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HMRC internal manual

Business Income Manual

Private Finance Initiative (PFI): interest: pre-trading: example 6

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 SSAP9 ‘Stock and long-term contracts’ principles are adopted during the construction period (see BIM64085). The construction costs of the prison, 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 prison at the end of the accounting period. For accounting purposes the prison is therefore reported as 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 sale) £75m Cr WIP account £75m
Dr Finance debtor £75m Cr P&L account (notional sale) £75m

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

The £5m interest debit is to an asset that falls within the definition of fixed capital project and so the fixed capital asset or project rule (see BIM64295) applies. If the interest debit had been made to a fixed capital project in the first period of trading it would have been an allowable trading deduction. The example assumes that 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 was 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.

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

The £3m credited to the finance debtor is trading income for services provided and is therefore included as an addition in the trading profits computation (see BIM64125). The whole of the £5m interest debited to the fixed capital project in the pre-trading period (accounting period 1) is an allowable deduction in the trading tax computation for accounting period 2, by virtue of the company’s election.

The proportion of the finance debtor, against which the £3m credit is matched, 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. Therefore no adjustment is required in the trading profits computation (see BIM64130).

Trading Income computation  
Income (recognised in P&L account) £12m
Plus part payment £ 3m
Less pre-trading interest £ 5m
Profit (before overheads) £10m

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