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HMRC internal manual

Business Income Manual

Private Finance Initiative (PFI): interest: pre-trading: example 5

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 SSAP9 ‘Stock and long-term contracts’ principles are adopted during the construction period (see BIM64085). The construction costs, including £5m interest on the construction loan, are debited to the work-in-progress (WIP) account and a notional sale is recognised on completion of the hospital at the end of the accounting period. For accounting purposes the hospital is therefore reported as a finance debtor on the operator’s balance sheet, under FRS5 Application Note F (see BIM64070 onwards), at a figure of £75m representing cost.

Dr WIP account (construction costs and interest) £75m Cr Bank £75m
Dr P&L account (costs of sales) £75m Cr WIP account £75m
Dr Finance debtor £75m Cr P&L account (notional sale) £75m

The hospital is a fixed asset of a property business for tax purposes, not trading stock, and therefore the notional sale and capital construction costs are not recognised.

The interest is debited to an asset that falls within the definition of fixed capital project and the fixed capital asset or project rule (see BIM64295) applies. An election under BIM64325 is not possible, since the loan is for the construction of a property for use in a property business. The £5m interest is therefore a non-trade debit of the accounting period (see BIM64325). 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-trading 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 business) and £10m for the provision of support services (trading).

For accounting purposes £12m is credited to the profit and loss account (being notional interest on the finance debtor and operating income) and £3m is credited to the finance debtor.

Dr Bank £15m Cr P&L account £12m
      Cr Finance debtor £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 £3m credited to the finance debtor is income and is included as an addition in the trading and property income computations (see BIM64125). The proportion of the finance debtor against which the £3m credit is matched represents capital construction costs and 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 no matching adjustment is required in the trading and property income computations.

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

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