Exploring the different approaches to taxing PPP and PFI vehicles

Exploring the differentapproaches to taxing PPPand PFI vehiclesReceived: 18th June, 2004

Paul Bartlettis a director in the Deloitte and Touche Real Estate, Travel and Tourism Tax Group. He

specialises in advising on complex real estate and public–private partnership/private

finance initiative (PPP/PFI) transactions for financial institutions, real estate

companies, PFI operators and public sector clients. Paul is a leading expert in the

taxation of PPP and PFI transactions and has advised on many of the UK’s largest

PPP/PFI transactions since their inception in 1992.

AbstractThe focus of public–private partnerships (PPPs) and privatefinance initiatives (PFIs) remains, as it has from their inceptionin 1992, firmly on the provision and maintenance of publicsector property assets such as schools, hospitals, socialhousing and civil engineering projects including ‘Design, Build,Finance and Operate’ roads. Many of the techniques used infinancing PPP and PFI transactions are common to real estateprojects. It is likely therefore that the tax issues and consequentsolutions developed for PPP and PFI transactions will haveincreasing relevance to the property investment industry,particularly as the principles of PFI become more common inthe private sector. The purpose of this paper is to explore thedifferent approaches to taxing PPP and PFI project vehicles andprovide an update on the latest developments in their taxation.This is a topic which has been brought into focus by the hightax rate suffered by early PFI projects which are now reachingmaturity and the consequent effect this has on shareholderreturns. In response, the industry has, in partnership with theInland Revenue, sought greater certainty over the tax treatmentof PPP and PFI projects. Changes to key parts of PFI contractsand the way in which services are delivered can result in amuch lower effective rate of tax for PPP and PFI projects.

Keywords:taxation, PFI, PPP, composite trade, contract debtor, capital allowances,finance

TAX RELIEF FOR DESIGN AND CONSTRUCTION COSTSMany of the early public–private partnership (PPP) and privatefinance initiative (PFI) projects put risk transfer at the centre of thetransaction. Public sector balance sheet requirements called forprojects to be structured in such a way that demand and related

Paul BartlettReal Estate, Travel and Tourism TaxGroupDeloitte & Touche180 StrandLondon WC2R 2PS, UKTel: +44 (0)20 7007 2854Fax: +44 (0)20 7007 2258E-mail: [email protected]

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risks were transferred to the private sector. The tax treatment ofdesign and construction costs in such circumstances is invariably ascapital costs which create the setting from which the PPP/PFIbusiness operates. This approach is often referred to as ‘fixed asset’tax treatment.The distinction between design and construction costs that create

the setting of a trade, and design and construction costs that formthe subject matter of a trade, is fundamental to the tax treatment ofthese costs. Costs which create the setting for a trade are non-deductible capital and costs which form the subject matter of a tradeare allowable for tax purposes. The reason for this distinction isthat, under the UK tax system, costs are only deductible for taxpurposes if they are wholly and exclusively incurred for the purposeof a trade. Capital costs are rarely deductible, although capitalallowances can be claimed on some expenditure.

CAPITAL DESIGN AND CONSTRUCTION COSTSThe scope of the PPP/PFI operators’ trade will be defined by theproject agreement entered into with the awarding authority; wherethis stipulates that the PPP/PFI operator will provide services whichcan only be delivered from the completed building, this will beindicative that the design and construction costs form the setting ofthe operator’s trade and are disallowable capital.Examples include PFI prisons, certain ‘Design, Build, Finance

and Operate’ (DBFO) road contracts and some PFI hospitals. In atypical PFI prison contract, the project agreement provides that thePPP/PFI operator is required to provide custodial services to theHome Office in exchange for a unitary charge based on availabilityof secure accommodation. The operator will acquire freehold orleasehold land, build the facility and employ its own staff to manthe prison. The scope of a prison operator’s trade is providingcustodial services, and the prison is the setting from which the tradeis carried on; the design and construction costs are thereforedisallowable capital.In DBFO road projects, the project agreement will require the

road operator to provide a new or upgraded road in exchange for ashadow toll (or, in some cases, a real toll) to be paid based on trafficusage and volume. The scope of a DBFO road operator’s trade isoperating a toll road and the cost of building or upgrading the roadis capital expenditure on a fixed capital asset of the DBFO roadoperator’s trade.In the hospital sector, the PFI project agreement may provide for

an operator to supply a hospital and non-clinical support services inreturn for an annual service payment, the unitary charge. In suchcircumstances, the operator will acquire an interest in land for thepurpose, typically a freehold or leasehold, build the hospital andlease it to the awarding authority. The PFI hospital operator will beregarded, for tax purposes, as using its interest in the property togenerate rental income. The hospital buildings will be a fixed capital

Scope of trade

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asset of the PFI operator’s business, and the design andconstruction costs of building the hospital are capital expenditurefor tax purposes.Some conclusions can be drawn on the characteristics that a PPP/

PFI contract will exhibit when the related design and constructioncosts are capital. First, the project agreement will require theoperator to ‘provide’, rather than ‘build’, a facility. In other words,the scope of the operator’s trade will not include carrying out designand construction work for the awarding authority. Secondly, thenature of the interest in land acquired by the PPP/PFI operator willbe a freehold or leasehold interest in land. This test is importantbecause holding a freehold or leasehold is indicative that theoperator is either the main occupier of the property that providesthe setting in which it carries on its trade, or that the land has beenacquired for the purpose of letting it out by granting a lease, sub-lease or licence as part of a property rental business. Thirdly, whenthe operator employs all of the staff running the facility, as opposedto providing just the facility’s management staff, this will beevidence that the design and construction costs are capital.When a PPP/PFI contract is structured so that the design and

construction costs are disallowable capital, it will be necessary todetermine the extent to which the activities are regarded as tradingand the extent to which they are regarded as property rental. Theexact split will depend on the facts of each case but it is likely that incases where a PPP/PFI operator has acquired a freehold or leaseholdinterest in land for the purpose of letting it out by grant of a lease,sub-lease or licence, a property rental business will exist. This will bethe case even when the terms of the lease, sub-lease or licence specifya nominal rent or when payment of the rent is dependent on theoperator meeting specified standards of performance. When thePPP/PFI operator is also required to provide related supportservices, such as property and general facility management, thesesupport services may constitute a trade. The unitary charge will needto be apportioned on a just and reasonable basis between the partrelating to the right to occupy or use the land (which may notnecessarily be limited to any nominal rent specified in the lease) andthe part relating to the provision of services. A similar exercise willneed to be undertaken for deductible expenses including capitalallowances. The result of this apportionment work will be twoseparate streams of taxable income. Difficulties may arise insituations where one activity results in a loss and one activity resultsin taxable profits. Losses of one activity can be set against the profitsof another arising in the same year. Losses of a rental business canbe carried forward and set against future total profits, but losses inthe trade can only be carried forward and set against trading profits— they cannot be set against rental or interest income.It should be noted that the accounting treatment adopted by a

PPP/PFI operator is of limited assistance in determining the scopeof a PFI trade and whether the design and construction costs are

Capital design andconstruction costs

Interest in land

Exploring the different approaches to taxing PPP and PFI vehicles


disallowable capital or not. Ownership of a PFI asset for taxpurposes may or may not be reflected in the accounts of the PFIoperator. The criteria that define whether or not, for accountingpurposes, the property is shown as a fixed asset on the operator’sbalance sheet are different from those applied to determine whetheror not it is a fixed capital asset for tax purposes.

CAPITAL ALLOWANCESIn cases where the PPP/PFI asset is regarded as a fixed capital assetfor tax purposes, capital allowances may be available on some partof the design and construction expenditure. The extent to whichcapital allowances are available on the design and construction costsof a fixed capital asset used in a PPP/PFI operator’s trade will varydepending on the nature of the asset constructed, the nature of thelegal interest in the land held by the PPP/PFI operator and whetherthe awarding authority makes a contribution towards the design andconstruction costs.There are three main categories of expenditure which may be

eligible for capital allowances on a PPP/PFI project: plant andmachinery eligible for writing down allowances at 25 per cent on areducing balance basis; plant and machinery eligible for writingdown allowances at 6 per cent on a reducing balance basis (long lifeassets); and industrial building expenditure eligible for writing downallowances (‘industrial building allowances’, or ‘IBAs’) on a 4 percent straight line basis.Rather than ‘plant and machinery’ being a defined term within

the capital allowances legislation, the definition of what does anddoes not qualify for plant and machinery allowances has beendeveloped from case law over a number of years. Generally,expenditure on the following categories will qualify for plant andmachinery allowances.

. Heating, ventilation and air conditioning systems (includingenergy and building management systems), building work inconnection with heating, ventilation and air conditioninginstallations, heat source equipment (radiators) and associatedpipe work and fittings, tanks, gas main distribution, air supplyand extract equipment, chillers, fan coil units, plenum ceilings,plenum floors and environmental control items;

. Hot water installations, including water heaters, associated pipework and fittings, tanks and gas main distributions;

. Complete cold water installations which are tailored to meet therequirements of the trade for which they were designed andconstructed as a fully integrated entity;

. Complete electrical installations designed to meet therequirements of the trade for which they were designed andconstructed as a fully integrated entity; main distribution boardand switchgear, transformers and substations, electrical powerwiring to plant and machinery, standby generators, emergency

Plant and machineryallowances

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lighting, illuminated signals and specialist lighting designed tomeet the requirements of a trade;

. Computer and communications installations, including buildingwork in connection with computer and communicationinstallations, telephone wiring data, cabling, audio–visualconference facilities, public address and intercom systems andtelevision, radio and TV aerial systems;

. Fire protection installations and equipment including fire alarms,fire fighting installations, fire shutters and fire containmentequipment, smoke extract plant and mechanical door furnituresuch as overhead door closers, floor springs and fire bolts;

. Security installations and equipment such as alarm sensors andassociated wiring, closed circuit CCTV installations, automaticentry and access control equipment, electrically and mechanicallyoperated security gates, shutters and grilles, blast curtains andblast film;

. Lifts and hoists, including passenger and goods lifts, escalators,dock levellers and document handling equipment such asdocument hoists and pneumatic tube installations;

. Sanitary and welfare equipment including sanitary fittings andwaste pipes up to soil stack or connection to drainage system,hand driers and disabled fittings;

. Furniture, fittings and equipment, including loose and fixedfurniture, cupboards, reception desks, seating, display cases,screens, shelving, racking and storage platforms, buffer rails andprotection equipment, blinds and curtains, trade and informationsigns, carpets, removable floor coverings and entrance mats,demountable partitions, catering and refrigeration equipment,laundry equipment and manufacturing and processing equipment.Certain ambient features in restaurant areas may also qualify;

. Disposal installations and equipment including pumps, completesewerage installations designed to meet the requirements of atrade and refuse disposal systems, including refuse chutes,compactors, incinerators and containers;

. Car parking and related equipment including electrical vehiclecontrol equipment, petrol interceptors, petrol pumps and tanks,weighbridges and turntables.

In addition, certain special-purpose buildings, rooms or structuresmay qualify as plant and machinery when they are designed andconstructed as a fully integrated entity, function as plant and fulfil arequirement of the trade.The rate of allowances given on this expenditure depends on

whether the plant and machinery is a long-life asset or not. Whenthe plant and machinery is a long-life asset, the rate of capitalallowances is 6 per cent on a reducing balance basis. In other cases,the rate is 25 per cent on a reducing balance basis. Long-life assetsinclude plant and machinery for which the expected useful economiclife, when new, is at least 25 years. There is an exemption from the

Rate of allowances



long-life asset rules for railway assets until 1st January, 2011. Ingeneral, the long-life asset rules will be relevant when equipment isspecifically designed for a purpose and has a design life in excess of25 years, such as in the case of simulators built for Ministry ofDefence training PPP/PFI contracts. The depreciation policyadopted by the PPP/PFI operator may be indicative of the usefullife.In practice, there can be some considerable difficulty in

identifying the amount of expenditure qualifying for capitalallowances and determining whether or not the long-life asset rulesapply to plant and machinery used in a PPP/PFI business. The keyto maximising the quantum of a capital allowance claim is thequality of information available from the design and constructionsubcontractors. It is essential that contract sums are properlyanalysed, particularly where lump sum design and build contractsare used. The proper allocation of design costs and constructionoverheads such as prelims, contractor profit and contingencies willaugment the amount of any claim.When the plant and machinery constitutes fixtures, an ownership

test based on legal title must be met for capital allowances to beclaimed. The definition of what is and what is not a fixture is basedon case law rather than statute, and there is no clear rule. Broadlyspeaking, plant and machinery will constitute a fixture if they areaffixed to a building for its better enjoyment. In practice, many ofthe plant and machinery items listed above will be regarded asfixtures. The ownership test requires that the PPP/PFI operatorincurring the expenditure owns the plant and machinery as a resultof incurring the expenditure. Typically, this will require the PPP/PFIoperator to own the freehold, leasehold or exclusive licence tooccupy the premises. When a freehold, leasehold or exclusive licenceto occupy is held throughout the design, construction andoperational phase of a PPP/PFI contract, no particular issues shouldarise and the ownership tests are normally met. Holding such aninterest in land would be consistent with the PPP/PFI operatorholding the asset as a fixed capital asset.There may, however, be circumstances in which the PPP/PFI

operator does not hold a freehold, leasehold or exclusive licence tooccupy throughout the life of the PPP/PFI concession. Typically,this may arise when, rather than a freehold or a lease beingconveyed to the PPP/PFI operator, the operator relies on anexclusive licence to occupy which covers the construction phaseonly. Provided that the PPP/PFI operator begins its trade andincurs expenditure before the exclusive licence to occupy terminates(normally on completion of construction), the PPP/PFI operatorwill have a sufficient interest in the land to claim capital allowanceson plant and machinery that become fixtures in the property.When the construction work is completed, the exclusive access to

the site may cease; this will cause a termination of the exclusivelicence to occupy, as the PPP/PFI operator will no longer have

Fixtures and interestin land

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control over the land. The expiry of the exclusive licence to occupywill normally mark the point where the fixtures cease to belong tothe PPP/PFI operator, for capital allowance purposes. There isusually no problem with continuing to claim capital allowances onqualifying plant and machinery which are fixtures, as no disposalproceeds will be received. It should be noted, however, that anyreplacement expenditure on plant and machinery fixtures that isincurred during the operational phase of the PPP/PFI project maynot attract capital allowances, as no qualifying interest in land willbe held at the time the expenditure is incurred.When the assets are chattels, the necessary ownership test will be

met when the assets are acquired. It is possible that ownership of theassets may cease when they are made available to the awardingauthority under the terms of the PPP/PFI project agreement; if thisis the case, a disposal will occur with proceeds equal to marketvalue.IBAs are relevant to transport-undertaking PFI projects, such as

rail and DBFO road contracts awarded by the Highways Agency orScottish Office. No IBAs are available on DBFO roads built forlocal authorities. A relevant interest in land, such as a lease orlicence, is necessary for the PPP/PFI operator to claim IBAs on aroad or rail undertaking. For a road undertaking with the HighwaysAgency or Scottish Office, the DBFO concession can be regarded asthe relevant interest for IBA purposes.When the PPP/PFI awarding authority makes a contribution

towards the operator’s capital expenditure, this may potentiallyreduce the capital allowances available to the operator. This isbecause there is a requirement that, in order to claim capitalallowances, the PPP/PFI operator must incur the relevant capitalexpenditure. The same principles apply when land is introduced bythe awarding authority as a payment in money’s worth in order toreduce the capital costs of the project to the PPP/PFI operator. Theexact way in which the contribution is taxed will be determined bythe project agreement and the intentions of the parties. Generally,the following tax consequences will apply. First, the PPP/PFIoperator will be treated as having received a capital contributionresulting in a reduction of the base cost for capital gains purposes.Secondly, when the project agreement specifies the costs to be metby the contribution, this will be followed in calculating anyreduction in entitlement to capital allowances. If there is a partialcontribution, for example, towards the cost of a building withvarious categories of expenditure for capital allowances purposes,the contribution will be apportioned across the various categories ofexpenditure. Typically, a PPP/PFI project agreement will stipulatethat the contribution is to be applied against expenditure which doesnot qualify for capital allowances in the first instance, in order toensure maximum entitlement to capital allowances for the operator.Any allocation of the contribution must be consistent with the facts;for example, no contribution can exceed the amount of the capital

Industrial buildingsallowances



expenditure to which it is allocated. If there is an excess, then theexcess has to be reallocated over other categories of expenditure.It is important to note that capital payments or transfers of

surplus land by the awarding authority to the PPP/PFI operatormay alternatively be made as a payment on account of futureunitary charge payments. In these circumstances, the release of thecontribution to the operator’s profit and loss account will bechargeable to tax as income of the operator’s trade in the normalway. It is likely that the timing of the income for taxation purposeswill follow the accounts treatment. When the contribution is madeby transfer of surplus land and the land is not immediately sold,then its market value at the date of entry into the PPP/PFI projectagreement will be taken as the value of the prepayment of theunitary charge for tax purposes. If the land is subsequentlyappropriated to capital account (eg as an investment), the marketvalue of the land at the date of appropriation will be used toestablish whether any taxable profit and loss arises in the operatoras a result of his ownership prior to appropriation.

REVENUE DESIGN AND CONSTRUCTION COSTSMany PPP/PFI contracts are not structured so that the design andconstruction costs are a capital asset of the operator. Instead, thescope of a PPP/PFI operator’s trade may extend beyond theprovision of facility management and related support services andinclude the provision of the design and construction services. Inother words, the PPP/PFI operator has a composite trade ofproviding design, construction and facility management services.This is generally referred to as ‘contract debtor’ or ‘composite trade’tax treatment.For contract debtor tax treatment to apply, the PFI property

must be regarded as a fixed capital asset of the awarding authority,for tax purposes. This can be contrasted with the fixed asset taxtreatment where the design and construction costs are a fixed capitalasset of the PPP/PFI operator. Take, for example, the case of aPPP/PFI operator entering into a contract to build a hospital andprovide non-clinical support services in exchange for an annualservice payment, the unitary charge. The hospital will belong to theawarding authority throughout the period of the contract and willprovide a right of access, or non-exclusive licence to occupy, toenable the operator to do no more than go on to the land to providethe construction, support and ancillary support services. For taxpurposes, the PPP/PFI operator’s trade is the provision of design,construction and support services. The operator is not carrying on aproperty rental business, as he is not earning rents from the interestin the land granted to him. The PPP/PFI operator has not acquiredthe hospital as a fixed capital asset. The design and constructioncosts will therefore be regarded as revenue expenditure for taxpurposes and allowable against the trading income receivable.A similar example arises in the case of DBFO roads, where the

Surplus land

Tax deductibledesign andconstruction costs

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PPP/PFI awarding authority enters into a contract whereby theoperator builds a road and then maintains it in exchange for aunitary charge. The land will belong to the awarding authoritythroughout the period of the contract and they will provide a rightof access or licence, or enable the operator to construct the road andprovide maintenance. In these circumstances, the cost of the road isrevenue expenditure and will be allowable against the unitary chargeas it is written off to the profit and loss account.The nature of the interest or right over land granted by the

awarding authority to the PPP/PFI operator is therefore one of thekey factors in determining whether contract debtor tax treatmentcan apply or not. Normally, a PPP/PFI operator who is intending touse the contract debtor approach should not require any interest inland beyond the minimum rights of access that are required toenable it to provide construction and support services. A limitedinterest in land will be consistent with the provision of design andconstruction services which are part of the composite trade. A PPP/PFI operator adopting contract debtor tax treatment would notnormally be expected to employ any staff working in the building,beyond those responsible for construction and maintenance.From time to time, a PPP/PFI operator may require a lease of a

minor part of the project site, to enable sublets of rental space to begranted to tenants, for example, retail units near a hospital entranceor catering concessions within the building. Arrangements of thissort will not normally undermine the PPP/PFI contract debtor taxstatus, provided that the resultant income is minor in relation to theunitary charge, as will usually be the case.

INCOME AND EXPENDITURE RECOGNITIONRegardless of whether a PPP/PFI operator is treating the design andconstruction costs as a capital asset or adopting contract debtor taxtreatment, the accounting policies adopted will be relevant fordetermining when income and expenditure are recognised for taxpurposes. In all cases, irrespective of whether the income will betreated as trading, rental or a mixture of both, the starting point forincome recognition will be the income credited to the profit and lossaccount.When, under FRS 5 — Application Note F (‘FRS 5’), the costs of

the property are recognised as a fixed asset on the balance sheet ofthe PPP/PFI operator, the whole of the unitary charge will berecognised as trading or rental income. When, under FRS 5, afinance debtor is recognised on the PPP/PFI operator’s balancesheet, the unitary charge is accounted for as two separate parts. Theoperating income (payment for support services) is credited directlyto the profit and loss account and this is taxed. The balance of theunitary charge will be a part payment of the finance debtor ascredited to the balance sheet as a reduction in the debtor, although anotional interest charge on the finance debt will be credited to theprofit and loss account (with a corresponding debit to the finance

Licence to occupy

Profit recognition



debtor). Both the operating income and notional interest are taxableincome, as recognised in the profit and loss account. In addition,because the whole amount of the unitary charge must be broughtwithin the charge to tax, to the extent that it has not previously beenrecognised and will not be recognised in a profit and loss account,the amount credited to the finance debtor must be included astaxable income in the computations.Similar principles apply for recognising deductions in cases where

FRS 5 accounting policies apply. When the design and constructionexpenditure represents the cost of acquiring a fixed capital asset fortax purposes, no deduction is available for that expenditure,although capital allowances may be available.When contract debtor tax treatment applies, costs are allowable

as a revenue deduction. When SSAP 9 accounting principles areadopted during construction, tax relief will be given for the designand construction costs as they are recognised in the profit and lossaccount (typically against the sale of work in progress oncompletion of construction). When FRS 5 principles are adopted,the design and construction costs may be capitalised either as a fixedasset or finance debtor. When a fixed asset is recognised, thedepreciation charge will represent amortisation of capitalisedrevenue expenditure and be deductible as charged to the profit andloss account. When the property is reported as a finance debtor,income credited directly to the finance debtor is taxable, so relief isgiven for the matching reduction in the value of the finance debtorto the extent that it reflects capitalised revenue expenditure.

RELIEF FOR INTEREST EXPENSERelief is normally available for corporation tax purposes for interestincurred in relation to a trading activity in which an interest debit ismade to the profit and loss account. When the debit is made to afinance debtor, it is deductible, as it is matched against income. Theone exception to this is in the situation where the interest is debitedto a fixed capital asset or project in which case relief is immediatelygiven in the same accounting period as if it were debited direct tothe profit and loss account. When a PFI asset is treated by the PPP/PFI operator as a fixed asset for tax purposes, relief will be given forinterest debited to the cost of the asset, regardless of whether it isreported as a fixed asset or financial asset for accounting purposes.When a PPP/PFI operator is constructing an asset which will

generate rental income as well as trading income, some part of theinterest it incurs will be treated as a non-trade debit (the part relatedto the rental income) and part will be a trading debit. Non-tradeloan relationship debits are aggregated with credits arising fromnon-trading loan relationships (interest income), any net surplus istaxed as interest income and any net deficit may be set against otherincome (eg rental income) for a period or carried forward and setagainst future non-trading income. Relief for non-trade interestdebits is normally given when it is debited to the profit and loss

FRSS/SSAP 9

Tax relief forfinancing

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account, or if debited to a finance debtor it is deductible as matchedagainst income. Non-trading interest debits are allowable in theaccounting period as they are debited to a fixed capital asset orproject.Interest incurred prior to the start of a PPP/PFI operator’s trade

is treated as a non-trade interest debit; however, provided that thedebt would have been a trading debit (had the trade started) andthat an election is made within two years of the end of the pre-trading accounting period, the debit can be treated as a tradingdebit of the accounting period in which the company begins totrade. Interest payable in a pre-trading period that is not recognisedfor tax purposes until a later accounting period, after the trade hasstarted, because interest is debited to a finance debtor, will not beregarded as a pre-trading expense; relief for such interest is given, asit is matched against income related to the finance debtor.

COMMENCEMENT OF TRADE AND PRE-TRADING BID COSTSA PPP/PFI operator will normally commence its trade once it is in aposition to provide the relevant services under its project agreement.When the PPP/PFI asset is a fixed capital asset used in theoperator’s trade, it is unlikely that the trade will commence until theproject has been completed and is ready for occupation. If the PPP/PFI asset is a fixed capital asset used in the operator’s rentalbusiness, the latter and associated support services trade does notstart until the property has been completed and occupied. If thePPP/PFI operator has a composite trade of providing design,construction and support services, the trade will start when theoperator is ready to provide design and construction services, whichwill probably be the date on which the PPP/PFI project agreement issigned.Bid costs are generally incurred by the project sponsors in the pre-

trade period. There is normally no problem with securing a taxdeduction on the vast majority of such costs in the PPP/PFIoperator once they have been recharged by the sponsors. It may benecessary to ensure that the recharge does not include any costs thatmight not be regarded as costs of acquiring a lease or granting asub-lease. Such costs are unlikely to be allowable.

CONCLUSIONContract debtor tax treatment should, in the majority of cases, offerconsiderable tax efficiencies over traditional fixed asset taxtreatment. This is because under contract debtor tax treatment thedesign and construction costs of a PPP/PFI asset are revenuedeductible, whereas under fixed asset treatment tax relief is onlyavailable for that proportion of capital expenditure that qualifies forcapital allowances. Typically, this may mean that only between 20per cent and 40 per cent of design and construction cost expenditureis allowable, meaning that between 60 per cent and 80 per cent ofcapital expenditure will attract no tax relief.

Set up costs



There are, however, some advantages to fixed asset tax treatmentbecause of the timing of when tax losses arise and the possibility ofsurrendering these losses by group or consortium relief. Thesetiming benefits arise because capital allowances are generally givenat a 25 per cent reducing balance and relief is available for interestdebits made to a fixed capital asset or project. For these reasons, aPPP/PFI operator adopting fixed asset tax treatment is likely toaccumulate significant tax losses in the early years of a project,particularly when the amount of plant and machinery is high. Thesetax losses may be available for surrender as group or consortiumrelief to project sponsors in exchange for a payment probably basedon the tax saved by the purchaser. Group relief enables all of thelosses to be surrendered, provided that both parties are members ofa 75 per cent group. Consortium relief is available when 75 per centor more of the ordinary shares are owned by corporates owning inexcess of 5 per cent of the ordinary share capital. Under theconsortium relief rules, a loss surrender is made in proportion to theshare capital owned.It should be noted that consortium relief is not available when

property rental activities predominate for the PPP/PFI operator.For consortium relief to be available, the main activity of the PPP/PFI operator must be trading. If the generation of rental income isancillary to the trade of providing support services and design andconstruction services, consortium relief should be available.Because it may not necessarily be clear as to whether it will be

advantageous to adopt contract debtor tax treatment, some form offinancial modelling may be necessary to determine the correctapproach.

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Exploring the different approaches to taxing PPP and PFI vehicles