I enclose a note explaining the increase in capital DEL, as requested in your letter of 21 March.

30 April 2003

INTRODUCTION

  1.  This note explains the £141 million increase in capital DEL in the Treasury's revised Spring Supplementary Estimate relating to 1 Horse Guards Road.

  2.  As the Committee will recall, the Treasury's main headquarters building, Government Offices, Great George Street (GOGGS) is the subject of a Private Finance Initiative contract. Under that contract the Treasury is provided with serviced accommodation in refurbished space in the West end of GOGGS by its private sector partner, Exchequer Partnership plc (EP). In return, the Treasury makes an annual Unitary Payment to EP of some £14 million at 1999 prices. Following refurbishment of the West end (now known as 1 Horse Guards Road), the Treasury reoccupied it from 22 July 2002. The contract will run for 35 years.

  3.  EP has entered a similar contract in respect of the East end of GOGGS with HM Customs and Excise and the Inland Revenue.

ACCOUNTING TREATMENT OF PFI PROJECTS

  4.  The proper accounting treatment of PFI agreements and their private-sector equivalents is determined by UK Generally Accepted Accounting Principles (implemented in the central government sector by the Resource Accounting Manual). In line with the relevant accounting standard (FRS5), the treatment depends on which party has the majority of the risks and benefits of the property. The key points are:

—  If the majority of risks and benefits fall on the private sector partner, the government body's balance sheet shows only the reversionary value of the property—ie the value of the property when it reverts to the government body at the end of the contract, discounted to reflect the passage of time. The full annual costs of the contract are accounted for in the body's operating cost statement.

—  If, on the other hand, the majority of risks and benefits fall on the government body, its balance sheet must show the full value of the property as an asset. The creation of that asset is represented in the body's accounts by an equivalent amount of capital expenditure in the year in which the asset is brought into use.

  5.  It is important to note that these alternative accounting treatments do not affect the actual amount of money paid to the private sector partner—simply the way in which it is represented in the government body's accounts.

1 HORSE GUARDS ROAD

  6.  Initial analysis commissioned by the Treasury of the agreement in respect of 1 Horse Guards Road suggested that the balance of risks and benefits lay with the private sector partner, Exchequer Partnership. That provisional treatment was reflected in the Treasury's 2002-03 Main Estimate.

  7.  The asset was brought into use in July 2002. This fell to be reported in the Treasury's 2001-02 Accounts as a post-balance sheet event. During 2002 the Treasury commissioned a leading accountancy practice to provide further advice about the risk assessment and the resultant treatment of the contract. They were able to take account of information about the property and associated risks which had not been available when the original advice was prepared—reflecting, for example, information about property market conditions.

8.  In the light of the updated evidence and this further advice, it was concluded that the majority of risks and benefits now fell on the Treasury rather than on Exchequer Partnership. This conclusion was audited and agreed by the National Audit Office, and reported in note 29.2 to the Treasury's 2001-02 Accounts. Now that 1 Horse Guards Road is on the Treasury's balance sheet, all costs incurred by Exchequer Partnership in relation to this building need to be accounted for.

SPRING SUPPLEMENTARY ESTIMATE

  9.  The bringing into use of the asset fell in the 2002-03 financial year. It was therefore necessary for the Treasury to take a Spring Supplementary Estimate to change the treatment given in its Main Estimate. The Supplementary made all the changes required by the accounting treatment described above. The largest of these related to capital expenditure. The £141 million of capital expenditure about which the Committee has enquired represents the costs incurred by Exchequer Partnership in its renovation of the building. The expenditure is not matched by 2002-03 cash outlays: the Treasury's payments to EP in that year were a part-year share of the £14 million referred to above (subject to indexation).

April 2003