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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Private Finance Initiative (PFI): interest: non-trade: example 2

A private sector operator”enters into a PFI contract with a public sector purchaser, a local authority, to lease a fully equipped school to the purchaser for 25 years. In addition, the operator is to provide ancillary support services for the school, and the authorities existing schools, for the duration of the contract. The support trade commences immediately (see BIM64065). The operator builds the school on land it acquires for the purpose, the construction costs being financed by a bank loan. In return, the operator receives an annual service payment, the unitary charge.

Accounting period 1

Construction of the school is completed during the accounting period.

For tax purposes the design and construction costs of the school are capital expenditure. The extension is a fixed capital asset of the operator’s property business (see BIM64025 onwards). For accounting purposes the example assumes that the school 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 construction loan, are shown as debited direct to the fixed asset on the balance sheet during the construction period, at a figure of £75m representing cost.

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

A unitary payment of £15m is receivable in the first accounting period. The example assumes that £2m of the payment is for the provision of the school (property business) and £13m for the provision of support services (trading).

For accounting purposes the whole of the unitary payment is credited to the profit and loss account (see BIM64125). 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 £ 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 business income for services provided and no adjustment is required in the trading profits and property computations. The depreciation represents capital construction costs and non-trade interest, since the loan is for the construction of a property for a property business. Neither of these is an allowable deduction of the business for tax purposes (see BIM64295). The whole of the depreciation is therefore added back in the tax computations.

The interest is a non-trading debit to a fixed capital asset and the fixed capital asset or project rule (see BIM64295) applies. If there are no other non-trading credits or debits of the period arising from the company’s loan relationships, this creates a non-trading deficit which can, for example, be set off against any profits of the ompany for the deficit period.

Tax computation   Trading Income Property Income Non-trade deficit  
Income (net of depreciation) £12m        
Plus depreciation £ 3m        
Profit (before overheads) £15m £13m £2m (£5m)