represent a financial return from the investment in the solar system. The factual circumstances, and in particular whether the receipts represent activity more than private or domestic in nature, needs to be considered in determining whether or not the receipts are income. Taxation Ruling IT 2167, which deals with rental properties, and in particular, circumstances when amounts received in connection with letting of property are income and when they are not provides some guidance on this issue.

Amounts that you receive as a recoupment of a deductible expense 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 allows you to deduct. Examples of specific deductions include repairs under section 25-10 and deductions for depreciating assets under section 40-25.

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) 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 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.

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, 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.

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. It is worked out as at the time you begin to hold the solar system, such as when it is installed and ready for use. It also generally includes amounts you are taken to have paid after that time to bring the solar system to its present condition and location, such as a cost of improving the solar system.

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) to include a grant in respect of a loss or outgoing, that is, expenditure.

Under the Renewable Energy (Electricity) Act 2000 ('REE Act'), if you install an eligible solar system on your private residence, you are entitled, by a statutory right, to create Renewable Energy Certificates ('certificates') 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 not advised which option you will choose to exercise.

Your right to create certificates under the REE Act could be exchanged for a financial benefit. In this sense, the RET scheme provides a financial incentive to you to purchase an eligible solar system. Because of this, your right to create certificates arising under the REE Act constitutes a grant for the purposes of Subdivision 20-A of the ITAA 1997. This is because the right to create certificates provides a financial benefit in kind to you.

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 may decided to assign to the installer..

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. However a number of judicial decisions have considered the meaning of the phrase in relation to other areas of the 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; 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, the subject of your grant, being your right to create certificates, 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 certificates. 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).

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

Where you receive a recoupment of a loss or outgoing by way of insurance or indemnity and you can deduct an amount for the loss or outgoing for the current year under any provision of the ITAA 1997, the amount will be an assessable recoupment under subsection 20-20(2). It is clear in this case that the recoupment will not be received by way of insurance.

Indemnity is not a defined term and therefore must be given its ordinary meaning. The Macquarie Dictionary, [Multimedia], version 5.0.0, 1/10/01, definition of indemnity includes compensation for damage or loss sustained.

The issue of whether an amount is received by way of indemnity for the purposes of the predecessor provision to subsection 20-20(2) (paragraph 26(j) of the Income Tax Assessment Act 1936) has been considered in a number of cases including: FC of T v. Wade (1951) 84 CLR 105; (1951) 9 ATD 337; 5 AITR 214, Robert v. Collier's Bulk Liquid Transport Pty Ltd (1959) VR 280, Goldsbrough Mort & Co Ltd v FC of T (1976) 76 ATC 4343, 6 ATR 580 'Goldsbrough'; and Commercial Banking Company of Sydney Limited v. FC of T 83 ATC 4208 (1983); 14 ATR 142 'Commercial Banking'.

These cases make it clear that an amount received by way of indemnity is not restricted to amounts received under a contract of indemnity. This was made clear by Hunt J. in Commercial Banking who, referring to the decision in Goldsbrough, stated

'… his Honour was correct in ruling that the expression "by way of… indemnity" should not be construed narrowly in the sense of "pursuant to a contract of indemnity".'

The cases also make it clear that an amount received 'by way of indemnity' would include a receipt pursuant to an antecedent obligation (whether by virtue of a contract, statute or a breach of some common law duty of care) to make good or compensate for a loss which arises after the obligation comes into existence.

Therefore, the phrase 'by way of indemnity' broadens the range of receipts to be considered an assessable recoupment under subsection 20-20(2) to include receipts other than amounts received under a contract of indemnity.

The granting of the right to you to create certificates satisfies the antecedent statutory obligation arising under the REE Act to partially compensate you for the outgoing to own and install the solar system. That being so, the value of the rights granted is therefore 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 (the abovementioned decline in value deductions), the recoupment, being the right to create certificates, will be an assessable recoupment under subsection 20-20(2).

Because the cost of your solar system is deductible under Division 40 over several income years, section 20-40 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. You intend to enter into a contract with your electricity retailer to use the system to generate receipts. As a result any income generated from the system would be assessable to you.

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 payment to you either by cheque or direct deposit. The value of electricity that you will produce and be paid for is not related to the amount of electricity the tenant will consume. You expect to receive payments regularly, generally quarterly.

Although you state your reasons for entering into the arrangement are private in nature, it is considered that your solar system installation amounts to an arrangement other than private or domestic in nature because:

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

The electricity retailer will pay you a premium feed in tariff per kilowatt hour for all the electricity you generate.

You will control the electricity account to ensure that the payments for the electricity generated are received by you as the landlord.

You will invoice the tenant for the cost of electricity that they consume.

There is a realistic opportunity to profit from the arrangement.

Accordingly, the payments you receive from the electricity company will represent a return on your investment in the solar system because your arrangement is other than private or domestic in nature.

In addition, by receiving these payments quarterly, they are able to be relied on, and form part of the return on your tenanted investment property.

Consequently, all of the payments received for your electricity generated and sold to the electricity grid are ordinary income.

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;

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

· repairs and maintenance of the solar system.

You have not stated whether the purchase price of the solar system installation takes into account the discounts or credits you may receive in respect of assigning your renewable energy certificates. These amounts may impact on the cost of the system for the decline in value deduction and may constitute an assessable recoupment. This ruling has not fully considered these issues as you have not provided sufficient information and documentation to determine the actual amounts.

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