Embedded Networks - Some Tax Issues To Consider1 May 2018
Outline of an Embedded Network
Whether embarking on a new development project, or making revisions to your existing building, there’s a lot that goes in to making even the most minor decisions. So, when it comes to making key choices like installing an embedded network, make sure you read up and have all the facts. In this recent piece, Tony Nunes, Senior Client Director at prominent Sydney accountancy firm Kelly + Partners, shares an interesting perspective on tax considerations that may apply to embedded electricity networks and some important factors to be aware of if you have, or are considering having an embedded network installed – read his insights in the full article below.
Embedded electricity networks are becoming more and more common in strata buildings and are starting to spread to other services such as gas, hot water, air conditioning, internet access and storm water. In broad terms an embedded network is where there is a “parent” or “gate” meter between the infrastructure forming the national electricity grid and the meters of individual lot owners. This effectively creates a private network, known as an “embedded network”, through which an “embedded network operator”, acquires energy supplied by an authorised retailer and on-sells electricity to “embedded network customers”. Although there can several different configurations of an embedded network, in this article we will highlight some of the tax considerations that apply to an embedded electricity network that exhibits the following features:
1. The embedded network is a system where the Parent Meter measures all the electricity used by a body corporate complex.
2. The embedded network consists of each participating lot having its own meter which is read by a third party. The body corporate then bills the occupier of each lot for energy usage at an agreed rate which is generally comparable to the market though can be lower than what the occupier would pay on the open market.
3. The electricity is supplied to the lot occupier who has the obligation to pay for electricity used. The lot occupier could be a strata unit owner or, where the unit has been leased by the strata unit owner, a tenant.
4. In some cases, the body corporate incurs the capital expenditure in establishing the initial infrastructure of the embedded network and the body corporate provides the funding to the lot owner. The costs incurred by the body corporate may be recovered by an increased electricity charge. It is possible that repayments are made to a commercial finance arrangement from income generated from the embedded network.
5. The electricity meters are owned by the strata plan/lot owners and not by the electricity supplier.
6. The body corporate may levy the lot occupier a special administration fee for the management of the electricity accounts.
7. All unit owners must participate in the scheme once it has been approved by the body corporate.
Taxation Aspects of an Embedded Network
1. Is the income received assessable or non-assessable income?
The body corporate will incur a cost of electricity payable to the external supplier. This cost is offset by the electricity income received by the body corporate from owners or lot occupiers in relation to the electricity purchased from the body corporate for use in the individual strata lots. To determine the correct treatment of the income received by the body corporate a distinction must be made between the payments for electricity made by the lot owners and payments for electricity used by other lot occupiers.
The profit made by the body corporate on the on-sale of electricity to lot owners should be captured by the principle of mutuality and would not be taxable income of the body corporate (however see further below). The administration fee received from lot owners should also be considered mutual income of the body corporate.
Any payments from the strata’s tenants (that are not lot owners) to the body corporate are taxable income of the body corporate, irrespective of whether the payments relate to the electricity used in the individual strata lots or common property electricity usage or if it is the administration fee charged to them. Any external receipts by the body corporate cannot be considered “mutual dealings” and are thus taxable.
A deduction may be available to the unit owners based on the amount paid to the body corporate for such electricity purchased from the body corporate. Where strata plans that are installed with Parent Meters only or strata plans that estimate occupier’s electricity usage based on some formula, the allocation of income (and associated expenditure) in respect of utilities services provided in these strata plans should be accepted by the ATO, provided such allocation has been done on a reasonable basis.
2. When can the Body Corporate have a tax liability on receipts from lot owners?
To determine which entity (i.e. lot owner or body corporate) is required to include the assessable income from electricity charged to occupiers and is able to claim the relevant deductions for the expenditure incurred in respect of the electricity meters, it is necessary to determine whether the electricity meters are “personal property” of the body corporate or “personal property” of the lot owner or “common property”.
If the electricity meters are personal property of the body corporate or common property, any income derived from lot owners is subject to the principle of mutuality and not assessable to the body corporate (as noted above). In contrast, where an individual sub-meter is installed, even if it is located in the common property and where it only serves a particular strata unit and measures the specific usage by the individual lot, the individual sub-meter is likely not common property and not personal property of the body corporate. As the sub-meter is not common property, nor is it personal property of the body corporate, income (and related expenditure) may not be assessable (nor deductible) by the body corporate.
If the body corporate receives income from such electricity usage, it is likely that this is not mutual income as it relates to a transaction with an individual strata lot owner. The terms of the electricity service being provided would need to be reviewed in these situations to determine whether the installation of the submeter impacts whether the provision of the electricity service is to the body corporate or the individual lot owner. This could impact the tax liability of the body corporate and the lot owner in these situations. The administration fee, however, is likely to continue to be considered mutual income of the body corporate.
3. Can deductions be claimed for the cost of electricity meters?
A deduction for electricity meters is only allowable when the strata plan is the “holder” of the electricity meter. We would recommend that each strata plan review its own specific situation, prior to informing strata unit owners of their entitlement to a tax deduction for expenditure or a tax depreciation deduction, as a distinction should be made between electricity meters that are the body corporates’ personal property, meters that are common property and electricity meters that are a particular unit’s sub-meter. (We note that in some cases the “holder” of the electricity meters is the electricity supply company and it is the electricity supply company that is entitled to claim the tax depreciation deductions for the meters.)
Where the cost of an individual meter is less than $300, or the cost of the head meter apportioned to a unit holder is less than $300, an immediate deduction may be available to the lot owner. Alternatively, tax depreciation may be claimed by the body corporate or the individual strata lot owner.
4. What other matters should be taken into account?
- Strata plans should independently review the details of the embedded network to confirm the allocation of the tax liability.
- Strata plans should maintain records with sufficient detail on the income derived from electricity sales for each lot and income related to electricity expended on common property. This information should be provided to unit owners soon after 30 June each year so that owners can properly complete their income tax returns.
- Strata plans should ensure that proper records are kept of any expenditure. If possible, distinguishing between expenditure incurred in respect of common property, the body corporate’s personal property and expenditure for a particular unit’s sub-meter.
These issues are complex and often require an analysis of the legal agreements and transaction documents to determine the tax outcome for each party. It is best if you get tax advice on these issues upfront prior to having an embedded network installed. However, if you already have an embedded network installed, your transactions should be reviewed, sooner rather than later.
Kelly+Partners specialises in property development and strata management. Our Tax Consulting team works closely with strata owners and strata managers to help plan, review and manage taxation issues. We add value to our clients by working with them to proactively manage tax risks and by structuring transactions in a tax effective way.
Tony Nunes, Senior Client Director - Kelly Partners Tax Consulting Pty (Ltd)
Please note the information herein is general in nature. It does not constitute tax advice. As different states have different rules of ownership, the tax outcomes in your state may be different to what is noted herein. As this is general information only, specific advice should be obtained in relation to particular circumstances.