Private ruling: Deductions
Published: November 2014
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014 | Year ending 30 June 2015
Date scheme commenced: 1 July 2012

Ruling: Q1: Are the interest costs associated with your freehold block deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Are payments received from your electricity retailer for the generation of electricity from a solar system assessable income under section 6-5 of the ITAA 1997? | A2: Yes. | Q3: Are the costs associated with the solar system, such as maintenance and depreciation, deductible under section 8-1 or 8-5 of the ITAA 1997? | A3: Yes

Relevant facts and circumstances: You and your partner own a freehold rural holding. There is a house and one shed on the property. Each of these has their own power line and power account. Your freehold block is also used to store another entity's products in return for specified benefits that are returned on the other entity's land. These benefits produce a small periodic income but no profit since you engaged in it. On a shed on the same rural holding you are considering installing a solar power system that will feed directly back into the commercial grid, this will produce income. You will not finance this solar activity through a loan.

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 25-10 | Income Tax Assessment Act 1997 section 40-25

Reasons for decision: Summary: No deduction is available for interest costs in relation to your freehold block as the activity producing income is not carried-on within that block. The intended solar activity will produce assessable income and deductions will be available. | Detailed Reasoning - Freehold block: Section 8-1 of the Income Tax Assessment Act 1997 allows you a deduction for any loss or outgoing that is incurred in gaining or producing your assessable income, to the extent that it is not of a private, capital or domestic nature. Whether interest has been incurred in the course of gaining or producing assessable income generally depends on the purpose of the borrowing and the use to which the borrowed funds are put. Where a borrowing is used to acquire an assessable income producing asset, or relates to expenses of an assessable income producing activity, the interest on this borrowing is considered to be incurred in the course of gaining or producing assessable income. Paragraph 3(c) of Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith states; …the following general principles are relevant to the question whether interest is deductible under section 8-1: A tracing of the borrowed money which establishes that it has been applied to an income producing use may demonstrate the relevant connection between the interest and the income producing activity. Normally this would be the case for non-business taxpayers. It might also be the case where a business makes a specific borrowing which goes to the structure of the business - for example, where a business makes a large borrowing to fund an offshore acquisition. In your circumstances you borrowed funds to purchase a freehold rural property on which there is a dwelling that is not rented and with no plans it rent in the future. Your income producing activity is being carried on another property to which you have access. However the borrowed money is only demonstrated to be connected to your land and not to the income producing activity. | Detailed Reasoning - Solar: 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. | Detailed Reasoning - 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. 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 roof 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 2012/2 Income tax: effective life of depreciating assets provides a table listing the effective life of depreciating assets. In accordance with TR 2012/2 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.