Stephen Sheen: making sure your MRP is ‘just right’

In a January article I wrote about the desirability generally for reviewing an authority’s policy for Minimum Revenue Provision (MRP).  The mushrooming of interest in borrowing to invest, or lend, makes it a good time to discuss how the MRP rules apply to the planning of individual projects.

MRP is often presented as a mechanism for generating funds to repay borrowing, but it is more properly the way in which expenditure on capital projects is financed out of revenue resources.  Simply put, good things have to be paid for, and borrowing just allows you to pay for them later, rather than excuse you from not paying for them at all.

If an authority incurs expenditure that will be of future benefit, it is able to spread the financing of that expenditure over the future periods that will benefit from it.  In the meantime, the authority will borrow (or reduce its investments) to fund the cash outflow and meet the interest implications from revenue.  MRP is the additional annual charge that is made to revenue to set aside resources to cover the cost of the original capital acquisition.

For any capital project, these financing issues are removed if you have capital receipts or grants that can be applied to resource the expenditure.  If not, the task is to work out what you have spent and plan a schedule of MRP charges that will make good what you have spent over an appropriate period.

The requirement for MRP comes from the 2003 Capital Finance Regulations (as amended).  Authorities have a duty to make an MRP charge each financial year, determined as an amount which the authority considers to be prudent for that financial year.

There are two particular points to note about this statutory duty:

• it is for the authority to determine its MRP, so you need to have conviction about the prudence of your policies and not just copy what other authorities are doing or what advisers are telling you
• if you want to do something unusual, this will be a matter of statutory interpretation and something that may require the support of your legal advisers

You are assisted in this duty by DCLG’s Guidance on Minimum Revenue Provision (2012).  It sets out the government’s recommendations for the arrangements that authorities should make in establishing an MRP policy (ie, approval by full council) and how a prudent provision should be arrived at.

The Guidance sets out a number of methodologies for scheduling MRP charges.  In relation to individual schemes, the options are to fix a period over which charges will be made and spread the cost of capital expenditure over that period or to match MRP to the depreciation charges that will be generated by the assets that have been acquired.

Under both options, the stated objective is to pay for capital expenditure over the period that is reasonably commensurate with that over which the expenditure provides benefits.

The guidance is statutory, in that authorities are required to have regard to it.  This means that it must be considered when deciding any aspect of MRP policy.  But that consideration can crucially take the form of rejecting the guidance if it is reasonable for an authority to do so and still meet its statutory duty to determine a prudent MRP.

Authorities have generally paid close attention to the guidance, but there is a growing appreciation that it may have an important weakness.  Several of its recommendations are clearly based on a government objective of limiting an authority’s borrowing, by expecting MRP charges in situations where they would not otherwise be needed.  These additional charges reduce the affordability of schemes that could otherwise be judged as good value for money.

The guidance is based on a presumption that plans are either prudent or imprudent.  But prudence can be thought of as a desirable middle point.  if you consider that the statutory duty requires you to be neither imprudent nor over-prudent, then these recommendations for additional MRP become questionable.  You will be in the Goldilocks position of wanting your MRP to be “just right”.

Such a view allows for policies that are more properly in line with the economic effects of a transaction for the authority.  Of particular interest will be:

• projects that will generate capital receipts – if expenditure is incurred on a project that will eventually result in capital receipts, there will be an argument for financing the expenditure from the eventual receipts rather than MRP.
• loans to other parties for capital projects – the Guidance recommends MRP whilst a loan is outstanding, but loans are self-financing in that the cash outflow will be made good by repayment of the loan – the only expenditure consequence of a loan for an authority is the interest on its cash shortfall whilst the loan is outstanding, so provision for the principal amount would be over-prudent until such time as the assumption has to be made that the loan will not be repaid
• acquisition of shares – as with capital loans, there are no direct revenue consequences arising from the purchase of shares but the Guidance recommends that acquisitions are financed from MRP over a minimum period of 20 years – prudent provision might only be needed where the value of shares falls below their cost.
• investment in property – passing over the issue of the legality of borrowing to invest, the argument is that investment property does not depreciate, so if your policy is to set MRP to cover depreciation there will be no annual charge – this argument would, though, be misguided as investment property does depreciate; you are just not required to account for depreciation separately – some level of MRP will be prudent, but careful consideration will be needed to determine what that level should be.

There are then plenty of opportunities for considering departures from the guidance.  However, the potential downside of playing the Goldilocks role is that it will be difficult to seek the shelter of the guidance if things go wrong later.

If a loan is not going to be repaid or an investment property falls in value and a loss has arisen, prudence would be whispering in your ear that the loss needs to be financed immediately.  What argument would you have for seeking a justification in the guidance to spread the loss instead over future periods?

The Goldilocks metaphor is not perfect, therefore, because you may not have the option to run back into the woods when things go bear-shaped.  The overall message is that the door to the bear’s house is open but you need to have conviction that you are walking on solid ground if you make your way through to the kitchen and start tasting the porridge.

Stephen Sheen is the managing director Ichabod’s Industries, a consultancy providing technical accounting support to local government.

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