RP Issues - A Briefing For Registered Providers Of Social Housing

Editor's comment

In many ways, the housing association sector is facing its most fundamental period of change for a generation. Not only does the comprehensive Spending Review provide major challenges and opportunities for the sector, but the basis for financial reporting (via component accounting and subsequently IFRS) is also going through a major upheaval requiring considerable preparation.

Change is not confined to these areas however; VAT issues are increasing in significance with the sector continuing to recover only small percentages of the substantial VAT costs that it incurs, growing as a result of the change in VAT rate and corporation tax, similarly, remains a planning issue for many RPs.

This edition of RP issues includes articles on each of these areas, but also covers sustainability and the Bribery Act, two further key areas requiring consideration. We are also delighted to feature a guest article by Sarah Chiappini from Charles Russell on codified directors' duties.

What should housing associations be aware of when planning for 2011?

With three Finance Acts in 2010, not to mention the SORP 2010 update and regular pronouncements by the Coalition Government, there are numerous issues which might be relevant at this time. We have identified and summarised four items which may be of particular interest to housing associations, some of these areas are explored in more detail later in the newsletter.

TAX ISSUES FOR ASSOCIATIONS

By Jane Haydon and Trudy Amy

Component accounting

Housing associations are increasingly adopting component accounting, as recommended in SORP 2008, and need to be aware (unless they are charitable) of the impact this change in accounting policy will have on taxable profits.

Previously tax deductible replacement costs of components will be capitalised under the new policy and only the annual depreciation will then be tax deductible. This can have a significant effect on profits chargeable to corporation tax, or on the speed with which accumulated tax losses are used, and therefore needs to be factored in to an association's business plan where appropriate.

Changes in tax rates

Business plans will also have to take account of various tax rate changes announced this year. All associations will need to assess the impact of the increase in the standard rate of VAT from 17.5% to 20%. Associations will also need to factor in the gradual reduction in the main rate of corporation tax, currently 28%, which will reduce to 27% from 1 April 2011, and thereafter reduce by a further 1% each 1 April until, with effect from 1 April 2014, the main rate becomes 24%.

SORP update 2010 – negative goodwill

The 2010 SORP update includes consideration of the accounting for 'negative goodwill'. In effect, the proposal is to recognise in the income and expenditure account the 'gain' – in substance a gift – arising on a transfer of engagements from one association to another, or an amalgamation of two or more associations.

The National Housing Federation is, we understand, consulting with HMRC on the tax implications of this accounting treatment and clarification has yet to be received. Our initial view is that while the tax treatment of this credit is not straightforward, in all likelihood there is only a possibility of it being taxable where it relates to stock/WIP or loans, with no tax effect arising from any credit relating to transfers of fixed asset housing stock.

Worldwide debt cap rules

New tax rules were introduced in Finance Act 2009 for restrictions on loan interest deductions for accounting periods beginning on or after 1 January 2010. While aimed at multi-national groups, these rules, (the basic intention of which is to prevent a group from securing a UK tax benefit from lending a greater proportion of debt to the UK part of the group than the worldwide group borrows externally), can apply equally to a group with no overseas entities, such as a UK housing association group. The legislation only applies to large groups (those with 250 or more employees or both turnover exceeding €50m and balance sheet total exceeding €43m). For such housing association groups, there may be circumstances where a combination of the structure of the group and the profile of the inter-company and external loans around the group can trigger a potential charge under these debt cap rules, even though this may not have been the intention of the legislation. We therefore recommend that all such groups review their position regarding rules as soon as possible.

RISKY BUSINESS RISK PROFILE FOR RPS INCREASES FOLLOWING THE SPENDING REVIEW

By Jonathan Pryor

We look at the issues arising from the comprehensive Spending Review which will affect the activities of RPs.

20 October 2010 was undoubtedly a big day in the collective life of the RP sector. It signalled, quite probably, the most substantial change ever in social housing in the UK. The details remain unclear and it will be many months before the full significance of the changes are understood. However, it is clear that the changes will have repercussions for many parts of RP activity, in ways which, we suspect, were not fully anticipated by the Government.

At this stage, many RPs are exploring the repercussions and trying to evaluate what, if anything, the change to 'up to 80% market rent' will mean for their business plans, their development strategies and current and future tenants.

This article, unfortunately, does not provide any answers but does attempt to illustrate some of the issues arising. The key word in all of this is risk: whichever route your association takes, whether to embrace the opportunities and expand your development activities or to withdraw and become largely management-focused, the risk profile has increased substantially.

Unlocking value

At face value, for some RPs, the change in future rent levels may unlock significant value and enable a more substantial development programme to be released. To take an example, suppose the association has 10,000 units and for half of these the potential for an increase in rent up to 80% market rent is capable over time of delivering on average an extra £20 per week of rent at present day values. Suppose also that 1% of properties become void each year, there is a 4% void and bad debt loss, and the relevant policies on rent setting do not change. Assuming a 5% real discount rate, this then equates to a massive £17m increase in the net present value of future cash flows. Surely this could generate a sizeable acceleration in development capacity?

Stepping into the unknown

Unfortunately, there are too many unknowns for this simplistic calculation to be sensible.

Increasing the cost of a service (i.e. the rent) will have some effect on demand; some properties may become hard to let. The end of lifetime tenancies may also have an impact on void periods. Now that a social rent is worth so much more to an existing tenant, we would expect voluntary movements of tenants to be less frequent. Therefore, expect the turnover of properties to slow to some extent. The burden on tenants of the higher rental will be increased. This is bound to have some effect on bad debts and arrears, particularly for those not receiving full benefits. Even for those on full benefits, the move to a universal benefit will mean for some that their income reduces. The restrictions on rentals (e.g. the local housing allowance) will need to be carefully assessed, as will the overall cap. This probably means that in London, for example, larger properties simply cannot be built under this mechanism. Expectations will be raised. Tenants will be paying closer to the market rent and therefore will perhaps expect higher quality in maintenance and service; associations may need to model higher maintenance costs and longer periods between lettings. This might be offset to some extent by tenants taking more care over the property. The dependency on local and central government not changing the rules is now a major threat. Even if a local authority is keen on the changes at the moment, would (following an election) a council led by a different party in say three years time have the same view? How will local authorities react to situations where increases in rents in their authority are applied to subsidise new units in another authority? Given that the risks are higher, surely the association's modelling of schemes needs to reflect a greater level of risk. This would either be via a higher discount rate or a more challenging internal hurdle rate; depending on how the association assesses its potential schemes. Similarly given the higher risks, expect borrowing costs to rise and security requirements to increase. What to expect going forward

There are two other areas hugely affected by the Government's general approach towards funding social housing and care.

We expect temporary housing to go through a boom; whether or not it is the most sensible use of Government money, this is the one area that seems to be a clear winner from the changes.

Secondly, expect some care and support organisations to get into serious financial difficulties. The 11% or so cut and the removal of ring-fencing from Supporting People funding, the severe contraction in local authority funding generally and the relatively easy process for local authorities to tender and achieve reductions in cost, are combining to make care and support organisations, particularly those with a dependency on Supporting People funding, extremely vulnerable. Furthermore, the costs of redundancy on some projects may be borne by the existing provider which, given the limited level of reserves held by some of these organisations, it may not be in a position to bear.

One further consequence we expect to see is an increase in the level of merger activity amongst RPs and similar charitable bodies; as such, all associations should review their merger and acquisition strategies.

The increased risks...

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