Edited version of your private ruling

Authorisation Number: 1012047977806

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Ruling

Subject: Electricity generation - solar - carrying on a business - assessable income - allowable deductions

Question 1:

Does the generation of electricity from two small scale solar panel power systems amount to the carrying on of a business?

Answer: No.

Question 2:

Can deductions be claimed for the 50% small business tax break under Division 41 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the purchase of the solar systems?

Answer: No.

Question 3:

Are credits/payments, you receive, from your electricity retailer and provider (through your retailer) for the generation of electricity from the solar systems, assessable income under section 6-5 of the ITAA 1997?

Answer: Yes.

Question 4:

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

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

This ruling applies for the following periods:

1 July 2009 to 30 June 2010.

1 July 2010 to 30 June 2011.

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 2009.

Relevant facts and circumstances

You have two small scale solar panel power systems (solar systems) installed on your property. The property has two dwellings and two electricity meters. One dwelling is rented and you live in the other. As there were two meters you were able to install two systems. The systems are wired separately and you receive two electricity statements.

You sell all of the electricity generated from the solar panels and they are both gross systems.

The solar systems you purchased were eligible small generation units (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 received RECs due to your installation of the solar assets. You have not sold the RECs.

The solar cells are guaranteed for 20 years. However, it is expected that they will continue to produce power beyond that at about 80% of their original specification.

The operating and maintenance expenses relating to the solar power generation activity are small. The operating and maintenance involved is cleaning the solar surfaces, maintaining the trackers and keeping the grounds clear of weeds and free from shadowing on the surface of the cells.

You currently receive a substantial amount of money from the feed-in tariff.

You entered into the activity of generating and selling electricity with the intention of making a profit and to make money.

You keep accounting records in relation to all your business activities and your activity of generating and selling electricity.

You have a business plan in relation to your activity of generating and selling electricity.

You do not have expert knowledge of electricity or the solar power industry but you have developed knowledge over time.

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 20-20(2)

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

Income Tax Assessment Act 1997 section 20-30

Income Tax Assessment Act 1997 section 20-40

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

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 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 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 www.ato.gov.au 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

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

The relevant legislation is the Income Tax Assessment Act 1997 (ITAA 1997). All references to legislation are to the ITAA 1997 unless otherwise stated.

Question 1:

Carrying on a business

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators to determine the matter, these indicators are summarised in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production. These indicators are applicable to business activity generally, relevant indicators include:

§ the size, scale and permanency of the activity.

§ whether there is repetition and regularity of the activity, and

§ whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business.

Size, scale and permanency of the activity

Paragraph 77 of TR 97/11 states that the larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business. However the size or scale of the activity is not a determinative test and a person may carry on a business though in a small way.

In your case the activity involves the operation of a two small scale solar systems. Once the solar systems were installed no more work other than maintenance is required to operate it. The size and scale of the operation is very small.

A smaller scale of activity may detract from the commercial purpose or character of the activities, for example the activity may more properly be described as the management of a capital investment rather than a business.

However, this factor alone is not conclusive. Paragraph 82 of TR 97/11 states that the smaller the scale of the activity the more important the other indicators become when deciding whether a taxpayer is carrying on a business.

Whether there is repetition and regularity of the activity

Paragraph 55 of TR 97/11 discusses the need for repetition and regularity. It is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business. TR 97/11 refers to Hope v. The Council of the City of Bathurst (1980) 144 CLR 1, 80 ATC 4386, (1980) 12 ATR 231 where 'the transactions were entered into on a continuous and repetitive basis', such that the taxpayer's activities 'manifested the essential characteristics required of a business'.

In your case the measurement of and payments for the electricity generation are the responsibility of the energy company. There is little to no repetition and regularity in terms of action required for the activity to continue, the solar systems only require installation to operate and generate revenue. However, this factor must be considered together with the other relevant indicators.

Whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

The activities of a taxpayer are more likely to be a business when carried on in a manner similar to that in which other participants in the same industry carry on their activities.

The factors below, set out at paragraph 64 of TR 97/11, are used to compare the characteristics of others engaged in the same type of business:

§ the volume of sales, if there is a small number of sales it is less likely that a business is being carried on

§ the types of customers the taxpayer sells their product to - wholesalers, retailers, the public at large, or friends or relatives - and the manner in which this marketing takes place

§ the sort of expenses incurred by the taxpayer, and

§ the amount invested in capital items.

You expect to generate recurring receipts from the energy company. The major expense you will incur is the cost and installation of the solar system. There will be no significant operating costs.

You have a single customer. There is a contract agreement in place for each solar system, however, you are not required to meet or maintain a certain supply level, rather you merely sell back what the solar systems generate.

A business of electricity generation would usually be expected to produce and maintain certain amounts of electricity and meet certain levels of demand. A business of electricity generation would also require a larger scale of production to ensure they were able to manage demand levels. It could not be said that your activity is alike to an ordinary business of solar electricity generation.

Conclusion

From a consideration of the factors above the activity would not amount to the carrying on of a business. The size and scale of the activity is small, there is little repetition and regularity in the activity and the activity when compared to an ordinary business of solar generation could not be said to be similar. As a result you are not be considered to be carrying on a business by receiving payments for the export of electricity generated from small scale solar systems.

Question 2:

Small business tax break

Small business entities are able to claim a 50% bonus tax deduction (the tax break) for eligible assets costing $1,000 or more that they:

§ commit to investing in between 13 December 2008 and 31 December 2009, and

§ start to use or have installed ready for use by 31 December 2010.

To qualify for the 50% rate you need to meet the definition of a small business entity in section 328-110 of the ITAA 1997. This generally means that the taxpayer is carrying on a business and has an annual turnover of less than $2 million.

Businesses can commit to investing in an asset by:

§ entering into a contract under which they will hold the asset, or

§ starting to construct the asset.

Conclusion

To access the small business tax break you must be an eligible entity. An eligible entity is an entity that is in business and has a turnover of less then $2 million. As you are not considered to be in business in relation to electricity generation, you are not an eligible entity and cannot claim the small business tax break on the purchase of a the solar systems.

Questions 3 and 4:

Summary

Based on the configuration of the solar system you have installed, the arrangement with your energy supplier/retailer and your feed-in tariff payments, the arrangement is not private or domestic in nature. As a consequence:

§ the credits/payments you receive for the generation of electricity from the solar system are ordinary assessable income under section 6-5

§ the costs you incur in relation to the generation of electricity from the solar system are deductible under section 8-1 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

Potential capital gains tax and goods and services tax consequences may also apply but have not been addressed in this ruling.

Detailed reasoning

Assessable income

Assessable income is made up of ordinary income and statutory income. Section 6-10 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) defines ordinary income as income 'according to ordinary concepts'. Under subsection 6-5(2), the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources during the income year.

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 at 4420; (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.

A solar system is considered to be the property of its owner. Receipts received in connection with it, therefore, are potentially assessable income. Consequently, it needs to be determined, in light of the nature and the circumstances of the receipt, whether the payments or credits received in return for transfer of electricity to the grid are income.

In determining whether or not the payments are assessable income, the factual circumstances, and in particular whether the receipts indicate an activity that is more than private or domestic in nature, need to be considered. 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

§ the regularity of payments/credits received from the feed-in tariffs such that they can be relied upon.

Deductions

The general provision that determines the deductibility of expenses is section 8-1. Under section 8-1 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 are made allowable by section 8-5. Examples of specific deductions include repairs under section 25-10 and deductions for the decline in value of depreciating assets under section 40-25.

Interest

Under section 8-1 you can deduct interest expenses you incurred in financing the acquisition and installation of the solar system where you incur the expense in deriving assessable income from the system.

Repairs and Maintenance

Under section 25-10 you can deduct expenditure you incur in respect of repairs and maintenance to the solar system. That is because the expense is incurred in deriving assessable income from the system.

Under subsection 25-10(3) expenditure incurred for repairs is not deductible if it is of a capital nature. For further information regarding the deductibility of repairs 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. 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, each income year you can deduct an amount equal to the decline in value 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. Where it is used in producing assessable income a solar system would fall into that category.

You must reduce any applicable 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 but private usage is not.

A solar system comprises modules of photovoltaic cells, a mounting frame, various fixings, electrical wiring and conduits and inverters. The entire solar system is considered to be a single depreciating asset and would be depreciated accordingly.

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 that are on residential property is twenty years.

Generally speaking, the cost of a solar system is those amounts which you are taken to have paid to hold the solar system, such as the purchase price and its associated installation and connection costs. It is worked out as at the time that you begin to hold the solar system; in other words, when it is installed and ready for use. The cost 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 2010-11.

Application to your situation

Under the gross feed-in tariff scheme operating in your state and as described in your ruling application, the electricity company credits or pays a premium feed-in tariff to you for all electricity generated and contributed to the electricity grid. You then separately buy electricity from the company according to your consumption. Payment for the electricity generated is distinct from and unrelated to the amount of electricity consumed. The rate paid by you for electricity consumed is the same as that applied to any other householder in your state.

In your case, you have stated that you will receive credits/payments provided under an arrangement between yourself and the relevant electricity company. You have already received payments and expect further regular payments. The value of electricity that you will produce and be paid for is not related to the amount of electricity you consume.

Based on your factual situation, it is considered that all of the credits/payments received for your electricity generated and sold to the electricity company are assessable income because:

§ The electricity retailer is required to buy all electricity that is generated from the system under the gross feed in tariff scheme.

§ The feed-in tariff payments are considered to represent a return on your investment in the solar system.

§ There is a realistic opportunity for you to profit from the arrangement.

§ The payments from the feed-in tariffs are received regularly and can be relied upon, including to meet regular household electricity expenditure.

The arrangement is not of a private or domestic nature because the solar system does not provide electricity to your private residence. Instead, all electricity produced is exported back to the grid. You then buy back electricity to meet your own electricity needs.

As the payments received for the electricity generated to the electricity grid are assessable income, the expenditure incurred in producing the income from the sale of the electricity would be deductible. You may be entitled to deductions for the installation and operating expenses of the solar system, such as for:

§ interest on money borrowed to fund the purchase of the solar system

§ repairs and maintenance of the solar system

§ decline in value of the solar system based on 20 year effective life.