Edited version of private ruling

Authorisation Number: 1011831648933

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Ruling

Subject: Income - other - solar power

Question 1:

Are payments/credits you will receive from your electricity retailer and provider (through your retailer) for the generation of excess electricity from a solar system exported to the grid assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes.

Question 2:

Is the value of electricity generated from a solar system and used by the household for domestic purposes assessable income under section 6-5 of the ITAA 1997?

Answer: No.

Question 3:

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

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

Question 4:

Is the value of the Small-scale Technology Certificates (STCs), formerly known as Renewable Energy Certificates (RECs), that you will assign to the system's supplier/installer and receive value for via a discount on the invoice for the purchase of the system, assessable to you as ordinary income?

Answer: No, however, an amount should be included in your return as an assessable recoupment.

This ruling applies for the following periods:

1 July 2011 to 30 June 2012.

1 July 2012 to 30 June 2013.

1 July 2013 to 30 June 2014.

1 July 2014 to 30 June 2015.

1 July 2015 to 30 June 2016.

1 July 2016 to 30 June 2017.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

You acquired and installed a photovoltaic system (solar system), on the roof of your jointly owned private residence.

The State Government provides for a net feed-in tariff solar 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 household consumption at the time of generation as recorded by the meter. The electricity retailer then pays an additional amount per kilowatt hour under the Renewable Energy Buyback Scheme (REBS).

Your electricity retailer will calculate any credits at each billing cycle and forward you a cheque if the balance they owe you for electricity exported to the grid exceeds a set amount.

The solar system will be installed on your residence and will be used entirely for domestic purposes. You own the property jointly with your spouse. The solar system will become an integrated component of the overall electricity system for your house.

A deposit was paid at the commencement of the supply and installation contract. You expect to take out a personal loan to pay for the balance of the net purchase price.

The solar system was purchased to produce electricity primarily to meet your own domestic consumption needs through to 2030, with the added bonus that any excess electricity from time to time could be exported into the electricity grid. This you understand is described as a 'net' feed-in tariff scheme.

The solar system you purchased 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 STCs.

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 STCs 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. The reduction reflects the value of the right to create STCs that you assigned to the installer.

You are not registered for goods and services tax (GST) purposes.

It is not your intention to make a profit from the installation of the system.

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 6-10

Income Tax Assessment Act 1997 section 20-25

Income Tax Assessment Act 1997 subsection 20-25(1)

Income Tax Assessment Act 1997 paragraph 20-25(1)(b)

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 section 20-40

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

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/credits you will receive for the generation of excess electricity from the solar system are ordinary assessable income under section 6-5 of the ITAA 1997

· the value of electricity generated by the solar system and used for private and domestic purposes will not be 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

· the value of the right granted to you to create STCs is not assessable to you as ordinary income but is an assessable recoupment and must also be included in your assessable income.

Potential capital gains tax and goods and services tax consequences may also apply.

Detailed reasoning

Assessable income

Assessable income is made up of ordinary income under section 6-5 of the ITAA 1997 and statutory income under section 6-10 of the ITAA 1997. Section 6-10 of the ITAA 1997 provides that assessable income includes statutory income which constitutes amounts made assessable by specific statutory provisions. There are no specific legislative provisions relating to money or credits received from electricity suppliers therefore such amounts are 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

· 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

· 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 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 STCs 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.

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 where you incur the expense in deriving assessable income from the system.

However, you cannot deduct interest expenses relating to your private residence (such as in relation to a home loan) on which the system would be fixed. Expenses associated with your home are usually of a private or domestic nature and do not qualify as deductions for taxation purposes.

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 twenty 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.

Apportionment of deductions for private and domestic usage

A net feed in tariff scheme is configured into the electricity system of the home - the solar system first supplies electricity to the home to satisfy household electricity consumption before exporting excess electricity to the grid. Where income received under a net feed in tariff scheme is assessable, any expenses incurred in generating the assessable income will need to be apportioned to take into account expenses incurred for electricity generated for private and domestic purposes. For example, one method to apportion will be to reduce the deduction by the percentage of electricity consumed by the household divided by total electricity generated by the system.

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) of the ITAA 1997 to include a grant in respect of a loss or outgoing, that is, expenditure.

Under the REE Act, if you install an eligible solar system on your private residence, you have a statutory right to create STCs (previously 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 certificates and sell them on the market. You have advised you assigned the rights to the installer. This resulted in a reduction in the amount you paid for the solar system and this reduction is considered to be a financial benefit.

You gained a financial benefit when you assigned your right to create the STCs to another entity (the installer of the system). 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 assign to the installer. As a result, the right to create STCs arising under the REE Act is taken to constitute a grant for the purposes of Subdivision 20-A of the ITAA 1997.

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 of the ITAA 1997. However a number of judicial decisions have considered the meaning of the phrase in other areas of the tax 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 your right to create STCs, 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 STCs. 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) of the ITAA 1997.

As the right to create certificates is a grant in respect of the outgoing for the solar system under paragraph 20-25(1)(b) of the ITAA 1997, there is a recoupment of a loss or outgoing under section 20-25 of the ITAA 1997.

For the recoupment of the loss or outgoing to be an assessable recoupment under subsection 20-20(2) of the ITAA 1997, the amount you receive must be by way of insurance or indemnity.

In this instance, the recoupment is clearly not received by way of insurance.

However, relevant case law makes it clear that an amount received 'by way of indemnity' would include a receipt pursuant to an obligation, including under a statute, to make good or compensate for a loss which arises after the obligation comes into existence. As the granting of the right to create STCs satisfies a statutory obligation arising under the REE Act to partially compensate you for the costs to own and install the solar system, the value of the rights granted is considered to be 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 of the ITAA 1997, the recoupment, being the right to create certificates, will be an assessable recoupment under subsection 20-20(2) of the ITAA 1997.

Because the cost of your solar system is deductible under Division 40 of the ITAA 1997 over several income years, section 20-40 of the ITAA 1997 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 of the ITAA 1997 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.

Application to your situation

Under the net feed-in tariff scheme operating in your state you would receive credits whenever your electricity generation exceeds your household consumption at intervals during the day as recorded by your meter. The credit will be applied to your electricity account. After a period, you are able to make arrangements with the retailer to be paid out for any remaining credits on your account exceeding a set amount.

The scheme is connected with the electricity needs of the householder as:

· The solar system is configured into the electricity system of the home.

· The solar system primarily supplies electricity to the home and satisfies the electricity consumption of the householder before exporting excess electricity to the grid.

However based on your factual circumstances, it is considered that the credits you would receive on your electricity account (or payment for credits) are ordinary income because:

The scheme is more than private or domestic nature, this being demonstrated by

· the size of the system you have chosen to install is quite sizeable and has a capacity in excess of the needs of a typical household

· the amount of electricity generated by the system being significantly greater than the domestic consumption requirements of your household. In particular:

· You expect to generate excess electricity from the solar system. Only a portion will be used for personal consumption in your private residence, the excess will be transferred to the electricity grid.

· The credits you would receive for excess electricity do more than offset the cost of your electricity and represent a return on investment for the system.

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

Consequently, any credits (and payment of credits) received for the electricity generated by the solar system and sold to the electricity grid would be considered to be assessable income.

However, if there were a decrease in the size or scale of the activity in which you are engaged in, or a decrease in the payments/credits received or the regularity of the payments, this might indicate the payments were not ordinary income and therefore not assessable.

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 to the extent it were not private or domestic in nature. 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

· interest deductions on money borrowed to purchase the solar system

· decline in value of the solar system based on twenty year effective life or some other effective life you have determined for the solar system in accordance with TR 2010/2 and the Guide to depreciating assets 2010).

You would be required to apportion your deductions to take into account expenses incurred in generating electricity consumed by your household, as this will have a private and domestic character. For more information on deductions and apportionment you can refer to TaxPack 2010 and the Guide to depreciating assets 2010.

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

Additional information

You generally make a tax loss when the total deductions you can claim for an income year exceed the total of your assessable and net exempt income for the year.

If you make a tax loss in an income year you can generally carry it forward and deduct it in future years against income for tax purposes.

Individuals can generally carry forward a tax loss indefinitely, but must utilise a tax loss at the first opportunity.

That is, if your income in the current income year exceeds your current year's deductions, you must offset any losses you have carried forward from previous years against your current year's income. You cannot choose to hold onto losses to offset them against future income if they can be offset against the current year's income.

(If in your return for a particular year you failed to utilise a loss when you were entitled to do so, you can later request an amendment for that year.)

Carried-forward losses are offset first against any net exempt income and only then against assessable income. Losses must be utilised in the order in which they were incurred.

Subject to the requirement to utilise losses at the first opportunity, tax losses can be carried forward indefinitely except for:

· non-primary production losses incurred before the 1989-90 income year, which are extinguished and can no longer be utilised

· foreign losses incurred before the 1999-2001 income year, which are extinguished and can no longer be utilised. There are restrictions on the utilisation of foreign losses incurred before 1 July 2008.

However, there are some deductions you cannot use to create or increase a tax loss, including donations, gifts and personal super contributions.

Certain deductions that would otherwise be allowable cannot be claimed as deductions where they would give rise to a tax loss. They are:

· payments of pensions, gratuities or retirement allowances to employees, former employees, or their dependants

· gifts or contributions made to deductible gift recipients

· payments made under conservation covenants

· personal superannuation contributions.

Generally, you must keep proper records relating to your tax affairs for at least five years after preparing or obtaining them, or after you completed the relevant transactions or acts, whichever is later. If you carry forward a tax loss, you may have to keep records for longer.