Minimum Revenue Provision on Capital Loans David Green

Since the minimum revenue provision (MRP) regulations were relaxed in 2008, English local authorities have supported local public services with loans towards other bodies’ capital expenditure. Under the pre-2008 rules, such loans would have incurred an annual cost of 4% for the lending authority; the current regime merely requires a prudent amount of MRP be set aside and where authorities are confident the loan will be fully repaid, that prudent amount can be zero.

In November 2021, the Government proposed that the use of zero MRP be banned. This was in response to concerns that local authorities were charging no MRP on investment property on the basis that they planned to sell it at some point in the future for more than they bought it, so there would be no overall cost. Of course, the difference between a loan and a property is that you know at the outset who will repay the loan, when they will repay it and they are contractually obliged to repay exactly the original amount of the loan; neither the buyer, the date or the sale amount are known for a property on the purchase date.

The Government has now accepted that capital loans are a special case and in June 2022 proposed further changes. If enacted, these will mean that MRP on loans made for service purposes need only cover the IFRS 9 expected credit loss (ECL) on the loan. This will need to be made in the year after the loan is lent and cover the full ECL; the charge cannot be spread over the life of the loan or the underlying asset. Any increases in ECL, e.g. due to the diminished creditworthiness of the borrower, will also need to be charged immediately.

Loans made for commercial purposes (e.g. to enable a subsidiary to purchase an investment property) are not covered by this zero MRP exemption. But where such loans are repayable in at least annual instalments, the capital receipts from those instalments can be used instead of a revenue charge to meet the MRP requirement. This only applies in the year of receipt, so local authorities cannot defer MRP on the basis of capital receipts expected in later years.

The use of capital receipts to defray MRP will also apply to assets leased out under finance leases. This will be particularly useful for back to back arrangements where a property is leased in and leased out again. Under the accounting arrangements for finance leases, part of the income from the lessee is treated as a capital receipt and so normally unavailable to cover the revenue cost of interest and MRP on the purchase cost. The new proposal will treat capital receipts from principal repayments on lease receivables the same as those from capital loans.

The permitted reasons to make zero MRP and to use capital receipts in year will be specified in regulations. All other assets forming part of the capital financing requirement (CFR) will need a charge for MRP each year. And any other capital receipts applied against the CFR will only take effect from the following year, reducing MRP pro-rata over the remaining useful life of the assets.

The draft regulations published in June 2022 are more restrictive than the existing statutory guidance on MRP, which they will override. As currently drafted, the regulations do not allow zero MRP on housing revenue account assets, permit the use of overpayments built up in earlier years to offset current year MRP, or allow MRP to be deferred until the year after an asset becomes operational. There was no indication that these are policy changes and the draft will therefore need amending to avoid unintended consequences. The government has launched a survey running for two weeks to iron out any such issues.

Local authorities should welcome these latest proposals. While some will have argued for the continued ability to make no MRP on investment property, government is committed to removing the remaining incentives to borrow to invest. The latest proposals for capital loans are generous, especially for loans made for service purposes, and will broadly retain the status quo.

Bringing expected credit losses into the scope of MRP is the quid pro quo for exempting the remainder of the principal. It will bring the calculation of ECLs into sharper focus, now that there is a direct revenue consequence. It also introduces the risk of having to charge the full loan principal immediately to revenue in the event of a default so should make local authorities think twice before agreeing large unsecured, or insufficiently secured, loans.

Please get in touch by emailing if you require any assistance in calculating minimum revenue provision or expected credit losses, or for advice on making loans to other bodies.

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