DLUHC consultation on changes to the capital framework: Minimum Revenue Provision

1. The Local Government Association (LGA) is the national voice of local government. We are a politically led, cross party membership organisation, representing councils from England and Wales.

2. Our role is to support, promote and improve local government, and raise national awareness of the work of councils. Our ultimate ambition is to support councils to deliver local solutions to national problems.

3. This response has been cleared by the lead members of the LGA’s Resources Board.

4. On the face if it this seems like a straightforward proposal with the aim to ensure that the existing Minimum Revenue Provision (MRP) guidance is followed, which is what already happens for the vast majority of local authority debt. However, the results of the proposed changes will be more far reaching than that and there will be significant financial consequences for some councils which will need to be addressed.

5. Paragraph 31 of the consultation document (Consultation on changes to the capital framework: Minimum Revenue Provision) states that “based on the analysis, the gross underpayment of MRP for the sector in 2019/20 is around £0.7 billion”. It is not clear how this figure has been calculated and the document does acknowledge that there is a need to work with the sector to calculate a more robust figure. Nevertheless, all things being equal and taking this figure at face value means that the potential impact of local authority budgets in 2023/24 will be a revenue cost of £700 million.

6. This is a significant sum and one likely to impact unevenly across the sector. Many councils that are affected have acted in good faith on the basis of the current regulations and believe they have followed prudent accounting practices. The implications for these councils are potentially devastating for local public services.

7. Before any changes are implemented this cost must be fully understood, including identifying which authorities are affected and by how much and what mitigation arrangements can be put in place. In our response to the detailed questions below we suggest what some of these mitigation arrangements could include the recommendation that the implementation only applies to new debt funded assets for which new debt was taken out after the new regulations come into effect on 1 April 2023 rather than to existing debt. This will ensure that any future capital decisions made by councils take account of the changes. This will enable councils to mitigate or avoid the £700 million cost, over a reasonable period.

8. There is a significant concern that in addition to immediate financial consequences arising relating to existing schemes, the proposals will also severely limit councils’ options for delivering priority capital investment in the future. Several councils have raised concerns that the proposals will seriously compromise future housing delivery, particularly through companies that deliver housing outside of the Housing Revenue Account, with a concern that such schemes will cease to be viable and those schemes will never be built out (the market will not step into these sites) and therefore national housing delivery will be compromised. This will include schemes that have been agreed as a priority with the government. We are recommending the following mitigations:

• 8.1. they are not applied retrospectively but only apply to new schemes after 1 April 2023 (as mentioned above);
• 8.2. “double” MRP is avoided by not requiring MRP on debt where the principal is being repaid at a regular rate, even if that repayment is by capital receipt; and
• 8.3. further consideration is given to the special circumstances around council transport companies and whether they need to be treated differently.

9. It is also worth noting that increasing the amount of MRP made by local authorities will increase their long-term cash holdings and impact on treasury management investment activity.

Question 1: Do you agree with the government’s proposal to amend the 2003 Regulations to prevent the omission of debt from the MRP calculation?

10. We agree that it is right that prudent provision is made. But there may be consequences that are hard to manage. As mentioned in the general points made above, the consultation document itself identifies a cost of £700 million which will need to be addressed.

11. One of the main aims of changes made when the current guidance was introduced in 2018 was to ensure that MRP would be made for all debt relating to commercial investments and particularly investments in property primarily for financial return, and as an aim this is generally supported across the sector.

12. However, there are other areas of debt where councils do not make MRP but still argue that they are acting prudently. In particular, there are examples of councils that make secure capital loans to wholly owned or closely associated companies and do not make annual MRP but instead use repayments from the company to repay the loan, either on an annual basis or as a lump sum at the end of the term. This particularly relates to companies engaged in delivering key objectives such as provision of housing mainly or transport.

13. In such cases, a strong argument is made that MRP is unnecessary as the loan is secure and regular repayments can be closely monitored. It is correct under the current regulations which require that the section 151 officer to “have regard” to the guidance which acknowledges that alternative MRP treatments are appropriate. Being forced to make a MRP for such debts could result in over provision from revenue over time. This could result in taxpayers being over-taxed public services being cut, or a combination of both for limited benefit where assets such as housing for market / affordable rent are being constructed and an immediate uplift in value upon completion (equivalent to a developers profit) can be evidenced as well as long term capital appreciation being a very realistic expectation and evidenced by the significant equity held within the accounts of wholly owned council housing companies. As a minimum there will be a transfer from revenue to capital as the repayment of a loan from the company counts as a capital receipt to the council, limiting its use and will only be possible if the council cuts back on services to its community or increases its council tax. That said, we are aware that there are some councils that do make MRP for such loans where rent levels and construction costs enable schemes to be viable which unfortunately will not be the case in all parts of the country. It does not get away from the fact that housing values will increase, there is equity built in upon completion as referenced above and therefore MRP has cover in equity and ongoing value. In simple terms, the significant percentage of buy to let properties nationally are financed based upon equity and capital growth with rental levels covering the borrowing cost. To challenge full provision in MRP in all cases associated with housing does not hold as a rationale.

Question 2: Does the draft statutory instrument achieve the Government’s objectives as outlined in this document? Are there any unintended consequences arising from the statutory instrument?

14. We believe the proposal will achieve government’s objective of placing the MRP guidance on a statutory footing. The proposal may also have the effect of placing additional controls on council borrowing, including borrowing that is currently assessed as being prudent; it is not clear whether this is an intended or unintended consequence. There will also be significant immediate revenue consequences that need to be addressed. As is outlined in the consultation document there is a potential revenue cost of £700 million across the sector. We believe the simplest way to avoid this cost being an excessive burden on councils which could impact negatively on services would be to only apply them to new debt funded assets for which new debt was taken out and for which MRP would apply after 1 April 2023 (including projects that are already contractually committed before the final regulations are issued even though some expenditure may slip in to 2023/24) rather than applying the regulations retrospectively. Councils can then set up any new arrangements on the basis that they will have to include provision for MRP. It is likely, however, that like for like replacements for some schemes currently undertaken to deliver key objectives such as housing will no longer be viable. As covered previously, we believe the full MRP provision for housing is not required in all cases.

Question 3: Is it clear from the wording of the statutory instrument, as drafted, that authorities may still postpone the MRP charge as per paragraphs 40 and 41 of the MRP guidance?

15. Paragraphs 40/41 of the guidance allow for MRP to be made from the year after a loan is taken out or after the asset represented becomes operational. We believe this is clear and that there is no specific impact on this through the wording of the statutory instrument. We also understand no change is being proposed by this. However, if there is a possible issue with the wording, which is not obvious to us, it would seem more sensible to take legal advice on this point rather than rely on responses to a public consultation?

Question 4: Are these changes consistent with the current MRP guidance? If not, what is unclear or inconsistent in the guidance?

16. We believe that the changes are consistent with the guidance. Currently, however, councils have discretion not to make MRP, provided that this is done prudently and provided that the guidance has been properly considered. The changes will take away this discretion and in future MRP will have to made for all debt using the methodology outlined in the guidance.

Question 5. Do you agree with the government’s proposal to amend the 2003 Regulations to prevent the use of capital receipts to be used in place of a revenue charge?

And

Question 6. Does the draft statutory instrument achieve the Government’s objectives as outlined in this document? Are there any unintended consequences arising from making this change?

17. We understand why this proposal is being made and that the intention is to clarify what the current arrangements should be, that capital receipts should not be used instead of making revenue contributions to cover MRP. However, we are concerned that the proposal will have further unintended consequences with regard to capital loans made by councils that they have funded by debt. If the principal of these loans is being repaid on an annual basis, then that repayment will – all other things being equal – likely be equivalent to any MRP that should be made. It will, however, count as a capital receipt. So, a situation is likely to arise where the council’s debt is being repaid regularly and it is also necessary to provide for an equivalent amount of MRP, effectively a double provision each year. By the time the loan comes to an end the council will have had to make an excessive amount of MRP over the period of the loan with consequences for public services in the interim. In this case, a possible solution would be to seek a way of avoiding having to make MRP on debt where the principal is being repaid at a regular rate, even if that repayment is by capital receipts.

Question 7. Is it clear from the wording of the statutory instrument, as drafted, that authorities may set capital receipts against borrowing?

18. The proposed wording of the statutory instrument does not appear to refer to councils’ ability to use capital receipts to repay debt. Therefore, the new wording should not change the position on this. The consultation document is clear that there is no intention to change this.

Question 8. Are these changes consistent with the current MRP guidance? If not, what is unclear or inconsistent in the guidance?

19. This appears to be the case, with the proviso that the situation outlined in our answer to questions 5 and 6 is considered.

Question 9. Where these changes will have a financial impact on your authority, what is the estimated increase/(decrease) in annual revenue cost (for illustrative purposes, assume the changes take effect from 2022/23)

And

Question 10. Where these changes affect the amount of MRP charged by your authority what, if any, effect will there be on financial sustainability?

20. These questions are for individual councils to answer, however, as outlined in the general points made above, there is a potential revenue impact of £700 million across the sector over and above significant existing budget pressures from 2023/24 if mitigating action is not taken to avoid it.

Question 11. Aside from financial sustainability, what other impacts will the changes have? For example, changes to capital plans, debt management or current investments. Include a costed impact if appropriate?

21. While this is a question for individual council to answer, a number of councils have made the point that the changes will have a major impact on their capital activities where they make loans to wholly owned or associated companies to further local objectives. The need to make MRP on these loans may make such activities unviable in the future, with a major knock-on impact to local delivery. The most commonly quoted example is companies that deliver housing outside of the Housing Revenue Account, with a concern that such schemes will cease to be viable. It is anticipated that this will have a major impact on delivery of housing in the future.

22. Another example quoted is where the council continues to own the local transport or bus company. There are only a few of these now left but they have a major impact on their local areas. The ability of the council to make loans to the company – for example rolling loans that are regularly repaid to cover the capital costs of vehicles – can be essential to the viability of the transport company. We would suggest that this is an area where specific impacts need to be fully understood before the new regulations take effect and consideration given to making separate arrangements if it can be done prudently.

Question 12. Do you agree that the government should implement the amendments to the legislation to come into effect from the 2023/24 financial year?

Question 13. If not, are there any specific proposals for deferring implementation to a later financial year? What would be the implications of not doing so?

23. As outlined in earlier answers, we believe that the most prudent way to mitigate the unintended consequences of the changes and to enable councils to make informed decisions on their capital activity is to ensure that the regulations are not applied retrospectively. This can be done by making the new regulations apply only to new assets for which debt was taken out and for which MRP would apply after 1 April 2023. In addition, amendments should be considered to take account of the special circumstances of Transport companies, and of the situation where there is regular repayment of loan principal by instalments by third parties that has to count as a capital receipt.

Bevis Ingram

[email protected]