Exceptional Financial Support (EFS) and the Capitalisation Direction are not the same thing in local government finance, though they are related concepts.
Exceptional Financial Support (EFS):
- EFS is a form of temporary financial assistance provided by the UK government to local authorities that are facing severe financial difficulties. This support is typically used to help a council meet its immediate financial obligations and avoid insolvency.
- It is provided under specific, exceptional circumstances, and local authorities usually need to demonstrate that they have exhausted all other options before this support is granted. The terms of the support can vary and might include loans or other forms of financial assistance.
Capitalisation Direction:
- The Capitalisation Direction allows local authorities to treat certain revenue expenditures as capital expenditures. This means that instead of funding these costs from the revenue budget (which must be balanced annually), they can be funded by borrowing or from capital receipts (e.g., from the sale of assets).
- To use this direction, local authorities must apply to the Ministry of Housing, Communities, and Local Government (MHCLG) for permission. It is often used to manage extraordinary financial pressures by spreading the cost over several years rather than dealing with it all at once.
- A council might apply for a Capitalisation Direction to cover the costs of a significant restructuring or to manage one-off costs related to a financial crisis.
Key Differences:
- EFS is direct financial support provided under exceptional circumstances, while the Capitalisation Direction is a permission to reclassify certain expenditures to ease short-term financial pressure.
- EFS involves receiving funds or financial support, whereas the Capitalisation Direction is about adjusting how existing funds are managed. To date, most cases of EFS have been via the authorisation of a Capitalisation Direction, highlighting the overlap.
Both are tools to assist local authorities in financial difficulty, they serve different purposes and operate in distinct ways. This includes complying with existing limits set by the Council. A Capitalisation Direction is typically inside an authorised limit set for a local authority's borrowing.
Complying with Authorised Limits
Local authorities in the UK have statutory limits on the amount they can borrow, known as the Authorised Limit. This limit is set annually by the council and approved as part of the local authority's prudential indicators, under the Prudential Code. The authorised limit represents the maximum amount of debt the local authority can have at any one time.
When a local authority is granted a Capitalisation Direction, it allows them to treat specific revenue expenditure as capital expenditure. This typically enables the authority to borrow funds to cover those costs or to use capital receipts (e.g., from the sale of assets) that would otherwise be restricted to capital projects.
- The borrowing that results from a Capitalisation Direction would count towards the local authority's overall debt. Therefore, it must fit within the existing authorised limit for borrowing. The authority would need to ensure that any new borrowing associated with a Capitalisation Direction does not cause them to exceed their authorised limit.
- If the Capitalisation Direction requires significant borrowing and the authority is close to its authorised limit, the local authority might need to review and adjust its authorised limit to accommodate the additional borrowing. This would typically be done as part of their treasury management and prudential borrowing framework.
MRP Implications
Local authorities are required to pay Minimum Revenue Provision (MRP) on expenditure that is capitalised under a Capitalisation Direction because these amounts are treated as capital expenditure funded by borrowing, and MRP is the mechanism to ensure that this borrowing is repaid.
- Capitalisation Direction: When a local authority receives a Capitalisation Direction, it allows certain revenue costs to be treated as capital expenditure. This means that these costs can be financed through borrowing or capital receipts, rather than being funded directly from the revenue budget.
- MRP Requirement: Since the expenditure that is capitalised under a Capitalisation Direction is treated as capital expenditure, it is subject to the same rules as other capital spending financed by borrowing. This means the local authority must calculate and make MRP payments for the capitalised amount, ensuring that the debt is repaid over time.
The specific amount of MRP to be set aside each year will depend on the local authority's MRP policy, which typically reflects the life of the asset or the period over which the capitalised costs are expected to generate benefits.
It should be noted in all recent cases Capitalisation Directions have required MRP to be set aside over a maximum period of 20 years. For the capitalisation direction, where borrowing is undertaken from the PWLB, there is a 1% penalty rate as well as requiring commissioners to carry out a Best Value review. This 1% is applied to the Councils typical rate of borrowing; for example, if the Council were typically to borrow at the PWLB Certainty Rate, this would add 1% to Certainty Rate.
If you have any questions about EFS or Capitalisation Directions please contact treasury@arlingclose.com
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