Edited version of your private ruling

Authorisation Number: 1011940061682

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Ruling

Subject: Income - solar feed in tariff scheme

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 repairs 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 3

Does the solar system qualify as a depreciating asset that is eligible for decline in value deductions under section 40-25 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

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.

You and your spouse (you) carry on a business of farming and grazing in partnership on rural land which you jointly own.

You have used the land for commercial farming and grazing purposes to date.

You have been allocating your electricity costs for income tax purposes between business and domestic use. Electricity supply is needed to operate bore/pumps for stock water, tools for plant repairs, and to run a home office.

You installed a 9.6 Kilowatt photovoltaic system (solar system), onto the roof of a shed on the land for the purpose of offsetting the cost of your electricity.

You entered into a gross feed-in tariff 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. You will enter into a contract under which you will be paid per kilowatt hour for electricity generated by the network provider through your electricity retailer. Your retailer will pay you an additional amount per kilowatt hour for electricity generated.

You will receive this as a separate payment as a direct payment either by cheque or direct deposit into a bank account from your energy retailer.

The frequency of the payment will depend on your arrangement with your electricity retailer, but it is expected that you will be paid quarterly. The scheme will operate for a number of years.

You provided an estimate of the amount you expect to receive per year from your electricity retailer through the feed-in tariff rate. Your eligibility for the feed-in tariff is not linked to your consumption of electricity.

From past electricity accounts you provided an estimate of the electricity costs associated with business use. You are billed for your electricity consumption in the usual way.

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 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 will pay for the purchase and installation of the solar system. The reduction reflects the value of the right to create RECs that you will assign to the installer.

You assigned your rights to create RECs to the installer for a discount on the purchase price of the system.

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 Section 6-10

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 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 used for business use, the arrangement is other than private or domestic in nature. That being so;

· the payments/credits received for the generation of electricity from the solar system are ordinary assessable income under section 6-5 of the ITAA 1997

· the costs that are incurred 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 are able to claim deductions in respect of the decline in value of the capital cost of the system because the solar system is used to produce assessable income, and

· the value of the right granted to you to create RECs is an assessable recoupment and must also be included in your assessable income.

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.

Subsection 6-5(1) of the ITAA 1997 defines ordinary income as 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 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 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.

A solar system is considered to be the property of its owner. Receipts received as a result of employing that asset, therefore, are potentially assessable income to the owner. Consequently, 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 which is more than private or domestic in nature, need to be considered in determining whether or not the receipts are income. The following are important:

· the terms of the arrangement with the electricity retailer in particular any requirement on the retailer to buy all electricity generated from the system

· 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 RECs which offset the cost of the system) may potentially also be included in your assessable income. That issue will be discussed in greater detail 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 depreciating assets under section 40-25 of the ITAA 1997.

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 - Division 40 of the ITAA 1997

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.

Assessable recoupments

Under Subdivision 20-A of the ITAA 1997, your assessable income may include an amount which 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) in respect of installing and owning that system.

Under the 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 that 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. Effectively, the financial benefit is the reduction in the amount which you would otherwise pay for the purchase and installation of the solar system. In effect that reduction is the price discount which the installer offers you in return for surrendering the RECs to them.

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. Where you can deduct an amount for the decline in value of the solar system under Division 40 of the ITAA 1997 (as outlined above) the recouped amount in respect of the RECs is an assessable recoupment.

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 until it has been fully accounted for.

By way of clarification, consider the following example:

On 1 July 2009, a taxpayer installed on the roof of his private residence a 10 kilowatt solar system costing $60,000. He received the right to create RECs to the value of $12,000. He assigned them to the installer, resulting in a reduction in the price paid for the solar system to $48,000.

The taxpayer claims the decline in value of his solar system using the prime cost method and an effective life of twenty years. He 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 (i.e. $60,000 /20).

He received the right to RECs to the value of $12,000 and that is considered to be an assessable recoupment. As his deduction for decline in value of the system is $3,000 each year, he will include an assessable recoupment of $3,000 each year in his assessable income for the first four income years. The total value of the RECs will then be fully recouped. In subsequent years, the deduction can still be claimed but with no off-setting recoupment required.

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 discusses 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 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 credit to your electricity account. The value of electricity that you will produce and be paid for is not related to the amount of electricity that is used for business and private purposes. You expect to receive payments/credits regularly, generally quarterly.

Having regard to all of the facts, it is considered that your solar system installation amounts to an arrangement which is not private or domestic in nature because:

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

· The electricity retailer will pay a premium feed in tariff per kilowatt hour for any excess electricity that you generate.

· The arrangement is commercial in nature; an agreement has been created.

· There is a realistic opportunity to profit from the arrangement even if no profit is actually made in any particular period

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 under Division 40 of the ITAA 1997, and

· repairs and maintenance of the solar system.

Where the purchase price of the solar system installation was reduced because you assigned to the installer your right to create RECs, the grant of the right to create the certificates is an assessable recoupment. That is because it is a grant in respect of a loss or outgoing and you can deduct an amount for that loss or outgoing.

The amount by which the cost of the system is reduced because of the assignment is the value of the assessable recoupment. The amount of the assessable recoupment is applied to reverse the effect of a deduction for decline in value of the full cost of the solar system. The assessable recoupment will reduce such allowable deductions for a certain number of years, that period being determined by the original cost of the system and the annual amount of the deductions.