Renewable Energy and Tax (Part 2) – Business Tax

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On 31 October, the Department for Energy and Climate Change announced a consultation on the Feed In Tariff for Solar pv installations which proposed to reduce the level of the Generation Tariff to just 21p per kWh, down from 43.3p, for any installations completed on or after 12 December 2011 – and this will be reduced even further, to just 9p per kWh, unless the building itself meets new energy-saving criteria. Anyone contemplating a Solar pv installation should factor these very significant reductions into their investment decision – see www.decc.gov.uk for further information. In this second of two articles we will look at some of the business tax aspects of renewable energy installations for property owners, principally for electricity generation.

If a rental business installs a renewable energy system, then the resulting income from the Feed In Tariff(s) or ’FIT‘ will generally be taxable. This is because the legislation basically acts to exempt from tax only income derived by individuals who are generating electricity for their own domestic needs.

So How Should it be Taxed in a Business?

We referred to HMRC’s Business income Manual (section BIM40520) in the previous article. The preceding section (BIM40510) talks about FIT taxation in a business context.  For both the main Generation Tariff and the additional Export Tariff, it says, “In general where the receipt is... in a business capacity... [it] will be a business receipt on normal principles.”

HMRC’s guidance refers to the taxation of grants and subsidies generally. Grants and subsidies may be taxed as income or capital or they may not actually be taxable at all, although that guidance clearly indicates that HMRC is satisfied that the Tariffs are (of course!) taxable.

The following factors are perhaps relevant:

1. The Tariffs are paid for the production of a commodity – electricity – generating an income stream dependent on the amount of electricity produced.

2. For most property businesses, the activity will be ancillary to the activity of letting property.

3. But some businesses may install on a large scale: they might have a number of properties, or potentially the nature of the land / property might be such that the income from renewables is substantial in relation to the corresponding rental income.

Property Income or Trading?

Some property investors will arguably have dealt with this issue already, albeit from a slightly different angle. Historically, HMRC has been very keen to treat most property businesses as investment activities for tax purposes. (See below).

This would be the case even when the level of activity required significant resources for decorating and maintenance, advertising for tenants, etc.

However, it was sometimes possible to ‘carve out’ such activity – traditionally into a property management company – which could stand on its own legs as a trading entity.

It seems fair to infer that a similar approach applies in the context of income from renewable energy installations. At one end of the spectrum it will make no difference so it would make sense just to treat the FIT as income from property; there may be a band where one might be able to arrange one’s affairs to suit; and at the opposite end of the spectrum the property income could be secondary to the income from ‘renewables’ and trading overall.

Capital Allowances – Good News and Bad News

Capital Allowances are available for property letting as well as for trades provided in either case that they are run on a commercial basis.

The good news is that HMRC accepts that electricity generating equipment may qualify for Capital Allowances so the business investor may claim a tax deduction for the installation cost.

However, there are a few points to bear in mind:

1. Capital Allowances are generally not available for installations ‘in’ a residential property (ignoring hotels and Furnished Holiday Lets) so it is broadly only commercial properties which may claim.

2. The government published a consultation document earlier this year which proposed from 1 April 2012:

a. To remove eligibility for the 100% immediate Enhanced Capital Allowances (www.eca.gov.uk) for any installations qualifying for FITs, and

b. To force all expenditure on plant eligible for FITs into the ‘special rate pool’ (only 8% a year from 2012) instead of the main rate pool.

3. There’s still the 100% Annual Investment Allowance – but that’s also being restricted from April 2012 to just £25,000, rather than £100,000 as now. That may be more than sufficient for a single installation, but investors with several commercial properties might want to weigh up spreading installations over a few years, against the falling total FIT income receivable for later installations outlined in the first article.

Is there any Benefit to Trading Status?

Trading status is generally perceived to be beneficial, due to the enhanced flexibility for utilising trading losses and the wide range of Capital Gains Tax (CGT) reliefs, such as Entrepreneurs’ Relief which reduces the tax rate on eligible disposals down to 10% from the usual 18% or 28%.

But in the context of renewable energy installations, the ‘fine print’ could significantly reduce the advantage of trading status:

1. Trading losses may be set against other income or capital gains, whilst normal property business losses can be set only against future property profits, after pooling. However, since 2008 this ‘sideways’ relief for trading losses has been capped at £25,000 a year for ‘non-active traders’ defined by HMRC as broadly those individuals (or partners) who spend less than 10 hours a week personally engaged in trading activities. It’s difficult to see how an individual could be ’actively involved‘ in electricity generation after the installation phase is complete, so it seems likely that even if trading status is achieved, sideways relief for losses will be capped at £25,000.

2. When it comes to Capital Gains Tax advantages and Entrepreneurs’ Relief in particular, if the trade also includes a substantial investment element then the relief may be forfeit. ‘Substantial’ is taken to mean ‘more than 20%’ for Entrepreneurs’ Relief, and it could be by reference to the value of assets applied for investment (the rental element) as against total assets including the renewable installation, or alternatively by comparing property income to total income including the FIT.

So Entrepreneurs’ Relief, whilst valuable, may be difficult to secure where the individual owns both the land/property and the renewable energy system, and intends to sell them together as a ‘job lot’. But the situation might be quite different if the installation were owned separately, such as through a company owned by the individual. This would also side-step the £25,000 ‘cap’ on losses, which doesn’t apply to companies. But it should be stressed that this scenario wouldn’t be appropriate for everyone – the FIT income would have to be significant to make it worth considering.

VAT and Installation of “Energy Saving Materials”

The installation of Energy Saving Materials (including solar pv systems, wind or water turbines, heat pumps, draught proofing and insulation) into residential accommodation, and certain buildings used for a charitable purpose, is subject to VAT at only 5%. This reduced rate applies to the combined cost of the materials and their installation. The rate applicable to installations in commercial properties is the standard rate of 20%.

Investors who are VAT-registered may not be too concerned about the rate of VAT which they are charged, as long as they can reclaim it all but for those who aren’t registered or cannot reclaim VAT it is important to bear in mind that the reduced rate only applies to installations: the standard rate of 20% applies to materials supplied separately.

VAT and Feed In Tariff Income

Property investors need to be careful with VAT and the FIT.

The larger Generation Tariff element of the FIT is paid simply for generating electricity, whoever ‘uses’ it. The Generation Tariff is not a supply for VAT purposes and VAT isn’t due.

The smaller Export Tariff element is payable on any electricity supplied to the National Grid. This is a ‘supply’ for VAT purposes and VAT-registered businesses will need to account for VAT on this element – although it will in most cases be a small amount, chargeable at only 5% rather than 20%.

The Renewable Heat Incentive (RHI)

The RHI is a tariff system and will run in parallel to the Feed In Tariffs for electricity, but the RHI applies to heating installations rather than electricity generation.

There have been significant delays in the introduction of the RHI and the details have not yet all been finalised. (At the time of writing, the latest forecast is for the scheme to be up and running by the end of November 2011 – and domestic installations will have to wait until at least Autumn 2012). However, it is expected to operate on similar lines to the FIT.

The RHI rates are much lower than for the FIT but should theoretically still give a higher rate of return for lower installation cost.

Eligible technologies include “biomass” which primarily means timber – but note that stove heaters are ineligible, although some domestic wood-fuelled boiler systems should qualify.

Installations completed after 15 July 2009 are eligible to enrol for the RHI provided they meet the criteria. The original proposed main rates for the most relevant residential property tariffs are below.