Edited version of private ruling

Authorisation Number: 1011795508898

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Ruling

Subject: Income - other - solar feed in tariff scheme

Question 1

Are payments or credits 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 you eligible to claim decline in value deductions for the capital costs of the system under section 40-25 of the ITAA 1997?

Answer

Yes

Question 3

Are other costs associated with the solar system, such as rent, interest and maintenance expenses, deductible under section 8-1 or 8-5 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

1 July 2010 - 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You and two other individuals (you) entered into a partnership agreement for the purpose of acquiring and installing a 10kW photovoltaic solar system (the system) to generate income from the sale of power generated from the system.

The system is located on a commercial premises. The premises are owned by one of the partners. The partner receives consideration from the partnership for use of the roof space. The consideration is equivalent to the premises electricity consumption per year and payment of the quarterly electricity supply charge for the premises.

The system was sourced overseas and imported. You provided a breakdown of the cost of the system. Some of the funds for the system were borrowed using commercial finance.

You entered into a net feed-in tariff scheme (the scheme). Under the scheme, owners of eligible renewable energy systems are paid per kilowatt hour for energy exported to the grid that is in excess of the property consumption at the time of generation as recorded by the meter.

The tariff is applied on net electricity exported to the grid. Your retailer will pay you an additional rate per kilowatt hour for electricity exported to the grid. The maximum size solar system that can be installed under the scheme is 10kW. The scheme will operate for a number of years, however the electricity retailer's additional tariff is not guaranteed.

You provided an estimate of the maximum payment the partnership could receive per year which would be shared equally between the partners.

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 Renewable Energy Certificates (RECs).

You did not assign the right to create RECs to the installer. You will create and dispose of the RECs to an entity that trades in them.

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 subdivision 20-A

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 system you will install, the arrangement with your energy retailer for the feed-in tariff payments, and the fact that the system is located on a commercial premises, 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, and

· 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.

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 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.

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 if 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.

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 a solar system, you should refer to the Guide to depreciating assets 2009-10.

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 a property, 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 feed-in tariff scheme operating and as described in your ruling application, the electricity company credits or pays a premium feed-in tariff for energy exported to the grid that is in excess of the property consumption at the time of generation as recorded by the meter. The tariff is applied on net electricity exported to the grid.

In this case, the partners acquired and installed a 10kW system on a commercial premise to generate excess electricity and obtain a profit. The partners will receive a payment provided under an arrangement between them and the relevant electricity company. You will receive your share of the payment from the partnership. You expect to receive regular payments.

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 commercial property which is currently used to derive assessable income.

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

The arrangement is commercial in nature; a partnership agreement has been created.

The partners will compensate the property owner for use of the premises to house the system, and

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.

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;

· rent expenses (e.g. outgoings incurred for use of the property)

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

· repairs and maintenance of the solar system.

Credits you may receive in respect of assigning your renewable energy certificates 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 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.