CFM90718 - Debt cap: gateway test: definition of relevant liabilities - finance leases and ‘quasi loans’
Relevant liabilities for the purposes of calculating the worldwide gross debt and UK net debt amount
A finance lease is in effect a secured loan and so liabilities in respect of finance leases are treated as relevant liabilities (see TIOPA10/S263(3)(b) and S264(2)(b)). Accounting standards explicitly define what a finance lease is, only liabilities in respect of finance leases that are treated as such by the accounting standards under which the financial statements are prepared are relevant liabilities.
Relevant liabilities also include arrangements that are not short term or long term borrowing or finance leases but are:
- Financial liabilities; that
- Produce a return that is economically equivalent to interest; and
- Are not short term.
This includes within the debt cap rules arrangements that have the same economic effect as loans but are not legally loans. In particular for some PFI projects the application of the accounting standard IFRIC 12 may result in the constituent parts of the PFI project being accounted for separately. In this case the arrangement within S263 will be that part of the overall PFI contract that is accounted for as a financial asset rather than the entire contract.
TIOPA10/S263 (6) defines a return as economically equivalent to interest if it is reasonable to assume that it is calculated by the time value of money, is at a rate that is reasonably comparable (but not necessarily identical to) to the interest rate in comparable circumstances and it is practically unlikely that it will not be paid unless the person by whom it falls to be produced is prevented (by insolvency or otherwise) from producing it. In practise it should be accepted that where a contract under which a return economically equivalent to interest is paid contains non-performance or default terms this will not prevent the liability being a relevant liability under TIOPA10/S263(6).
For PFI contracts the return economically equivalent to interest may include elements that will not be present in external debt. When considering whether or not the return on a PFI contract is economically equivalent to interest a direct comparison with interest rates on loans for equivalent amounts may not be appropriate. If a non PFI contract such as a loan is used as a comparator consideration must be given to the reason for the difference between the return on the PFI contract and the comparator.
TIOPA10/S263 (6) (c) refers to there being no practical likelihood that the return will ceased to be produced ‘at the relevant time’. For PFI arrangements where the financial asset builds up over the construction period the relevant time is when the financial asset is recognised on the balance sheet. PFI contracts often include performance or service requirements, any failure to meet performance or service requirements will not prevent the arrangement from being included in S263.