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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 2

A private sector operator enters into a PFI contract with a public sector purchaser to provide a specified number of fully supported prison places over a 25-year period. The operator constructs a prison on land acquired for the purpose, financed by a bank loan. The trade commences when the prison is ready to accept its first prisoner (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 prison is completed at the end of the first accounting period.

For tax purposes the design and construction costs are capital expenditure. The prison is a fixed capital asset of the operator’s trade (see BIM64025 onwards). For accounting purposes the example assumes that the prison 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 and so the fixed capital asset or project rule (see BIM64295) applies. If the interest debit had been made to the fixed asset in the first period of trading it would have been an allowable trading deduction. The example assumes an election under BIM64325 is made. The interest is therefore not taken into account as a non-trading debit of the accounting period. The debit is treated as if it were a debit of the accounting period in which the company commences its trade.

Accounting period 2

The trade commences at the beginning of the second accounting period.

A unitary payment of £15m is receivable in the accounting period.

For FRS5 accounting purposes the whole of the 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 (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 relevant over-riding statutory or case law principle. The whole of the £5m interest debited to the fixed asset in the pre-trading period (accounting period 1) is an allowable deduction in the trading tax computation for accounting period 2 as a result of the election.

The £15m unitary payment is trading income for services provided and no adjustment is required in the trading profits computation. The depreciation represents capital construction costs and interest that is already relieved under the election. Neither of these is an allowable deduction in this, or future, accounting periods 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
Less pre-trading interest £ 5m
Profit (before overheads) £10m

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