Tax allowances for tri-generation

rp_0000163330.jpgAuthor: Ruaan van Eeden (Cliff Dekker Hofmeyer)

The South African energy landscape has undergone significant changes over the last few years with the introduction of a number of private and public sector funded renewable energy projects, aimed at feeding power into the national grid and reducing reliance on coal-fired power stations for generating electricity. Further initiatives for energy efficiency (and not necessarily energy generation) have also been introduced to further assist taxpayers in reducing their energy footprint.

The generation of electricity from renewable resources such as wind, solar, biomass or hydro is not only directed at feeding power into the national grid, but is also utilised by a wide array of corporate taxpayers for their own use. Corporate taxpayers are also investing in innovative technologies to reduce energy consumption. All of the aforementioned could be combined into a so-called ‘tri-generation’ or a Combined Cooling and Heating Power (CCHP) plant, which generates electricity from a renewable resource and, as a secondary process, captures heat and produces chilled water for energy reduction. It may be more beneficial for a corporate taxpayer, in a typical office environment, to implement a type of CCHP plant, given its relatively compact nature as opposed to solar, wind and hydro energy generation, which generally require enormous expanses of land.

In its basic form, a CCHP plant utilises a fuel source in the form of a gas, which has been derived from biomass to ignite an engine which, in turn, will generate electricity through a generator. As a secondary energy efficiency process, heat from the CCHP plant will be captured and processed through absorption chilling technology to produce chilled water for use, for example, in cooling computer equipment (as opposed to using an air conditioning unit powered by electricity from the national grid). The CCHP plant therefore generates electricity from a renewable resource (eg biogas extracted from biomass such as plant material) and reduces energy consumption through absorption chilling technology. A crucial aspect to understand is that the fuel used to ignite the engine in a CCHP plant (eg biogas) needs to be extracted through a complex process utilising specialised machinery, as logic dictates that biomass in its raw form (ie leaves, wood chips, manure etc.) is fairly useless from a renewable energy and energy efficiency perspective.

As investment costs into CCHP plants are substantial, it is essential that taxpayers claim relevant and qualifying tax allowances to ensure the commercial viability of a renewable energy or energy efficiency program. In broad strokes, the most relevant tax considerations when it comes to renewable energy and energy efficiency fall under s12B and 12L of the Income Tax Act, No 58 of 1962. The main difference between s12B and s12L is that s12B is specifically directed towards the investment in assets which are to be used in the generation of electricity from renewable resources (ie solar, wind, biomass or hydro) as opposed to s12L, which is directed at the investment in technology that reduces energy consumption.  

Provided the requirements of s12B are met, a taxpayer is permitted to deduct the cost of qualifying assets (including structures of a permanent nature), used in the generation of electricity from renewable resources, on a 50/30/20 basis (ie three years). The aforementioned accelerated capital allowance under s12B provides a substantial incentive to invest in renewable energy programs – the often difficult question that arises is which assets are in fact used in the ‘generation of electricity’ and where does the process start, which must be determined based on the objective facts of each case and is very much dependent on the type of renewable energy utilised and the technology adopted. 

As stated previously in this article, in the case of biomass in its raw form, it is fairly useless and needs to be processed to extract a fuel (in this case biogas), which is used to ignite an engine situated within a CCHP plant. Taxpayers would need to pay careful attention and take appropriate tax advice in determining where the process of electricity generation from a renewable resource actually starts, as significant capital investments would likely be made at the front-end of a ‘tri-generation’ process, through the setting up of biomass processing facilities, as an example.

As a secondary process, a CCHP plant is used to produce chilled water through a process known as absorption chilling, which in turn brings energy efficiency (as opposed to electricity generation) allowances into play. Section 12L provides a qualifying taxpayer with an allowance for implementing technology resulting in measured and verified energy efficiency savings. Subject to certain compliance and registration requirements being met (not forming the subject matter of this article), the allowance under s12L is calculated at 45 cents per kilowatt hour or kilowatt hour equivalent of energy efficiency savings.

The difficulty with s12L is potentially two-fold in that a taxpayer would essentially only receive a once-off benefit in its first year of assessment, unless continuous energy efficiency processes are put in place year on-year. The costs incurred could possibly outweigh any benefits under s12L after the first year of assessment in which the allowance is claimed, which is mainly due to the calculation of the baseline from which energy efficient savings are measured. Secondly, there is a debate as to whether s12B and s12L are concurrent benefits, in other words, a taxpayer may not be able to simultaneously claim both allowances in relation to the CCHP plant and would possibly need to ‘make a call’ on which allowance is more beneficial from a tax perspective.

There is no doubt that, through proper planning and expert advice, renewable energy and energy efficiency programs adopted by taxpayers could be extremely tax efficient. National Treasury has recognised the need for stimulating the aforementioned sectors of the economy, but one senses even more could be done to assist in offsetting the enormous capital investments that must be made.  

As the renewable energy and energy efficiency landscape grows, more and more taxpayers will be utilising technology to reduce reliance on the national grid and further reduce their energy footprint (especially in an office environment). Tax allowances will no doubt play a crucial role in determining whether the South African renewable energy and energy efficiency landscape will be sustainable in the long term.