Edited version of private ruling

Authorisation Number: 1011805492770

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Ruling

Subject: Income - net feed in tariff scheme

Question 1

Would payments received from your electricity retailer for the generation of electricity from a photovoltaic solar system be assessable income under section 6-5 of the ITAA 1997?

Answer

Yes

Question 2

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

Answer

Yes

This ruling applies for the following periods:

1 July 2009 - 30 June 2010

1 July 2010 - 30 June 2011

1 July 2011 - 30 June 2012

1 July 2012 - 30 June 2013

1 July 2013 - 30 June 2014

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You are a partnership.

You entered into a contract for the purchase of a 9.6kW photovoltaic solar system (system).

You own a property which contains your main residence and a smaller rental property which is tenanted. The system is connected to the rental property. You provided an estimate of the annual electricity costs for the rental property prior to the installation of the system.

You entered into a net feed-in tariff solar 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 household 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 amount per kilowatt hour for electricity exported to the grid.

You provided an estimate of the maximum payment you could receive per year for electricity generated from the system.

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 entered into an agreement with the installer of the solar system, who is an agent for the purposes of the REE Act, and assigned 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 paid for the purchase and installation of the solar system. You assigned your right to RECs to the installer of the system in return for a discount. You provided a breakdown of the cost of the system.

You have not provided 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 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 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 owners of the asset and the persons who enter into the contractual arrangement for the feed in tariff scheme, any income generated from it would be assessable to the partners.

Potential 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.

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 the residence where 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 where 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 can 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 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 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, you acquired and installed a 9.6kW system on the small dwelling that is tenanted to generate excess electricity and obtain a profit. You will receive a payment provided under an arrangement between you and the electricity company.

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 excess electricity the system generates.

· 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, 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.

Amounts received in the way of discounts or credits for assigning your renewable energy certificates impact on the cost of the system for the decline in value deduction and would constitute an assessable recoupment.