Accounting Under Ifrs for Properties Where a Body Holds a Legal Charge

ACCOUNTING UNDER IFRS FOR PROPERTIES WHERE A BODY HOLDS A LEGAL CHARGE

Background

Many NHS bodies (though usually PCTs) are involved in arrangements where they have a legal charge over property owned by a third party. Typically, these are residential properties for people with mental health issues or learning disabilities, transferred in the 1990s from NHS bodies to voluntary bodies (usually housing associations), although arrangements involving other types of property also exist.

Grants were made by health authorities using:

· Section 28A of the National Health Service Act 1977 (repealed by Section 6 of the National Health Service (Consequential Provisions) Act 2006 and replaced by Section 256 of the National Health Service Act 2006); and

· Section 64 of the Health Service and Public Health Act 1968.

In return, voluntary bodies used the grants to purchase the assets from Health Authorities, of which Primary Care Trusts are successors.

Directions made by the Department of Health (currently the “Directions by the Secretary of State as to the conditions governing payments by health authorities to local authorities and other bodies under Section 28A of the National Health Service Act 1977”, which came into force on 1 April 2000) require application of legal charges to these arrangements to guarantee continued use of these properties for health service purposes by specifying the purposes for which the property can be used. Often, the legal charge is linked with management and pre-emption agreements. These set further conditions on the use of the property and gave the NHS first option over the property if the housing association (or other voluntary body in receipt of the grant) wished to sell the property or the terms of the agreement were breached.

Guidance in respect of section 64 grants is set out in circulars HSG(94)4 and HSG (95)45, which similarly require a legal charge to be placed on the property where capital grants are given.

What is the issue?

Historically, the grant made by the NHS body was treated as revenue expenditure, with a contingent asset created to recognise the step-in right that might be secured by the exercise of the legal charge. That step-in right would only be disclosed in the accounts as a contingent asset when it was probable the NHS would receive a cash settlement, and would only be accrued as a debtor when it was virtually certain the sum would be received. However, with the move to IFRS, there is a need to consider whether that accounting treatment needs to change in light of:

· The public sector application of the principles of IFRIC 12: Service Concessions as set out in the HM Treasury FReM; or

· IFRIC 4: Determining whether an arrangement contains a lease.

This consideration is needed because the arrangements may confer on the NHS body an ability to control the service potential of the asset.

Service Concessions

To recognise an arrangement as a service concession under IFRIC 12 as interpreted for the public sector, the following key features must exist:

· the infrastructure (i.e. the property) is used to deliver public services; AND

· the public sector grantor (the NHS body) specifies the services to be provided by the operator (the housing association or other voluntary body), when and at what price; AND

· the public sector grantor (the NHS body) controls the residual interest in the asset.

Schemes will need to be considered on a case by case basis to assess whether these features exist. The following two examples, based on actual arrangements we have looked at, demonstrate the impact of IFRIC 12.

Example 1

· Housing Association A purchased the property from the NHS for £600,000 using a grant made by the NHS under Section 28A to provide accommodation for people with learning disabilities;

· As part of the agreement, the Housing Association enters into a Management Agreement with the NHS. This sets the levels of rent the Housing Association can charge residents and/or the NHS body and specifies the services to be provided by the Housing Association to residents.;

· As part of the grant conditions, a legal charge was placed on the property which specifies that, should the property cease to be used for a period of 3 months continuously for the specified purpose, or if the Management Agreement is terminated, the Housing Association must sell the asset, except where the NHS body exercises its right under the pre-emption agreement, and pay the NHS body the net sale price.

· The pre-emption agreement is exercisable for 21 years and specifies that, if the Housing Association wishes to sell the property or the Legal Charge or Management Arrangement are breached, the NHS has first refusal to purchase the property at market value;

Example 2

· Housing Association B purchased the property from the NHS for £600,000 using a grant made by the NHS under Section 28A to provide accommodation for people with learning disabilities;

· As part of the agreement, the Housing Association enters into a Management Agreement with the NHS. This specifies the standards of maintenance and repair required from the Housing Association to meet statutory requirements;

· Services provided to residents in the home are provided by the NHS or other agencies, and not by the Housing Association.

Assessment of schemes

IFRIC 12 Feature / Example 1 / Example 2
Infrastructure used for public services / Yes – the agreement requires the property to be available for people with learning disabilities. / Yes – the agreement requires the property to be available for people with learning disabilities.
Public sector controls the services to be provided / Yes – the Management Arrangement specifies the services to be provided by the Housing Association to residents and sets the charges that can be made. / No – the Housing Association has no responsibilities other than providing the accommodation to a standard that meets statutory requirements. All other services are provided by other agencies.
Public sector controls residual interest in the property / The legal charge prevents the operator disposing of the property without the NHS having first refusal. / The legal charge prevents the operator disposing of the property without the NHS having first refusal.
Is this a service concession arrangement? / Yes – the three key features of a service concession are in place. / No – the public sector does not control the services provided by the operator.

In conclusion, for Example 1, the asset is recognised as a service concession and would, therefore, need to be brought on to the NHS body’s statement of financial position. Example 2 is not recognised as a service concession and would, therefore, need to be considered further under IFRIC 4.

Areas where judgement may be needed

1) Does the NHS body control the services?

It will normally be clear that the property is being used to deliver public services, and that the NHS body has control of the residual interest. An area where judgement may be required is in respect of whether the NHS body controls the services i.e. whether it controls all of the following:

· the services to be provided

· to whom they are provided

· the price charged

The first two of these will normally be clearly set out in the grant conditions and supporting agreements or schedules. It may, however, be less clear as to whether the NHS body controls the prices that the operator charges to the NHS body and/or to the individual users/residents. Control of the price should be considered based on the substance of the arrangement, for example, does the NHS body’s contractually dominant position give it the practical ability to control the prices? (i.e. if the NHS body wanted to specify the price is there any realistic way that the housing association could refuse to charge that price?).

2) Where the property is also used to provide non-NHS services, do the NHS services represent only an insignificant part of the whole?

Where the property is also used extensively for non-NHS services, the NHS body’s control may only extend to its proportion of the services and the asset. If the NHS body’s element is insignificant to the property as a whole, then it may be appropriate to reach the conclusion that the arrangement is not, in substance, a service concession.

This could be overturned, however, if the NHS body’s control is over a separate asset or a distinct and separate part of the overall asset.

3) Will the NHS body be required to recognise a liability in its accounts to match the asset?

Where the NHS body recognises an asset under the IFRIC 12 principles, it would recognise a corresponding finance lease liability. The amount of this liability is determined in accordance with IAS 17 as the lower of the fair value of the asset and the present value of the minimum lease payments.

Applying this to legal charges, the NHS body’s liability to pay for the property will comprise:

· the initial capital grant payment; and

· in some instances, where the voluntary body has constructed a new property or has refurbished or enhanced the existing property and is recovering some or all of this cost through annual charges or ‘top-up’ payments levied on the NHS body, a liability for the present value of these. However, if the scheme limits control of the residual to the proportion of the fair value that the initial grant represented to the initial capital cost, these additional costs should only be recognised if they acquire rights over the residual of the additional capital.

The asset recognised will therefore be based on the present value of the minimum lease payments. Where the NHS body has exclusive use of the property, the asset recognised will also be the fair value of the property. Where the NHS body is only one user of the property, the approach above means that it will only recognise its share of the asset.

The initial capital grant paid by the NHS body will discharge that element of the lease liability immediately (in a similar manner to a lease premium). Therefore the ongoing lease liability then simply reflects the amount of new assets or refurbishment/ enhancement expenditure that is being recovered from the NHS body through the annual payment.

Where the original asset was purchased from the NHS body (rather than another source) it is probably more appropriate to treat this as a contributed asset and disregard the sale/grant/leaseback transaction. In such cases, therefore, any initial lease liability recognised is limited to the amounts of new assets or refurbishment/ enhancement expenditure that is being recovered from the NHS body through the annual payment.

IFRIC 4: Determining whether an arrangement contains a lease

In determining whether an arrangement is, or contains, a lease, IFRIC 4 requires an assessment of whether:

· fulfilment of the arrangement is dependent on the use of a specific asset or assets; and

· the arrangement conveys a right to use the asset.

The first of these features will normally be met because the grant conditions will name the specific property.

The second condition will be satisfied where any of the following occur:

· the NHS body has the ability or right to direct the provider to operate the asset in a manner it determines while obtaining or controlling more than an insignificant amount of the service output;

· the NHS body has the ability or right to control physical access to the underlying asset while obtaining or controlling more than an insignificant amount of the service output; or

· facts and circumstances indicate that it is remote that other parties will take more than an insignificant amount of the service output during the arrangement and the price paid by the purchaser is neither a fixed amount per unit of output nor equal to the current market price per unit of output.

Areas where judgement may be needed

The IFRIC 4 decision largely comes down to the degree that the NHS body has exclusive use of the property. Where the only users are those nominated by and/or funded by the NHS body, then it is likely that the arrangement will fall within IFRIC 4.

Conversely, where the property is also used to provide non-NHS services, this may be sufficient to take the arrangement outside IFRIC 4. However, in this situation, it is necessary to consider whether the NHS body’s element comprises a distinct and separate part of the overall property, or a separate building on the site. Where this is the case, then the IFRIC 4 decision should be applied to the distinct component and therefore the arrangement may fall within its scope.

For Example 2, the arrangement is dependent on the use of a specific asset – the property purchased by the Housing Association. In considering whether the arrangement secures the right to use that asset, an assessment of the three criteria shows: