Tax treatment of Feed-in Tariffs (FITs) scheme for small-scale low-carbon electricity generation. Feed-in Tariffs

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1 Tax treatment of Feed-in Tariffs (FITs) scheme for small-scale low-carbon electricity generation Feed-in Tariffs There are three financial benefits from FITs: Generation tariff the electricity supplier of your choice will pay you for each unit (kilowatt) of electricity you generate. Export tariff if you generate electricity that you don t use yourself, you can export it back to the grid. You will be paid for exporting electricity as an additional payment (on top of the generation tariff) Energy bill savings you won t have to import as much electricity from your supplier because a proportion of what you use you will have generated yourself Throughout this report Feed-in Tariff or FiT refers to the combined amount of generation tariff and export tariff, unless specified otherwise. Feed-in Tariff is taxable income Direct tax (income tax or corporation tax) Generally the feed-in tariff is taxable income for the individual or company receiving the income. For example if a company purchases and installs solar panels on its office roof, the FiT and the income from export tariff will form part of its profits, on which it pays corporation tax. Similarly if a landlord installs solar on a residential property that is let, the FiT and export tariff will be taxable as miscellaneous income on the individuals self assessment tax return. Any business or letting which is claiming tax relief on electricity costs will also have less tax deductible expenditure to the extent they are using self generated electricity. FiT taxable as business income The FiT will be taxable as business income if received by any: corporate entity (limited company, LLP, IPS etc), trading partnership or sole trade, individual or entity acting in a business capacity individual or entity carrying out the trade of electricity generation. If this creates additional income for an existing business, the FiT income will generally be considered other trading income and fully taxable as part of the profit of the business. However if a new business is created by the FiT income, then this income source needs to be registered with HMRC as a new trading business. In either case, the income will be subject to corporation tax or income tax and class 4 national insurance just as any other trading income. The income will also count as income for tax credit purposes.

2 Capital allowances on solar panels when FiT is taxable as trading income When FiTs are taxable as business income, a claim can be made for capital allowances for the cost of the panels. It should be noted that if FiTs are taxable this will either be because they are received as part of an existing business. Any claim must be for the net cost after deducting any grant received towards the cost of the panels. A of capital allowances is that any private use of plant and equipment will reduce the amount of capital allowances available. Capital allowances are claimed at 20% on a reducing balance basis (i.e. 20% of the cost in the first year, then 20% of the remaining 80% in the second year and so on) until such time as the capital allowance pool is less than 1,000 at which time the remaining allowance is given in full. Annual investment allowance (AIA) may be available. This is a special form of capital allowance giving 100% allowance (instead of 20% reducing balance) of up to 100,000 ( 25,000 from April 2012) subject to the AIA not being used on other capital purchases. Note that Solar Photovoltaics (PV) and wind turbines do not attract enhanced capital allowances (ECAs). Energy generating technologies are therefore outside the remit of the ECA Scheme which is for energy saving technologies. Capital allowances are not available to the extent that the purchase of equipment is grant funded. Also if there is a mixture of private and business use, the capital allowance claim will be restricted to the business proportion. Note that capital allowances are not available if there is not a trade. FiT taxable as miscellaneous income If the FiT is received by an individual acting in a personal capacity and: Either, the electricity generated is intended to be significantly (>20%) more than own domestic use Or, the installation is not at or near domestic premises occupied by the individual. This is then the worst tax position to be in. The income is not exempt and no capital allowances are available on the cost of the panels. It should be borne in mind that this is a relatively uncommon position to be in as it may be possible to take such a position and create a business from it, registering as trade generating electricity (see above section FiT taxable as business income) and then able to claim capital allowances. The income will also count as income for tax credit purposes.

3 Feed-in Tariff exemption from tax There is an exemption that applies from tax year from the tax charge where an individual generates electricity mainly for use in their own home. The actual exemption wording is found in Income Tax (Trading And Other Income) Act 2005 as amended by subsequent finance acts: Section 782A(1) No liability to income tax arises in respect of income arising to an individual from the sale of electricity generated by a microgeneration system if (a)the system is installed at or near domestic premises occupied by the individual, and (b)the individual intends that the amount of electricity generated by it will not significantly exceed the amount of electricity consumed in those premises domestic premises means premises used wholly or mainly as a separate private dwelling. microgeneration system means any equipment, apparatus or appliance for generating electricity or producing heat (a) which, in generating electricity or (as the case may be) producing heat, relies wholly or mainly on a source of energy or a technology mentioned below and (b) whose capacity to generate electricity or (as the case may be) to produce heat does not exceed electricity, 50 kilowatts; or in relation to the production of heat, 45 kilowatts thermal. Those sources of energy and technologies are (a)biomass; (b)biofuels; (c)fuel cells; (d)photovoltaics; (e)water (including waves and tides); (f)wind; (g)solar power; (h)geothermal sources; (i)combined heat and power systems; (j)other sources of energy and technologies for the generation of electricity or the production of heat, the use of which would, in the opinion of the Secretary of State, cut emissions of greenhouse gases in Great Britain. The exemption require the system to be installed at the home of the person receiving the income and for the electricity is intended to be mainly used at that home. HMRC guidance on when the exemption applies This exemption is aimed at domestic microgeneration which is primarily intended to match the generator's own home consumption needs. The term significantly exceed is not defined in ITTOIA/S782A and should be considered by reference to the particular circumstances. However, in general, a householder who does not intend to generate an amount of electricity more than 20% in excess of their own domestic needs is unlikely to be regarded as intending to significantly exceed the amount of electricity consumed in their own premises. No income tax will therefore arise on feed-in tariffs received by an individual from domestic microgeneration where the microgeneration system is located at or near their home and the individual intends that the amount of electricity generated will not significantly exceed their own consumption. The exemption may apply where an individual installs a microgeneration system at a property which is not the individual's main residence provided that the other domestic property is used by the individual, wholly or mainly, as a separate private dwelling and the other conditions for the exemption are met.

4 Mixed personal and business premises received in private capacity and tax exempt Where an individual occupies premises for both private and business purposes (e.g. bed and breakfast, farm house or home office) the FiT will be exempt from tax only if all of the following criteria apply: 1 the system is installed at or near domestic premises occupied by the purchaser 2 it is intended that the electricity generated will not be more than 20% greater than the electricity for the purchasers own domestic use. For this test, domestic use excludes business use electricity. 3 the person receiving the electricity is not providing a form of service or facility in connection with the electricity being generated. 4 the Feed-in tariff is received in a private capacity. This means that is must not be part of the business ordering system, bought in the business name, paid for by the business, advertised as part of the business or used for business purposes. If these conditions are all met then all of the Feed-in tariff will be tax free. This is reasonable in that the occupier of say a farm house or bed and bed breakfast should still have the opportunity to benefit from the tax exemption, as long as the criteria are met. In this case the actual electricity costs of the whole property (domestic and business use) will be less because of less electricity being imported. Also the overall cost will have to be reduced by the FiTs. It is then the net cost that will be apportioned between personal and business to establish the business deduction for electricity costs. Mixed personal and business premises not tax exempt To recap, the main reasons why the FiT is not tax exempt is that either it is received by a business, received in a business capacity, is used to create a business or is for electricity which is significantly more than personal use. In any of these circumstances the exemption does not apply and therefore the FiT is fully taxable. As per the above guidance: if the income is trading income capital allowances can be claimed if the income is miscellaneous income, capital allowances cannot be claimed. If the installation is at premises which are used for business and personal use (e.g. bed and breakfast, farmhouse or home office) then electricity generated might be used partly for business and partly for personal use. In the case the business use of the electricity generated needs to be calculated. The amount of capital allowance claimed is then proportioned as the business use percentage. Note, the FiT is still fully taxable, without proportioning.

5 Examples of mixed personal and business premises 1 Small system In a farmhouse the electricity use is 3,000kWh of which a claim has in past years been made of 1/3 business use. A solar system is then installed generating 2,000kWH of electricity per year. All points 1-4 under the heading Mixed personal and business premises received in private capacity and tax exempt above apply. Therefore this FiT income is exempt. 2 Medium system In a farmhouse the electricity use is 3,000kWh of which a claim has in past years been made of 1/3 business use. A solar system is then installed generating 2,500kWh (or more) of electricity per year. In this case the exemption does not apply as the intended generation (2500kWh) is significantly (more that 20%) greater than the domestic use (3,000 x 2/3 = 2,000kWh). The whole of FiT is therefore taxable. It would be then sensible to receive the FiT in a business capacity as part of the farm income of electricity generation. Capital allowances would be available on up to 40% of the cost (1,000 kwh used in the farm / 2,500kWh generated). If there were significant exported units then the figures would be altered to take account of those. 3 Large system If the farmhouse has a larger array installed generating 5,000kWh of electricity per year then this could be registered as a trade in its own right. A larger proportion of capital allowances would then be available. All electricity generated is either used in the business, exported to the grid or used domestically. The capital allowance proportion would be the total used in business or exported / total generated.

6 Indirect tax (Value added tax) Purchase of Solar Panels If you are VAT registered business you will be able to reclaim the VAT back on the purchase of your Solar Photovoltaics. This will be charged at 5% VAT if it has been installed on a residential property and 20% if installed on a business property. Please note that these rates will overrule any VAT rates if they are incorrectly quoted on the supplier invoice. It is important that the correct VAT rate is claimed otherwise this will mean that VAT reclaimed will be overstated. This should be reclaimed on your VAT return in the normal way. This has no consequence for private individuals or a non-vat registered business as they are not able to reclaim VAT from HMRC. If an individual is planning an installation that will include significant export of electricity to the grid then this, as outlined above, may be a business. If so then it is a requirement to register for the business. As a separate matter, it may then be possible with HMRC approval to register the business for VAT. However there is a stringent business test for registering for VAT which requires HMRC approval. If registered for VAT the VAT on the panels can usually be reclaimed. It is important to note that if the panels are then sold, gifted or assigned then VAT is very likely to be payable. Also if the business deregisters then VAT would be payable. The VAT input tax reclaim, whether as a new electricity producing business or part of an existing business, must be proportioned for any private use of the electricity generated. As outlined above for capital allowances, the proportion that can be claimed will be electricity used in business + electricity exported / total electricity generated. FiT income The generation FiT is a subsidy similar to that of a grant and as such is outside of the scope of VAT. No VAT therefore needs to be declared on the FiT income. This is the case if you are private householder, business owner or company. The export tariff is in respect of supply of electricity. As this is a supply it can be subject to VAT. It is not zero or reduced rate* VAT therefore it is standard rated for VAT. For a private individual this is of no consequence if they do not have a business activity. For a non-vat registered business the income will count towards the VAT threshold. For a VAT registered business the income is VAT inclusive and the relevant amount of VAT (export tariff x 20%/120%) must be declared on VAT returns. Important notice The above report is given as generally and publically available information not as tax advice. For specific circumstances it is strongly advised that professional tax advice is obtained prior to taking or refraining from any action.