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Edited version of your written advice
Authorisation Number: 1012746255665
Ruling
Subject: The effective life of a depreciating asset
Question 1
Where a commercial photovoltaic solar system (the system) is installed on the property of a commercial customer for a contractual period (the period), can you recalculate the effective life of the system to equal that of the period?
Answer
No.
Question 2
After the contractual period, is a balancing adjustment necessary for the remaining value of the system where you gift or sell the system to the customer?
Answer
Yes.
This ruling applies for the following periods:
Year ended 30 June 2015
Year ended 30 June 2016
Year ended 30 June 2017
Year ended 30 June 2018
Year ended 30 June 2019
Year ended 30 June 2020
Year ended 30 June 2021
Year ended 30 June 2022
Year ended 30 June 2023
Year ended 30 June 2024
Year ended 30 June 2025
The scheme commences on:
1 July 2014
Relevant facts and circumstances
You intend on starting a business which offers customers (commercial enterprises) a photovoltaic solar system (the system) under a purchase agreement (the agreement).
Under the agreement you will fund the purchase and installation of the equipment on the customer's premises.
The contract term will be for a specific number of years (the term).
You will meter the solar electricity produced and bill the customer based on an agreed tariff (based on $/KW).
At the end of the term, the solar equipment has little or no value to you, as there is no effective market for second hand systems in Australia.
The cost of removing the systems would most likely be greater than its value. Therefore you intend on either:
a) 'gifting' the system to the customer for no monetary consideration, or
b) selling the system to the customer for a nominal amount.
The Commissioner's determination of the effective life of a system is 20 years.
You believe that the effective life of the system installed under the agreement should be the term of the agreement.
Relevant legislative provisions
Income Tax Assessment Act 1997 Division 40
Income Tax Assessment Act 1997 Section 40-25
Income Tax Assessment Act 1997 Section 40-105
Income Tax Assessment Act 1997 Section 40-110
Income Tax Assessment Act 1997 Subsection 40-285(2)
Income Tax Assessment Act 1997 Paragraph 40-295(1)(a)
Income Tax Assessment Act 1997 Section 40-300
Income Tax Assessment Act 1997 Subsection 40-300(1)
Reasons for decision
Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997) deals with deductions for the cost of depreciating assets. Section 40-25 of the ITAA 1997 allows you to deduct an amount equal to the decline in value of a depreciating asset which is held for any time during an income year and used for a taxable purpose. A taxable purpose includes the purpose of producing assessable income.
Taxation Ruling TR 2014/4 Income tax: effective life of depreciating assets 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 is 20 years.
TR 2014/4 also discusses how the Commissioner determines the effective life of a depreciating asset, and where taxpayer may work out their own effective life.
How the Commissioner determines the effective life of a depreciating asset
TR 2014/4 states that the Commissioner makes a determination of the effective life of a depreciating asset by estimating the period the asset can be used by any entity for a specified purpose and if relevant for the asset:
a) assuming it will be subject to wear and tear at a rate that is reasonable for the Commissioner to assume
b) assuming it will be maintained in reasonably good order and condition, and
c) having regard to the period within which it is likely to be scrapped, sold for no more than scrap or abandoned.
In determining an effective life, the Commissioner considers the factors listed in the paragraph below. Where appropriate, each factor is considered on the basis of historical information and future expectations. No one factor is necessarily conclusive and the relative importance of each will vary depending on the nature of the asset.
The factors the Commissioner considers include:
physical life
manufacturing specifications/engineering information
use of the asset in a particular industry
use of the asset in different industries
industry standards
repairs and maintenance
retention period
obsolescence
scrapping or abandonment practices
lease periods
financial analysis, and
market value.
Working out your own effective life
The Commissioner only takes account of normal industry practice when estimating effective life. Taxpayers who choose to self-assess, however, can take account of their own particular circumstances of use (see section 40-105 of the ITAA 1997).
A taxpayer can recalculate the effective life of a depreciating asset if the effective life being used is no longer relevant because of changed circumstances relating to the use of the asset (see section 40-110 of the ITAA 1997). An example would be an unpredicted obsolescence such as more or less rigorous use of the asset than anticipated.
In your case, the circumstances relating to the use of the systems by customers over a contract period would be no different to usage of the same system by non-customers. Therefore it cannot be said that there would be more rigorous use of the system to allow a recalculation of the effective life of the systems.
Further a recalculated effective life must relate to the total estimated period the asset can be used by any entity for the purpose of producing income (assessable, exempt or non-assessable non-exempt). Therefore the effective life of the asset may include a period of time even if the taxpayer expects to dispose of the asset before its effective income-producing life is over.
As the system is able to be used by the customer to produce income after the contract period ends and after you dispose of the system, the effective life cannot be recalculated to less than the Commissioner's determination of the systems effective life.
Sale or disposal of the system
Paragraph 40-295(1)(a) of the ITAA 1997 states that a balancing adjustment event occurs for a depreciating asset if you stop holding the asset. This may happen where an asset is sold, lost or destroyed.
Balancing adjustment calculation
When a balancing adjustment event occurs for a depreciating asset, whose decline in value has been worked out under subdivision 40-B of the ITAA 1997, its termination value will be compared to its adjustable value to determine the balancing adjustment amount.
Whereas where the adjustable value exceeds the termination value, that amount will be allowed as a deduction (subsection 40-285(2) of the ITAA 1997).
Termination value
The applicable termination value will be determined by referring to section 40-300 of the ITAA 1997. In your case Item 1 of the table in subsection 40-300(1) of the ITAA 1997 applies. The termination value in this case is the market value of the asset when you stopped using it or having it installed ready for use.
If you 'gift' the system to the customer for no monetary consideration, the market value will be nil.
If the system is sold to the customer for monetary consideration, the market value will be the amount the system is sold for.
Adjustable value
Section 40-85 of the ITAA 1997 states that the adjustable value of a depreciating asset at a particular time is:
a) if you have not yet used it or had it installed ready for use for any purpose - its cost; or
b) for a time in the income year in which you first use it, or have it installed ready for use, for any purpose - its cost less its decline in value up to that time; or
c) for a time in a later income year - the sum of its opening adjustable value for that year and any amount included in the second element of its cost for that year up to that time, less its decline in value for that year up to that time.
In your case, the adjustable value of the machines at the time the balancing adjustment event occurred is its cost less the decline in value of the machines up to that time.