6 Capital and asset management
6.0.1 The capital assets owned (or leased) by the delegating partner will be used to provide the integrated services together with the host partner's capital assets.
6.1 Capital funding, budgets and allocations
What funding will be available for future capital investments?
6.1.1 The two partners will continue to provide the funding for capital assets, either through capital expenditure or from revenue. This will be funded from a number of sources. The main source of funding for a Health Board will be the annual capital grant allocation from the Scottish Government Health Directorate, while the majority of capital investment required by a Local Authority will be met by additional borrowing under the Prudential Code to supplement the general block capital grant from the Scottish Government.
What is the process for approval of capital investment required to deliver the Strategic Plan?
6.1.2 It is recommended that the investment needed to deliver the Strategic Plan is included as part of the host partner's capital plan. If funding is required from the delegating partner the Chief Executive of the host partner should prepare a business case as required by the delegating partner.
6.1.3 In developing the Strategic Plan the Chief Executive of the host partner should consider CIPFA guidance on place-based asset management and a "one public estate" model of delivery.
6.1.4 The Local Authority, Health Board and Scottish Government Health Directorate will continue to approve their own capital budgets and approve capital projects.
6.1.5 For health capital investment the Scottish Capital Investment Manual must be followed.
6.2 Use of assets
Will the delegating partner transfer assets to the host partner?
18.104.22.168 In delivering the integrated services the host partner will require the use of non-current assets owned or leased by the delegating partner to deliver the outcomes specified in the Strategic Plan. A number of options are available to the partners to facilitate the use of resources.
22.214.171.124 Where assets being considered for transfer are subject to PFI/PPP arrangements, it is recommended that professional advice is sought on a scheme by scheme basis as VAT will be chargeable on the regular facilities/unitary charge and it is important that this is recovered as it could be significant.
6.2.1 Host partner purchases asset from delegating partner (Health Board is the host partner
126.96.36.199 The Local Authority transfers, at market value, or at a value which is determined to be best value, assets to the Health Board. The assets transferred may include residential care homes and day centres.
188.8.131.52 The sale of relevant residential property (RRP) is likely to be exempt for VAT purposes or potentially zero-rated, so VAT will not be due on the supply. If the supply is exempt then there may be a "claw-back" of VAT previously recovered required by the Local Authority. This is a complex area and the VAT treatment will depend on certain factors as outlined below:
- Was VAT incurred on the initial construction?
- Was the use certified as RRP by the local authority?
- When was the RRP completed?
- Was the use all Local Authority non-business use or is there an element of business activity use, e.g. private charges?
- Is the RRP property more than 10 years old as this is important to establish if there is a self-supply?
184.108.40.206 Each case should be considered individually and advice sought if necessary.
220.127.116.11 Typically the sale of day care centres will also be exempt for VAT purposes unless the Local Authority has made an Option To Tax (OTT) in respect of the property. Where the supply is exempt the Local Authority will need to consider the impact on its VAT recovery position.
18.104.22.168 Where the Local Authority has made an OTT on relevant property then VAT will be due on the supply and the Health Board is unlikely to be able to recover this VAT under contracted out services (COS). The main benefit to the Local Authority of making a taxable supply of the property is that there will be no "claw-back" of VAT previously recovered. However Local Authorities enjoy a very favourable partial exemption position and each case should be looked at individually to establish if an OTT is required to protect the Local Authorities VAT recovery.
22.214.171.124 The freehold sale of new non-residential property (e.g. less than 3 years old) is mandatorily standard-rated irrespective of an OTT having been made. This must be considered if property is being sold to the Health Board.
126.96.36.199 The Health Board has two options to fund the capital purchase:
- From its annual capital allocation, but this may be fully committed and the overall funding is capped; or
- With a capital grant received from the Local Authority. It may be possible for the Local Authority to provide a capital grant from recycling the capital receipt from the sale. However, the value of the available grant may be reduced due to irrecoverable VAT on the sale and repayment of borrowings on the asset, and therefore there may be insufficient capital grant available to cover the cost of purchase of the asset.
188.8.131.52 In addition an annual depreciation charge would be incurred by the Health Board, resulting in an additional burden to the Integration Budget. The Local Authority does not have a budget for depreciation due to the accounting treatment prescribed in the statutory mitigation for capital accounting which could meet this annual cost.
184.108.40.206 Therefore, the purchase of assets from the Local Authority is likely to result in a significant capital shortfall and recurring unfunded revenue cost making the arrangement financially unviable.
6.2.2 Host partner purchases asset from delegating partner (Local Authority is the host partner)
220.127.116.11 It is mandatory for a Health Board to ensure the disposal of assets at market value. Therefore the Local Authority would require capital funding to purchase the asset. Examples of the type of assets which may transfer from a Health Board to a Local Authority include community hospitals and specialist equipment.
18.104.22.168 There are two options for capital funding for the Local Authority:
- Loan funding: Any borrowing undertaken by the Local Authority is subject to the conditions specified in the Prudential regime. In this case it would require the Local Authority to evidence that the it is financially viable for the additional borrowing to be funded from savings delivered by the new integration proposals and the Health Board would require to vire to the Local Authority the savings from transferring the assets so that they could be used to meet the additional borrowing costs. Alternatively the loan charges may be funded by transfer of the depreciation budget associated with the transferred asset. However, the depreciation budget is "ring fenced" within the Health Board and is not available to be transferred.
- Capital grant from the Health Board: The Health Board may be able to provide a capital grant from the proceeds of the sale to meet the purchase cost of the asset by the Local Authority. However, capital grants cannot be guaranteed by a Health Board as the current policy by the Scottish Government Health Directorate (SGHD) is that capital receipts will accrue to the SGHD to support overall capital program priorities. Unless this policy is changed it is unlikely that a capital grant would be approved for this purpose.
22.214.171.124 Therefore, it is unlikely that a Local Authority would be able to develop a viable case under the regulations using either of these funding methods for the purchase of assets from a Health Board.
126.96.36.199 Typically the sale of any property asset by a Health Board will be a business activity and potentially subject to VAT. It is not envisaged that the Local Authority will suffer this VAT as a cost, however the use of the property will need to be considered in detail. If the use by the Local Authority is non-business then any VAT incurred on the supply from the Health Board would be recoverable under Section 33, VAT Act 1994.
188.8.131.52 Typically it will be advantageous for the Health Board to make a supply subject to VAT and this is achieved by making an option to tax on the relevant property. The option to tax is disregarded on certain types of property, e.g. residential. Advice should be sought when considering making the option to tax to establish if it is valid.
6.2.3 Host partner leases asset from the delegating partner
184.108.40.206 It is possible for a host partner to enter into an operating lease arrangement for the use of non-current assets. The income and expenditure associated with the operating lease in the partner authorities should be adjusted through the partner contributions to the Integrated Budget.
220.127.116.11 Where the leasing arrangement is considered to be a finance lease the asset would need to be capitalised and the financial implications for the partners are similar to out-right purchase of the asset. Therefore, in entering into the leasing arrangement consideration should be given to the main terms which determine whether the lease is a finance or operating lease. For example:
- Does the lease transfer ownership to the lessee by the end of the lease term?
- Does the lessee have the option to purchase the asset at a price that is expected to be significantly lower than the fair value at the end of the lease term?
- Is the lease term for the major part of the economic life of the asset?
- Does the present value of the minimum lease payments amount to substantially all the fair value of the asset?
- Are the leased assets so specialised that the lessee is the only user without major modification, but not so specialised that other bodies cannot use them?
18.104.22.168 Each arrangement should be assessed on its own merit and agreement reached with the partners and the external auditors on the accounting treatment under IAS17.
22.214.171.124 From a VAT perspective the individual lease arrangements should be considered in each scenario. The VAT treatment may differ where there is a supply of property, for example where there is a lease of a RRP property HMRC tend to view a lease as not triggering a self-supply charge, whereas an outright sale of property is likely to do so. Non-residential property leases would be exempt unless the property was subject to an option to tax (which would make the supply taxable at the standard rate).
What are the financial implications if the lease is a finance lease?
126.96.36.199 Where the host partner is the Local Authority the financial impact is minimal. The accounting treatment for a finance lease would have a similar impact as purchasing the asset. A Local Authority would have the value of the asset in the balance sheet with additional depreciation charges incurred annually. However, statutory mitigation would be available to offset any implications.
188.8.131.52 The leased property will appear as an asset within the Local Authority balance sheet and a corresponding liability will be recognised in respect of the minimum lease payments due over the term of the lease. The property will be subject to revaluation and impairments tests, and a corresponding depreciation charge will be calculated annually; however statutory mitigation ensures that revaluation and/or impairment losses, together with the annual depreciation charge are reversed through the Movement in Reserves and do not impact upon the taxpayer.
184.108.40.206 The Health Board will derecognise the asset in its balance sheet and instead recognise a long term debtor in respect of the minimum lease payments (the principal element of which will be treated as a capital receipt.)
220.127.116.11 Where the Health Board is the host partner the capital cost of the leased assets are charged against their annual capital resource limit, which may be fully committed. As the Local Authority has not sold the asset there is no capital receipt available to provide the funding for a capital grant to the Health Board. In addition an annual depreciation charge would be incurred by the Health Board, which cannot be funded by the Local Authority as a consequence of the statutory mitigation for capital explained in 6.2.2. Therefore, a finance lease where the host partner is a health board is likely to result in unfunded capital and recurring revenue cost for the health board.
What are the financial implications for an operating lease?
18.104.22.168 Where the Local Authority is the host partner there are no net financial implications. The cost of the lease payments should be adjusted through the partner contributions to the Integrated Budget. The VAT charge can be recovered by the Local Authority.
22.214.171.124 Where the Health Board is the host partner, similarly the cost of the lease payments can be adjusted through the partner contributions to the Integrated Budget. However, the VAT element cannot be recovered by the Health Board and would not be offset in the adjustment to contributions to the Integrated Budget.
Can the lease charge be a nominal sum?
126.96.36.199 This depends on the host authority. A Local Authority is permitted to charge peppercorn rents, but a Health Board is not permitted to enter into concessionary leases with a Local Authority.
188.8.131.52 Where the Local Authority does grant an interest in property to the Health Board and this is for a "peppercorn" rental this is regarded by HMRC as a "non-business" supply and the Local Authority is not required to account for VAT on the transaction but is still entitled to full VAT recovery on any associated costs. It is common in this sector, because of this position, for a Local authority to grant an interest in property for a "peppercorn" as it will always allow full VAT recovery on any property related costs.
184.108.40.206 For VAT recovery to be allowed the expenditure on the property must be incurred by the Local Authority and this might realistically mean that the transfer of delegated budget is reassessed to leave a proportion with the Local Authority to cover any property expenditure.
6.2.4 Partners agree a right of access or service level agreement
220.127.116.11 The host partner may enter into a service level agreement (SLA) which specifies the right of access to use the assets owned or leased by the delegating partner for the delivery of the services specified in the Strategic Plan. The ownership rights and control of the long term future of the assets remain with the delegating authority. The agreement should cover the right to use the assets and services relating to its operation e.g. maintenance, utilities, etc. and include the costs for these. The agreement should be prepared with relevant professional advice and the interpretation of leasing arrangements given in IFRIC 4. A SLA is not a lease and is not subject to the accounting treatment specified under IAS 19.
18.104.22.168 The costs resulting from the SLA should be adjusted through the partner contributions to the Integrated Budget.
22.214.171.124 Typically an SLA can give a variety of rights as part of the agreement. This can include a right over property and the VAT implications are outlined above.
126.96.36.199 Alternatively an SLA can give the "customer" certain rights to operate that fall short of any interest in land and in the circumstances such a supply would be subject to VAT at the standard rate of VAT as the supply tends to be categorised as a supply of facilities services. HMRC do look closely at this sort of structure to ensure the nature of the supply is correctly categorised and treated as a right over land or not. Care should be taken when drafting the SLA to ensure the legal position is accurately reflected. For these SLAs where there is no interest in land:
- Where the Health Board is the host partner with an SLA for use of Local Authority property, and VAT is charged to the Health Board, then there could be scope to recover the VAT under Section 41, VA94 if the costs are able to be treated as contracted out services.
- Where the Local Authority is the host with an SLA for use of a Health Board property then VAT recovery will be determined by Section 33, VA94 and it is likely to be recoverable.
What is the preferred option for the use of assets?
188.8.131.52 Where the Local Authority is the host partner a service level agreement or operating leasing arrangements result in minimal financial impact.
184.108.40.206 Where the Health Board is the host partner the preferred option is the service level agreement specifying the right of use.
What are the implications of future proposals to the accounting treatment of leases?
220.127.116.11 The ISA consulting further on its approach for the treatment of leases (IASB ED/2013/6/Leases). It outlines proposals for the recognition of a liability and a right of use asset for all leases dependant on the classification. The proposals include recognition on lessee balance sheets of all leases of more than 12 months, based on discounted value of committed rental payments. This would have the impact of having all leases accounted for as financial leases, causing potential significant costs.
18.104.22.168 These changes, if approved in the future would not have a material impact on our recommendations. The proposed rental value of £1 per annum and the type of service level agreement developed would create a very low value in the local authority balance sheet, and a similar low monetary value on the partners income and expenditure account. The proposals would not be applicable for a service agreement when it does not meet the definition of a lease.
6.3 Repairs and maintenance
What property revenue costs of non-current assets will be met by the host?
6.3.1 The delegating partner should identify the running costs of the properties transferring as part of the payment into the Integration Budget e.g. rents, repairs and maintenance, rates, cleaning, property insurance etc.
6.3.2 The service agreement between the partners should determine the costs to be met by the host and the delegating partners. Revenue property costs which are deemed landlord costs will remain with the delegating partner. Revenue costs of the host should be met from the Integrated Budget.
6.4 Due diligence
6.4.1 The Health Board and Local Authority should undertake due diligence to identify all non-current assets which will be used in the delivery of the Strategic Plan. This will allow the partners to identify non-current assets within localities and their revenue and future capital liabilities.
6.4.2 Due diligence should also be carried put in respect of current asset balances, e.g. for client and patients funds and petty cash.