Deposit return scheme for Scotland: full business case stage 1

6 Annex

6.1 Accounting Treatment and Budgetary Analysis - Detail

6.1.1 Accounting Classification

6.0 In the UK, the classification of entities is determined by the ONS which itself is informed primarily by the European System of Accounts (ESA) guidance produced by Eurostat. In cases where the classification is unclear, the ultimate decision is taken by Eurostat. All EU countries are required to follow this guidance. The classification of institutional units - i.e. those entities with the economic competence to own goods and assets, incur liabilities, enter into contracts in their own right, and produce a complete set of accounts - involves establishing:

• Whether the unit is a market or non-market producer.
• Whether the unit is subject to public sector control, or not.

6.1 Determination of whether a unit is a market or non-market producer is based on whether the corresponding goods and services are traded under the following conditions:

37. Sellers act to maximise their profits in the long term, and do so by selling goods and services freely on the market to whoever is prepared to pay the asking price.

38. Buyers act to maximise their utility given their limited resources, by buying according to which products best meet their needs at the offered price.

39. Effective markets exist where sellers and buyers have access to, and information on, the market. An effective market can operate even if these conditions are not met perfectly.

6.2 Based on the above characteristics, it is expected that the Scheme Administrator would likely be deemed a non-market producer on the basis that it will not be selling goods or services with a profit motive, and its customers will have limited choice over their participation and interactions with the entity.

6.3 In ESA 2010, control over an entity is defined as "the ability to determine the general policy or programme of that entity". There are three criteria of control that are individually sufficient to determine government control. If they are inconclusive, there are a further six criteria that have to be considered, as "a number of separate indicators may collectively indicate control". In addition, ESA 2010 provides for an additional control criteria that needs to be considered when an institutional unit is a non-profit institution (NPI). This control criteria has been included in Table 37.

Table 37: ESA 2010 Control Indicators

Individual Criteria	Separate collective criteria	Non-Profit Institution (NPI) criteria
1. Rights to appoint, remove, approve or veto a majority of officers, board of directors, etc. 2. Rights to appoint, veto or remove a majority of appointments for key committees (or sub-committees) of the entity having a decisive role on key factors of its general policy 3. Ownership of the majority of the voting interest	4. Rights to appoint, veto or remove key personnel - determining general policy through influential members of the board 5. Rights under special shares and options - "reserve rights" that exert a decisive control on the strategy of the institutional unit and other key decisions 6. Rights to control via contractual agreements 7. Rights to control from agreements/permission to borrow 8. Control via excessive regulation 9. Others - provisions in the statute of an entity where public sector approval would be required for some important decisions such as allocation of its results, the development or the abandonment of activities, merging and acquisition operations, dissolving and changing statute.	(a) The appointment of officers (b) Other provisions of the enabling instrument - An NPI would be considered to be controlled by government if approval of government would be required to change the statute of the entity (or the type of activity carried out by the entity), or if the entity could not dissolve itself or terminate any relation with government without such approval (c) Contractual agreements (d) Degree of financing - An NPI that is mainly (>50%) financed by government may be controlled by government. Control assessed if such financing would be permanent (and not on temporary basis) and/or if it would result in a narrow monitoring of the use of the funds and a strong influence from government on the general policy of the entity. (e) Risk exposure - Government "exposed to all, or a large proportion of, the financial risks associated with an NPI's activities."

Source European System of Accounts ('ESA) Section 10

6.4 In order to determine the potential classification of an entity, an assessment against the above indicators is needed to determine the extent to which the public sector is deemed to control its general policy.

6.5 If a non-market producer is classified to the public sector it is considered part of general government. If not, then it is classified as a "non-profit institution".

Likely Budgetary classification of feasible Delivery Models

6.6 Based on the outlined structures Options 1A and 1B are likely to be classified to the public sector on the basis that another public sector classified entity (Scottish Government) will hold all of the voting rights. Option 2 is likely to be classified to the private sector based on the information presented, however further analysis of the details around issues including director nominations, contracts and funding would be required in order to fully determine how it would likely be classified by the ONS.

6.7 It is also necessary to understand the impact and extent to which a regulator would exert control over the Scheme Administrator under Option 2.

6.8 For Option 3, it is initially expected that the Scheme Administrator would be classified to the private sector. However, the existence of public sector equity, presence on boards, and voting rights starts to suggest the public sector is looking to influence the Scheme Administrator in some way. It is generally accepted that any holding below 20-25% would not necessarily cause a reclassification to the public sector, however the existence of special shares and voting rights, veto powers, or the ability to nominate directors would indicate control in spite of the minority equity stake.

Regulation and potential impact on Scheme Budgetary Classification

6.9 There are aspects of the design of the Scheme Administrator that could still lead to a public sector classification even under Options 2 and 3. Considerations around whether the Scottish Government mandates operational aspects such as recruitment and remuneration policy, marketing activities, and investment and procurement decisions, may not individually suggest public sector control. The assessment, however is a holistic one. While the threshold quantum is not defined, the existence of multiple indicators such as those listed could cause the ONS to classify the entity to the public sector, which would therefore result in budgetary implications for the Scottish Government.

6.10 The treatment of regulators is slightly different to other bodies. It is acknowledged by Eurostat, the ONS and HM Treasury that regulators play a unique role in a market and do affect control over other entities in discharging their responsibilities. This does not necessarily mean that all regulated bodies fall under the same classification as the regulator. For as long as regulation is over external actions - such as price regulation, and regulation of markets - it is unlikely to amount to overall control.

6.11 If regulation over an entity is so tight that it effectively dictates the general policy of an organisation, however, then this could amount to control. While uncommon, it is also possible for controls of regulators to make all subject bodies public. This is mainly an issue where regulation extends to internal management - e.g. setting pay levels, borrowing restrictions, or approval of appointments - and as a result, it could be seen as taking control. Therefore any considerations regarding the role of a regulator at FBC Stage 2 will need to take this into account.

Accounting Treatment of Scheme Administrator

6.12 Under a private sector delivery model and assuming a private sector classification, the Scheme Administrator will be bound by normal company law provisions to prepare financial statements in accordance with UK accounting standards and applicable law (Generally Accepted Accounting Principles (GAAP)).

6.13 If the Scheme Administrator was deemed to be classified to the public sector and fell under the departmental boundary of the Scottish Government, then it may be appropriate to consider applying International Financial Reporting Standards (IFRS) instead, in order to ease consolidation.

6.14 If it were later determined that the Scheme Administrator was to be converted to a charity, it would then need to apply the Charities SORP and FRS102.

6.15 Further discussion of how the individual elements of the scheme are treated is set out in the Financial Case.

Budgetary implication of feasible Delivery Models

6.16 If either of the two public sector Options 1A or 1B was to be pursued, the scheme could have both capital and revenue implications for the Scottish Government, summarised at a high level in Table 38 below. It should be noted that this is not a formal classification view, as the ONS is the arbiter for sector classification in the UK. The view represents an interpretation of the guidance at a point in time, based on the available information; however, the ONS may reach an alternative conclusion. Furthermore, subsequent iterations of the scheme design, and further detailing of the contracts and agreements within, are likely to have material impacts on the classification and budgeting implications.

6.17 Options 2 and 3 have not been included as it is expected they would be private sector classified so there would be no budgetary implications.

Table 38: Budgetary Implications Indications

	1A			1B
	CDEL	RDEL	Non-budgetary	CDEL	RDEL	Non-budgetary
Deposits inflow/outflow		+'ve and -'ve				+'ve and -'ve
Unredeemed deposits		+'ve			+'ve
Interest on deposits		+'ve			+'ve
Producer fees			√			√
Materials Fees		+'ve			+'ve
RVM acquisition	-'ve				*
RVM maintenance		-'ve			*
Counting centre/ bulking centre acquisition	-'ve			-'ve
CC/BC maintenance		-'ve			-'ve
Logistics costs		-'ve			-'ve
Scheme Administrator operating costs		-'ve			-'ve
Handling fees		-'ve			-'ve

*RVMs assumed to be acquired and maintained by Retailers. The Scheme Administrator would pay for this through the Handling Fee to retailers which would be a -'ve RDEL implication.

Source Deloitte LLP

6.18 Option 2 and 3 would have no budgetary implications based on the assessed private sector classification. Option 1A would result in both CDEL and RDEL implications, with the requirement for around £100m CDEL in the initial year, with ongoing RDEL implications. Option 1B would result in a reduced CDEL implication (around £30m) but this will be achieved by an increase in the RDEL implications.

6.19 Based on a high-level assessment of the various funding flows against the HM Treasury consolidated budgeting guidance, Table 39 outlines the potential budgetary implications under Options 1A and 1B.

Table 39: High level budgetary implications under Options 1A and 1B

Funding Flow	Potential budgetary implication	Key considerations
Deposits	N/A - the budgeting for deposits follows the accounting. Based on a proposed structure whereby the Scheme Administrator is deemed to be acting as a principal to two separate and distinct business relationships i.e. with the producers in billing for the number of materials sold into the system, and with the retailers to reimburse them for deposits paid out to the system, the budgeting treatment of any differences would likely impact RDEL. That is, if the Scheme Administrator is recognising the income from producers as an RDEL benefit, and the amounts paid out to retailers as an RDEL charge, any variance would score as a net RDEL benefit / charge in a given year. The ability for the Scheme Administrator to recognise the amounts billed to producers as revenue is dependent on this being considered a revenue generating activity in accordance with the applicable accounting framework and standards that the Scheme Administrator would look to apply. There is precedent in other parts of Europe for accounting in this manner. However further analysis should be carried out at FBC Stage 2 to confirm the details of how this would apply in the UK. It should also be noted that prudent accounting principles would require the Scheme Administrator to recognise its obligations to repay the system for any deposits that remain in circulation at any given time. To do this, the Scheme Administrator would likely need to provide for a certain level of the outstanding deposits in the system, effectively assuming they will be paid at some point in the next 12 months. The level at which this provision is set (i.e. at one end of the spectrum 100% of outstanding deposits or alternatively none of the outstanding deposits) would reflect a management estimate and judgement of the Scheme Administrator, and should be based on appropriate evidence and justification in order to be a true and fair representation of the likely obligations of the entity.	Further work may be required into whether the deposit is deemed to be a tax on the public if it is paid to a public sector scheme administrator. Exploration of this, and consultation with HM Treasury and ONS, will be carried out in FBC Stage 2 as necessary.
Unredeemed deposits	RDEL benefit - it is expected that the system will include terms and conditions around the length of time after which the Scheme Administrator is able to retain unredeemed deposits. The Scheme Administrator will need to provide justification and evidence to support their assumption, so the unredeemed deposits can be recognised as a benefit to the Scheme Administrator and would likely result in an RDEL benefit although this would be in turn be off-set by a reduced producer fee.	A more detailed understanding of the deposit redemption and retention process is required to fully assess against the applicable accounting and budgeting guidance.
Materials fees	RDEL benefit - income from materials is generated through sales to open market. These types of transactions, assuming they are genuine open market sales, and the buyer receives something in return, generally score as an RDEL benefit	None
Producer fees	TBC - this will depend on the economic substance of the receipts and whether the nature of how the transaction is administered.
Handling fees	RDEL or CDEL cost - this will depend on the economic substance of the transaction and what, if anything, the Scheme Administrator receives in return for the payment	The budgeting implications of the handling fee will be dependent on the economic substance, specifically how the fees are set, and whether the Scheme Administrator receives anything in return for the payment The fee could be considered a non-exchange transaction whereby the Scheme Administrator receives nothing (of tangible economic substance) in return for the amount paid. In which case, this could be considered a grant or subsidy (depending on the profit motive of the receiving body) If considered a grant or subsidy, the amount is generally scored to RDEL. In instances where the Scheme Administrator requires the recipient to use to money to fund capital, then this could be considered a capital grant, which would score to CDEL. Therefore, determination of how the handling fee is administered and controlled is important in understanding the budgetary implications. If the fee forms part of a contract with the providers in a commercial transaction, then this expenditure would most likely score to RDEL in the same manner as other government service contract expenditure. A more detailed review of the terms and conditions of any such contract, and the potential for any capital implications, would be required in order to fully understand the budgetary impact

Source Deloitte LLP

6.20 Specific budgetary constraints have not been identified but the ability to mitigate CDEL and RDEL implications through a private sector model further supports the selection of Option 2 or Option 3.

Conclusion on Scheme Accounting and Budgetary Implications

6.21 Based on the preferred scheme design of a private sector model, it is expected that the scheme is likely to be classified as private sector under relevant accounting regulations, meaning there will be no additional budgetary implications for the Scottish Government as a result of the scheme.

6.22 The public sector may incur additional regulatory costs, but it is expected these would be charged back to the private sector as a compliance fee in line with other regulated activities such as utility companies. This would result in a net nil impact to budgets.

6.23 The final classification of the Scheme Administrator would be undertaken by ONS and can only be completed once the full commercial details have been finalised, as a number of elements will need to be considered to achieve a final view.

6.24 If a different delivery model is chosen that results in a public sector classification, the Scottish Government will need to ensure that it has allocated sufficient budgetary cover for the operation of the DRS both from a capital (CDEL) and revenue (RDEL) perspective.

6.1.2 Precedents from other DRS Schemes - Detail

6.25 A 2016 report published by Reloop provides an overview of 38 different deposit return schemes currently in operation around the world^[54]. In Europe 133.1 million inhabitants have access to DRS, while in North America 121.9 million inhabitants have access. Several examples of deposit return schemes in countries that have comparable features to the preferred scheme design are presented below.

Europe

6.26 Across Europe, with the exception of Iceland, the various schemes currently in operation follow a return to a place of purchase model where the consumer returns their empty drinks container to a retail location.

6.27 With the exception of Norway and Sweden, all collect glass and metal cans and plastic bottles (with most predominantly collecting PET). The Netherlands only collects plastic bottles. All have a centralised clearing scheme, with the exception of Germany where a decentralised model is in place. The clearing scheme can be defined as "the entity responsible for reconciling the deposits paid/redeemed". The capture rate for these schemes varies country by country and is between 80-95%.

North America, Iceland and Australia

6.28 Across those states in North America and Australia where a DRS is in operation a 'depot model' (dedicated drop-off points) is the most prevalent method of return. This model can also be seen in Iceland. Under a depot model, consumers return their empty drinks containers to dedicated drop-off points, with such locations tending to be established where sufficient quantities of materials arise. Such DRS models tend to have a return rate of between 50-60% (with the exception of rural locations with small populations).

California, Maine and British Columbia

6.29 While the majority of North America follows a depot model there are some examples of a 'hybrid' DRS. Under such schemes, retailers are required to ensure that a dedicated drop-off point is located within a set proximity to their premise or accept containers for return directly. The return rate for containers within these schemes can be up to 80%.

6.2 Regulatory Considerations - Detail

Table 40: Regulatory Considerations

Issue	Principle
Deposit	Determine the deposit level, so that the right behavioural changes are encouraged Ensure all entities that sell any beverages with in-scope materials for packaging should collect these deposits Ensure all entities that sell these beverages (or any relevant intermediaries) should accept the packaging and pay the relevant deposit All these beverages should be traceable, so that the deposit levels are linked to each packaging
Handling fees	Determine the conditions and mechanism for paying the handling fees Ensure handling fees are only paid for traceable in-scope packaging (to help prevent fraud)
Materials in scope	Determine the materials that are to be included in the scheme, and how future materials will be assessed/incorporated Determine the target re-use and recycling rates
Tracing/marking	Determine how packaging is to be marked for inclusion into the scheme Determine that all packaging for which deposits are collected or paid should be registered and marked, although this needs to be considered in greater detail as it may not be possible due to reserved limitation
Registration	Ensure all stores and relevant intermediaries selling in-scope beverage packaging are registered with the Scheme Administrator so that the administrator may ensure deposits are collected and handling fees are paid. Products that have not been registered cannot be incorporated into the scheme. Determine who, how and when stores should register with the Scheme Administrator (including any registration fees) Determine how stores should register the beverage packaging they sell Determine how importers should register new packaging (including whether the packaging is re-usable or recyclable)
Collateral	All producers should provide collateral to the scheme for deposit collection and producer fees while the Scheme Administrator decides whether the new packaging is to be incorporated into the DRS Any producers that pose a financial risk to the Scheme Administrator through the significance of their deposits or producer fees should provide sufficient collateral to mitigate this risk What the size, and terms, are for the collateral that producers provide to the Scheme Administrator Determine the form and mechanism for the provision of collateral
Other	A robust and comprehensive regulatory regime can also help to facilitate the wider 'additional benefits' as discussed within the Commercial Case

Source: Deloitte Analysis