Maximize microFIT profitability
Disclaimer: I am not an accountant and I did not receive a validation of this information from Canada Revenue Agency (CRA). I contacted CRA via an open letter, published here a few months ago, trying to get their guidance on this matter. As of May 7 2010, I received no response from the agency. Use at your own risk
Here are a few (obvious) thoughts on how to position your microFIT project for profitability. Yes, despite all the advertising that is coming out, 15% return on your investment is far from being a foregone conclusion. If at least two of the three strategies below are not applied, it is easy to lose money with microFIT.
First – buy solar panels in the USA; don’t buy turn-key solar systems in Ontario
As of May 2010, microFIT consulting companies are still quoting around $10/watt for simple installations. They are charging approximately 300% markups* on solar panels and will tell you that you are breaking even around year 10. This guidance is also coming out from OPA, potentially as a result of market price studies. This is wrong. (* I am not suggesting that ALL consultants have lofty markups, but I have not seen any sensible proposals yet. If you are in this business and can correct me, your feedback would be very helpful).
Get your panels in the States or China, and find a contractor who is willing to do the rest of the project, without selling you their own panels. Get inverters too, if you can. Mounting is cheap(er) and heavy, and to control transportation costs it would be better sourced in Ontario (also don’t forget about domestic content requirement of 40% in 2010).
The biggest portion of the project cost, about 30-40%, is in solar panels, so by controlling your cost in just that one area you will make the biggest impact on your bottom line. After a few months of research I am convinced that this is the only way to do microFIT in Ontario, until solar consulting companies come back to their senses. Getting panels in China should be slightly cheaper but don’t count on being able to buy retail – they want to deal in container quantities. Our neighbors South of the border is the obvious destination for retail quantities (in person or over the internet).
Second – avoid financing at all costs; unless you have access to lots of (very) cheap money
Avoid financing at all costs, or figure out where to get cheap cash and pay it back as quickly as you can. Time = money, for the bank. Money for the bank comes out of your microFIT revenue. No brainer. 8-9% rate is absurdly high for microFIT to be a successfull project, 3-6% is obviously better but may be very hard to come by.
MBNA credit cards are known to offer 0.99% cash loans for 8-9 month periods or so, with a 3% transfer fee. If you happen to have one of those, with a steep credit line, this may be a great way to boost solar capacity, but be prepared to pay it down or transfer elsewhere before the rate goes back out into stratosphere.
Third – use your business; claim CCA deductions and HST credits to minimize income tax
Use your business to register with OPA, electricity company, pay for the installation, and collect microFIT payments (with HST). If you don’t have a business, register it. Doing this under your business potentially brings several advantages:
- Most importantly, cost of the project becomes your business expense, which is claimed against income. More specifically, cost of equipment can be depreciated, presumably as Class 8 equipment, at 20% annual rate. Example: you pay $20,000 for microFIT installation, this becomes your capital, which loses value over time (panels age, become obsolete, lose efficiency, need replacement). In recognition of this fact, businesses are allowed to claim reduction in capital value as a business expense. This would amount to:
- $2,000 in the first year (10% of 20,000 in the first year), balance $18,000
- $3,600 in the second year (20% of 18,000), balance $14,400
- $2,880 in the third year (20% of 14,400), balance $11,520
- $2,304 in the forth year (20% of 11,520), balance $9,216
- $1,843.2 in the fifth year, etc, until capital cost becomes negligible
- $20,000 installation done with a solar contractor (and overpriced panels) should be able to bring in around $1,700 per year in microFIT payments. Your “business” will continue to be cash flow negative in this example, until year 6, in which capital cost allowance (expense) becomes less than microFIT revenue (income). When this happens, you start being profitable, and income taxes will become due, BUT ONLY FROM THE PROFIT PORTION… so in year 6, your income tax will be close to $0, and will start climbing gradually as capital cost allowance continues to decrease… BUT! business losses from previous years can be carried forward and offset future profits, which kicks the income tax can that much further down the road. Get a good accountant to advise you on this setup, because when done right, it can make your day very bright. $100,000 dollar question here is, will CRA allow this setup in principle – I will repeat, that I have not received a reply from the government on this, yet.
- When income tax on your microFIT payments eventually does kick in, hopefully many years down the road, your income tax in incorporated scenario is only 18% as of 2010; not freakin’ 40%. This setup effectively ensures that you get your money back from your investment, BEFORE government starts to collect taxes on what is becoming an investment gain after the break-even point. That’s pretty fair.
- True, being incorporated attracts maintenance fees that you will be likely paying to your accountant, say $600-$1200 a year. But if the company just does microFIT and nothing else, the effort of yearly filings will be minimal and that potentially can be taken into consideration by your accountant.
- Also true, that retained earnings in the company are company’s money, until you either pay yourself a salary (and get hosed with that 40% personal income tax), or if happening after the current year, dividends. Dividends are currently taxed at 8%, I think… and unlike salary, dividends paid is NOT an expense to the company, it is an after-tax distribution of assets. So choose: pay 30-40% personal income tax, or 26% corporate tax + dividend tax. But either way, only company would allow you to shelter revenue from income tax until capital costs are written off.
- Since your business project is located on the roof of your personal property, in theory it should be possible to prorate home and mortgage costs relative to the area of the house, and write off this prorated portion against microFIT business expense. It remains to be seen, if such method gets permitted. If it gets a nod, micrFIT income will become practically tax-free. But once again, it is based on having a company.
- If HST works the same way like GST does today, which the government already announced that will be the case, buying the project under your business becomes even sweeter. Assume that this business makes only microFIT income. That translates, in our $20,000 example, to $1,700/year. In terms of HST, you will be required to collect from OPA $221, on top of $1,700. Instead of remitting full $221 amount back to the government, as a business you would claim your HST expenses against that amount, before remitting it. If you come up with more HST payouts, then HST receipts, guess what… The government owes you some HST back. In the first year, you are going to drop $2,600 in HST on the $20,000 project. As you continue to write off your capital cost allowance as shown in #1 above, you will claim progressively less HST against receipts from OPA. HST on capital goods is claimed on the allowance you deduct that year; you can’t claim full $2,600 HST hit in year one. So in the first year we are claiming $2,000 CCA, so HST on that amount is $260. Bingo, instead of remitting $221 HST we collected to the government, we instead collect $39 back from them. Second year, $221 – $468 = ($247), so we collect even more HST back. What this essentially means, is that our solar project will be sales-tax free. We are going to claim HST paid on labor in the first year, and HST paid on capital goods (durable portion of the project) over the next 5-10 years. This would not be possible without a business.
- Needless to say, any other maintenance or repair expenses related directly to the microFIT installation will be written off against microFIT income and HST.
Now, if CRA only responded to this letter to confirm that this will be allowed…
I will follow up in the next few days with comparative analysis of using these strategies vs. not using these strategies, with numbers and charts from RETScreen.