This is the first of two articles which will look at renewable energy installations for properties. We will look at the kind of systems that could be installed in most domestic or small commercial properties, the ‘tax breaks’ for homeowners and compare the tax position for property businesses.
Why Renewable Energy?
The government is committed to promoting ‘green’ renewable energy and is offering significant financial incentives for people to install qualifying renewable energy systems in their properties.
This is primarily to help offset the significant up-front capital cost associated with renewable energy installations. Historically, take-up of renewable energy has been quite low because it is so expensive to install; even now, it can take more than a few years for a new system to pay for itself – even with the government’s contribution. However, the government contribution may last for up to 25 years, which is well past the anticipated ‘payback period’ of a normal system so in many cases it will more than pay for itself. The contribution is index-linked to compensate for inflation, and will be paid for a guaranteed period.
What Types of Renewable Energy Systems are There?
There are many different types of renewable energy installation. The more popular systems which could potentially be installed in most properties are:
• Solar photo voltaic (‘Solar pv’) arrays which turn sunlight into usable electricity;
• Wind turbines to generate electricity;
• Solar thermal energy systems which use sunlight to heat water ‘directly’; and
• Air and ground source heat pumps which take heat energy from the external environment to heat water.
There are also small-scale hydro-electric systems and bio-energy systems but these are relatively unusual. Strictly, wood-burning systems also count as ‘greener’ energy (i.e. greener than burning fossil fuels like coal or gas) and we shall touch on this later.
So what are the Financial Incentives for Electricity?
When considering the financial incentives, we shall be focusing on “Microgeneration” installations – broadly those which generate up to 50 kiloWatts an hour (kWh). This is substantially more energy than a normal residential property uses, although larger multiple occupancy dwellings and commercial properties may well have higher energy requirements. To put things in perspective, as a general guide a standard solar pv installation for a normal-sized house would generate about 2-3kWh in optimum sunlight – which is roughly half the energy a family might need over a year.
The government incentive is known as the “Feed In Tariff” (“FIT”) and it breaks down into two elements:
Incentive 1: The Generation Tariff
This is the main contribution and it is paid for just generating electricity, regardless of whether it is consumed by the property or sold back to the National Grid. The Generation Tariff can be as high as 43.3 pence per kWh. The amount of the Generation Tariff depends on various factors, such as the category and size of installation.
Here is a table which sets out details for some categories of installation for systems installed and registered before 31 March 2012:
System Size Generation Tarrif (p/kWh) Tarrif Lasts For (Years)
Solar PV (new) Up to 4kW 37.8p 25
Solar PV (old) Up to 4kW 43.3p 25
Solar PV Up to 10kW 37.8p 25
Solar PV Up to 50kW 32.9p 25
Wind Up to 1.5kW 36.2p 20
Wind Up to 15kW 28p 20
Hydro-electric Up to 15kW 20.9p 20
(New = New build; Old = Fitted to exisiting building)
There are other categories and sizes but the ones in the table above are perhaps most relevant.
So, fitting a solar pv system to an ‘old’ house – one that’s already been lived in as against a brand new development – will yield a Generation Tariff of 43.3 pence per KWh of energy produced, for the next 25 years – and the Tariff is linked to the Retail Price Index so it should be ‘inflation proof’.
However, these rates are only available for systems installed and operational before 31 March 2012: each year the tariff rate applied to systems newly registered in that year is reduced on the basis that, as more people adopt qualifying renewable energy systems the installation cost will fall, so less government ‘compensation’ is required.
Incentive 2: The Export Tariff
The Export Tariff is paid for any surplus electricity which is sold to the National Grid. The Generation Tariff is always paid but the Export Tariff only applies to electricity which isn’t used on site. The Export Tariff is the same for all types of system.
The minimum price or ‘floor price’ for the Export Tariff is set at 3.1 pence per kWh for the current year to 31 March 2012 and it is also index-linked to rise with inflation. However, it is (theoretically!) possible to negotiate a higher rate for exported electricity with your supplier: the Export Tariff is the minimum which the supplier has to pay for the surplus electricity provided to the National Grid.
Note also that initially, many systems will not have the ‘smart meters’ required to measure the amount of electricity actually exported to the National Grid and if that is the case, it is assumed that 50% of the electricity generated is eligible for the Export Tariff. This may be unfair to people who, for instance, work during the day and don’t use most of the electricity they generate – but they can always install a ‘smart meter’ to measure the precise amount exported, if they wish.
Incentive 3: Pay for Less Electricity!
If a property is generating its own electricity then it will need to buy less so it will save on energy bills. Energy prices are expected to continue to rise, so the comparative saving should in turn become more significant over time.
So What do All the Incentives Add Up To?
Broadly, an average residential property could expect to earn/save between £900 and £1,100 a year. The initial cost may be between £10,000 and £15,000 – there are cheaper systems but take care because they may well generate less electricity than average, so the return may well be lower.
What are the Tax Implications for the Tariffs?
Many people will have heard that the Tariffs are “tax-free”. This will be the case for most people installing renewable energy systems in their own homes. But this favourable treatment is aimed at homeowners installing systems for personal use so the Tariffs are unlikely to be tax-free for businesses – including property businesses.
Income Tax – The Basics
Legislation was introduced in 2007 specifically to exempt income arising to individuals for the sale of electricity generated by domestic Microgeneration, provided:
• The system is installed at or near the “domestic premises” (i.e., a separate private dwelling) occupied by the individual, and
• the individual intends that the electricity generated should not ‘significantly exceed’ the amount consumed in those premises
Further guidance can be found at HM Revenue & Customs’ Business Income Manual BIM40520. In that section they explain that they will usually treat the phrase “significantly exceed” as applying only in cases where the individual intends that the electricity generated will exceed home consumption levels by more than 20%. Given that broadly, a standard size installation may contribute only up to half of a family’s annual electricity requirement, it is expected that the vast majority of domestic installations will enjoy tax-free income. A property doesn’t need to be the individual’s only or main residence in order to qualify as “domestic premises”; so long as the property is occupied as a separate private dwelling that should suffice.
The wording of the exemption does seem to allow for scenarios where the resident(s) don’t directly use the electricity they produce – perhaps because they go out to work when the solar pv array is generating electricity and therefore use mostly use ‘normal’ mains electricity from the National Grid when they come home in the evenings. The exemption requires that the amount generated is primarily intended to match the amount consumed in the domestic premises; not that most of the electricity is consumed in those premises. So as long as the installation doesn’t generate far more electricity than is used in the home overall, the income should still be tax-free.
However, businesses will not be able to enjoy the tax exempt status available to homeowners. They will be taxed according to normal principles. We shall look at how those principles are applied in the second article.
Capital Gains Tax – The Basics
Here again, homeowners will generally enjoy favourable treatment: where the installation is fixed to a person’s only or main residence it will be treated as part of the property and should therefore be eligible for the corresponding relief on sale.
Even where the Capital Gains Tax “only or main residence” relief is not available, the installation will be a “wasting asset” (whose expected useful life is less than 50 years) and will therefore be exempt.
But businesses cannot benefit from the ‘wasting asset’ exemption in most cases. This is because, where the business has claimed, or could have claimed Capital Allowances on eligible plant or machinery, then the wasting asset exemption is ignored and any surplus over original cost may be subject to Capital Gains Tax.
The capital outlay for such systems is very substantial, so careful consideration is strongly recommended.
Having said that, the level of the Tariffs is intended to result in a “return on capital invested” of about 8% - which appears to be most favourable.
In the second article we’ll look in more detail at the business tax implications of renewable energy installations, including Capital Allowances, VAT and Capital Gains Tax.
By Lee Sharpe