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HMRC internal manual

Business Income Manual

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Private Finance Initiative (PFI): interest: trade: example 2

A private sector operator, whose trade includes the provision of design, construction and maintenance services, enters into a PFI contract with a public sector purchaser, to build a road and maintain it for 25 years. The construction costs are financed by a bank loan. The trade commences when the PFI contract is signed (see BIM64065). In return the operator receives an annual service payment, the unitary charge, which commences after the road is completed.

Accounting period 1

Construction of the road is completed at the end of the first accounting period.

For tax purposes the design and construction costs are revenue expenditure (see BIM64025 onwards). For accounting purposes the example assumes that the road is reported as a fixed asset on the operator’s balance sheet, under FRS5 Application Note F (see BIM64070 onwards). The £5m interest on the loan is debited to the profit and loss account and subsequently capitalised (see BIM64245).

Dr P&L account (interest) £5m Cr Bank £5m
           
Dr Fixed asset (capitalised interest) £5m Cr P&L account £5m

No income is receivable in the first accounting period.

For tax purposes we follow the accounting recognition of income and expenditure in the profit and loss account, subject to any relevant over-riding statutory or case law principle.

The accounting period in which relief is given for the £5m interest is determined, under the loan relationship legislation, by the fact that it is capitalised to a fixed capital asset for accounting purposes (see BIM64245). A deduction is therefore included in the trading profits computation.

Trading income computation  
   
Income (net of interest debits and credits) £0m
Less interest £5m
Loss (before overheads) (£5m)

Accounting period 2

In the second accounting period a unitary payment of £15m is receivable.

For accounting purposes the whole of the unitary payment is credited to the profit and loss account. Depreciation on the fixed asset, calculated at £3m, is also debited to the profit and loss account.

 

Dr Bank £15m Cr P&L account £15m
           
Dr P&L account (depreciation) £3m Cr Accumulated depreciation account £3m

For tax purposes we follow the accounting recognition of income and expenditure in the profit and loss account, subject to any over-riding statutory or case law principle.

The £15m unitary payment is trading income for services provided and no adjustment is required in the trading profits computation (see BIM64125). The depreciation represents revenue construction expenditure and interest. To the extent that it represents construction expenditure it is an allowable deduction (see BIM64130).

However, the interest debit to the fixed asset relates to the first accounting period and relief has already been allowed for tax purposes. Therefore, to the extent that the depreciation represents interest, it is added back in the trading profits computation (see BIM64245). For this purpose, the interest is spread over the period to which it relates, normally the length of the contract, and is added back in line with the rate at which the asset is reducing. For the purpose of the example, this is assumed to be on a straight-line basis.

 

Trading income computation  
   
Income (net of depreciation) £12,000,000
Plus Interest (£5m/25) £200,000
Profit (before overheads) £12,200,000