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What the State Giveth, the Feds Taketh Away

By Gerald Arends

Changes to an ATO Public Ruling impact State-based and federal support for renewable energy.  State governments need to restructure support mechanism and ensure support mechanisms can achieve their stated aims.  Projects need to consider the tax implications of grant funding in their commercial structures.  

The background

For many years, renewable energy developers that applied for government funding in the form of capital contribution (e.g. from ARENA) had to deal with the tax implications of grant funding received.  At first pass, grant funding is ordinary income and taxed in the year of receipt.  

Renewable energy assets are of course long-term assets and are – in the case of solar farms – depreciated over 20 years.  These assets also have a relatively low operating cost which means that the tax treatment of upfront grant funding and the subsequent receipt of depreciation benefits become important commercial considerations for the project financial model.  

The world we knew

If a special purposes vehicle (an “SPV”) received grant funding during the development and construction of a renewable energy asset, such grant funding was treated as ordinary income in the year of receipt.  The SPV would typically not be able to “expense” development and construction cost against that income as development and construction cost are “capital” in nature and need to be amortised over 20 years. 

Until late 2018, the SPV could have relied on Subdivision 20-A of the Income Tax Assessment Act 1997 (the “ITAA 1997”) and would normally seek further certainty through a private tax ruling.

While grant funding is and should remain taxable, the timing of those tax implications can make or break a project

Subdivision 20-A allows, effectively, to spread grant funding over the depreciation period of an asset, in our example 20 years.  This ensures that, while the grant funding is received up front, it is tax effective in the same period as the depreciation benefits are available and that means that the depreciation benefits can be used to offset the tax liability.  It is important to note that Subdivision 20-A was not a mechanism to avoid taxation, but a reallocation of the timing of that income to align with the operating life and depreciation period of the asset. Else, grant funding would be taxed upfront with later depreciation benefits not being able to be carried back. 

What the industry was not aware of

The detail of the operation of Subdivision 20-A is managed under public tax ruling “TR 2006/3 – Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business” (“TR 2006/3”).  

In late 2018, TR 2006/3 was amended with two crucial provisions:  First, a new paragraph 15A of TR 2006/3 stipulates that a “government payment to industry” (“GPI”) paid with the intention of funding the cost of building or constructing a substantial capital asset, is typically assessable as income under section 6-5 (i.e. in the then-current year) as it is derived in the course of carrying on a business. 

The critical consideration here is that it brings forward what is considered to be the ordinary course of business for the purposes of taxation.  In our example of a solar farm, the “business” in a narrow sense is generating electricity and selling that electricity and large-scale generation certificates (LGCs).  The ATO is now (and this is a broader trend) taking an expansive view of what the business of an SPV is and effectively brings elements of establishment cost into the purview of “ordinary course of business”. 

This would be unproblematic of course, if the ATO then also allowed the expensing of development and construction cost during that establishment phase, but we are not aware of such leniency!  A consequence of this paragraph 15A is the federal government taxing grant funding provided out of State budgets.

Changes to the TR 2006/3 can be described only in one way:  What the State Giveth, the Feds Taketh Away

The second provision is example 8A (paragraphs 54A and 54B) provided in TR 2006/3 which uses the example of a renewable energy developer establishing an SPV that benefits from a GPI and draws this down to fund construction work. 

Example 8A uses some very specific facts, namely a situation where the GPI is transferred outright, but then subject to a SPV/government joint signatory account.  This speaks to a kind of “lock box” arrangement that is not commonly seen in government funding agreements.  What stands out here is that example 8A is very fact specific but seems to serve to support a more general principle.  

Why it does not matter (for the moment)

At present, the Covid 19-related federal instant asset write off and the ability to perform a loss carry back for any assets (including renewable energy assets) that are “installed ready for use” by 30 June 2023 means that the 2018 changes to TR 2006/3 have little practical impact on projects, other than cashflow disadvantages. 

Why it will matter in the future

While policy change may be desirable, it will require a very significant effort to mobilise sufficient subject matter expertise and opinion to achieve a reversal of the 2018 changes to TR 2006/3. 

In the meantime, project proponents will need to adjust to this new reality and, if a project anticipates that it will not be “installed ready for use” by 30 June 2023, it will need to consider the implication of taxation.  If considered early and adequately, projects can be structured to accommodate the tax position that is expressed in TR 2006/3.  

Pegasus Legal is a boutique law firm with an exceptional level of expertise in the renewable energy sector. Our lawyers have worked on a large number of solar, battery, biomass and wind projects in a wide range of countries. For further information please contact director Gerald Arends.

Pegasus Legal partners with Komo Energy to provide distributed energy project development services with a particular focus on mid-scale solar and battery deployment in regional areas.

Pegasus Legal has worked closely with Pilot Partners on the tax treatment of grant funding for a number of renewable energy projects.  

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