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HMRC internal manual

Business Income Manual

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Private Finance Initiative (PFI): interest: trade: example 6

A private sector operator, already carrying on a trade of running prisons, enters into a PFI contract with a public sector purchaser, to provide a specific number of additional prison places for 25 years. The operator builds an extension to its existing prison on land acquired for the purpose, financed by a bank loan. In return the operator receives an annual service payment, the unitary charge, which commences after the extension has been completed.

Accounting period 1

Construction of the extension is completed at the end of the accounting period.

For tax purposes the design and construction costs are capital expenditure (see BIM64025 onwards). For accounting purposes the example assumes that the extension is reported as a fixed asset on the operator’s balance sheet, under FRS5 Application Note F (see BIM64070 onwards). The construction costs, including £5m interest on the loan, are shown as debited direct to the fixed asset, at a figure of £75m representing cost.

Dr Fixed asset (construction costs and interest) £75m Cr Bank £75m
           

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 £5m interest is debited to a fixed capital asset and so the fixed capital asset or project rule (see BIM64245) applies. The £5m interest is therefore an allowable deduction in the trading profits computation for the accounting period. The example assumes an accounting profit of £10m.

Trading income computation  
   
Profit (P&L account) £10m
Less interest £5m
Profit (before overheads) £5m

Accounting period 2

In the next accounting period a unitary payment of £15m is receivable in respect of the additional prison places. 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 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 £3m depreciation represents capital construction costs and trade interest that has already been relieved for tax purposes in accounting period 1. Neither of these is an allowable deduction of this, or any future, accounting period for tax purposes. The whole of the depreciation is therefore added back in the trading profits computation (see BIM64130).

 

Trading income computation  
   
Income (net of depreciation) £12m
Plus depreciation £3m
Profit (before overheads) £15m