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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Private Finance Initiative (PFI): interest: pre-trading: example 1

A private sector operator enters into a PFI contract with a public sector purchaser to lease a fully equipped hospital to the purchaser, and provide non-clinical support services, for 25 years. The operator constructs a hospital on land acquired for the purpose, financed by a bank loan. The trade commences when the hospital is completed (see BIM64065). In return the operator receives an annual service payment, the unitary charge, which commences after the trade has started.

Accounting period 1

The hospital is completed at the end of the first accounting period.

For tax purposes the design and construction costs are capital expenditure. The hospital is a fixed capital asset of the operator’s property business (see BIM64025 onwards). For accounting purposes the example assumes that the hospital 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 at a figure of £75m representing cost.

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

The interest is debited to a fixed capital asset for accounting purposes and the fixed capital asset or project rule applies (see BIM64295). An election under BIM64325 is not possible, since the loan is for the construction of a property to be used in a property business. The £5m interest is therefore a non-trade debit of the accounting period. 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.

Non-trade deficit (£5m).

Accounting period 2

The trade commences at the beginning of the second accounting period. A unitary payment of £15m is receivable. The example assumes that £5m of the payment is for the provision of the hospital (Property income) and £10m for the provision of support services (Trading).

For FRS5 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 in the profit and loss account, subject to any over-riding statutory or case law principle.

The £15m is income and no adjustment is required to the trading and property income computations (see BIM64125). The £3m depreciation represents capital construction costs and non-trade interest that has already been relieved in accounting period 1. Neither of these is an allowable deduction of this, or future, accounting periods for tax purposes. Therefore the whole depreciation is added back in the property business computation (see BIM64130).

Tax computations   Trading Income Property Income
Income (net of depreciation) £12m    
Plus depreciation £3m    
Profit (before overheads) £15m £10m £5m

If the non-trade deficit has not been used in the previous accounting period, it can be carried forward and set off against the property income profit.

Capital allowances can be claimed on qualifying expenditure (see BIM64375).