Edited version of your written advice

Authorisation Number: 1012710377954

Ruling

Subject: Solar panels

Question 1

Would payments received from your electricity retailer for the generation of electricity from the photovoltaic solar system on your rental property be assessable income?

Answer

Yes

Question 2

Are the costs of interest, repairs and maintenance and depreciation associated with the system on your rental property, deductible?

Answers

Yes.

This ruling applies for the following period

1 July 2010 - 30 June 2015

1 July 2011 - 30 June 2016

1 July 2012 - 30 June 2017

1 July 2013 - 30 June 2018

1 July 2013 - 30 June 2019

The scheme commenced on

1 July 2014

Relevant facts

You installed three 10kW photovoltaic systems on your rental property at a cost of approximately $X. This does not take into account the discount received for assigning your rights to create renewable energy certificates (RECs) to the installer.

The system required three phase power. Each phase holds a 10kW system. One phase will be connected to the rental property. The others will feed directly to the grid.

The Government provides a net solar feed-in tariff scheme. The scheme is available to customers who have solar systems with a capacity of up to 30kW for three-phase power. Under the scheme, owners of eligible renewable energy systems are paid an amount 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.

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

The frequency of the payment will depend on your arrangement with your electricity retailer, but it is expected that your electricity account will be credited monthly and you will be able to elect to receive cash.

You took control of the electricity account for the investment property. You receive the payments from the electricity provider for the electricity generated from the solar panels. The cost of the tenant's electricity consumption is factored into the rent.

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

Income Tax Assessment Act 1997 Section 8-5

Reasons for decision

Assessable income

Under section 6-5 of the Income Tax Assessment Act 1997 (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 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, need 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 whether the solar system:

• 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 (referred to as a 'net' scheme), or

• exports all electricity to the grid (referred to as a 'gross' 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 may 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 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 the decline in value of 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 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) expenditure incurred for repairs is not deductible if it is of a capital nature. For further information refer to 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.

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 2014/4 Income tax: effective life of depreciating assets (applicable from 1 July 2014) provides a table listing the effective life of depreciating assets. In accordance with TR 2014/4 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 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.

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 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 Income tax: is a government rebate received by a rental property owner an assessable recoupment under subsection 20-20(3) of the Income Tax Assessment Act 1997 , where the owner is not carrying on a property rental business and receives the rebate for the purchase of a depreciating asset (for example an energy saving appliance) for use in the rental property, 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 Income Tax
Assessable recoupment: recoupment - grant of the right to create renewable energy certificates - solar system on a rental property 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 scheme you would receive credits whenever your electricity generation exceeds the household consumption at intervals during the day as recorded by your meter. The credit will be applied to your electricity account. You can make arrangements with the retailer to receive a payment of the credit.

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 excess the system will provide over the domestic consumption requirements of the household. In particular:

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

• You expect to generate excess electricity from the solar system, only one of the three phases will connect to the household, and be used, for personal consumption to the residence, the excess will be transferred to the electricity grid.

• The credits you would receive for excess electricity would offset the cost of electricity and in addition would provide receipts that 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 electricity generated 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 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 no longer 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:

• interest on the borrowings to acquire the solar system;

• repairs and maintenance of the solar system ;

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

The grant of the right to you to create RECs would be an assessable recoupment. This is because it is considered to be 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 an 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. Depending on the original cost of the solar system and the amount of the decline in value deductions, the assessable recoupment will reduce such allowable deductions over a number of years.