Edited version of private ruling

Authorisation Number: 1011731518010

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Ruling

Subject: Environment protection activities

Question

Is expense incurred in respect of solar panels and an inverter deductible in full in the year in which the expense was incurred?

Answer

No.

This ruling applies for the following period:

1 July 2010 to 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The taxpayer plans to add solar panels to an investment property. The primary reason for installing the panels is stated to be the reduction of the carbon emissions of the property.

Relevant legislative provisions

Income Tax Assessment Act 40-755 and

Income Tax Assessment Act 40-760.

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 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 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

Unless otherwise stated, all legislative references in the following Reasons for Decision are to the Income Tax Assessment Act 1997.

Summary

The expenditure on the solar panels would not constitute expenditure for carrying on environmental protection activities for the purposes of section 40-755. However, even if it did it would still be excluded from qualifying for immediate deduction by virtue of the operation of section 40-760.

Detailed reasoning

The taxpayer has incurred expenditure on applying solar energy to a rental property used in their income earning activities. The taxpayer states that the dominant purpose behind incurring the expenditure was to reduce the carbon emissions of the property.

Subsection 40-755(1) provides a deduction for expenditure incurred for the sole or dominant purpose of carrying on environmental protection activities. Qualifying expenditure can be deducted in full in the year in which it is incurred.

Those undertakings which constitute 'environmental protection activities' are listed in subsection 40-755(2). It is made clear in the sub-section that the definition is exclusive and no activities other than those specified will qualify. The activities are:

· preventing, fighting or remedying pollution resulting, or likely to result, from your earning activity; or

· treating, cleaning up, removing or storing waste resulting, or likely to result, from your earning activity.

'Your earning activity' is defined in subsection 40-755(3) as, amongst other things, an activity you carried on, carry on, or propose to carry on for the purpose of producing your assessable income (except a net capital gain). In defining the site of 'your earning activity', subsection 40-755(4) includes 'leasing a site (which) you own'.

The term sole or dominant purpose is not defined for the purpose of subsection 40-755(1). Former section 82BK of the Income Tax Assessment Act 1936 (ITAA 1936) was the original provision dealing with environmental protection activities. It was repealed and ultimately replaced with section 40-755. The Explanatory Memorandum (EM) to the Taxation Laws Amendment Act (No. 5) 1992, which introduced former section 82BK of the ITAA 1936, provides guidance in interpretation of the section and, by extension, of 40-755. It stated that:

Expenditure will only be for the sole or dominant purpose of carrying on an eligible environment activity if it is primarily directed to that environment protection activity. A deduction will not be available if the protection of the environment is only a residual or subsidiary purpose of the taxpayer.

Nor is the term 'pollution' defined in the ITAA 1997. However, the EM to Taxation Laws Amendment Act (No. 5) 1992 states that 'pollution has its ordinary common sense meaning'. The conclusion from consideration of the authorities is that: (i) the ordinary meaning of 'pollution' is limited to some sort of contamination; and (ii) an adverse change to the environment not due to contamination is not pollution.

It follows that, stated in those terms, the replacement of the present method for the generation of power with solar generation does not prevent, fight or remedy pollution as that term is used in the ITAA 1997. While the installation of solar panels may indirectly reduce pollution in the long-term by reducing society's dependence on fossil fuels, it does not lead to a reduction in or avoidance of pollution for the purposes of this legislation. Therefore, that expenditure would not qualify as an eligible environmental protection activity. Accordingly, the taxpayer is not entitled to a deduction under subsection 40-755(1) for the expenditure incurred.

It should be noted that even if it could be argued that the expenditure qualifies under section 40-755, it would still be caught within the limitation on deductions imposed by section 40-760. Viewed objectively, the addition of solar panels would fall within the definitions in either of paragraphs 40-760(1)(b) or (c). Sub-section 40-760(1) states in part:

You cannot deduct an amount under section 40-755 for an income year for:

(b) capital expenditure for constructing a building, structure or structural improvement; or

(c) capital expenditure for constructing an extension, alteration or improvement to a building, structure or structural improvement…

The explanatory memorandum explains the interaction of sections 40-755 and 40-760 in the following terms:

Capital expenditure on constructing buildings, structures and structural improvements which are used by a taxpayer for eligible environment activities will not be deductible as allowable environment expenditure in the year of income in which it was incurred. Similarly, a deduction will not be allowed (as allowable environment expenditure) for expenditure on extensions, alterations or improvements to these items.

The explanatory memorandum goes on to say, "Expenditure incurred on plant or equipment used by a taxpayer for eligible environment activities will not be deductible as allowable environment expenditure in the year of income in which it was incurred."

It subsequently states: "For example, a new, specially designed filter is added to a factory chimney to filter out solid particles to prevent pollution. The filter, as an item of plant or a structural improvement, will be depreciable in the normal way". It should be noted that in this example, the immediate deduction in full is not available even though the structural change is directly referable to reduction of pollution from the site.

ATO ID 2004/44 considered a septic tank system to be a structural improvement.

In the present case, the addition of solar panels is "expenditure for constructing a... structure or structural improvement" or an "alteration or improvement to a building, structure or structural improvement." As a consequence, the cost will fall within the definition in section 40-760 and, therefore, not be an eligible expenditure for the purposes of section 40-755, regardless of whether it would otherwise meet the necessary qualifications.

Note: the expenditure incurred may be deductible under Division 43. This ruling does not address the issue of deductibility under that division or any other provisions beyond the question of immediate deduction in respect of environmental protection activities.