Local government finance circular 1/2023 - accounting guidance: accounting for capital receipts to fund qualifying expenditure on a transformation project

Local government finance circular No 8/2022

(As amended by local government finance circular 1/2023)

By email

To:

Directors of Finance of Scottish local authorities
Audit Scotland

Our ref: A42082883

20 February 2023

Dear Director of Finance,

Accounting for capital receipts to fund qualifying expenditure on a transformation project

The Department for Levelling up, Housing and Communities (DLUHC) recently issued updated statutory guidance for the flexible use of capital receipts. The updated guidance stipulates that only capital receipts from the disposal of assets to an unconnected entity may be used for transformation expenditure. In order to protect the Scottish Government Block Grant, this Finance Circular amends Finance Circular 8/2022 to provide parity with the updated Statutory Guidance issued by the Department for Levelling up, Housing and Communities.

Finance Circular 8/2022 provided an extension to the financial flexibility to permit the use of capital receipts to fund projects designed to transform service delivery to reduce costs and/or reduce demand, or both, for the financial year 2022-23. This update amends Finance Circular 8/2022 to require that capital receipts used to fund transformational projects must be generated from a disposal to an unconnected entity. 

This circular is also available from the Scottish Government website.

If you have any questions, please do not hesitate to contact me.

Yours faithfully,

Elanor Davies

Head of Local Authority Accounting

Local Government Finance and Analytical Services Division

Part 1: accounting for capital receipts to fund qualifying expenditure on a transformation project

Background and commentary

Power under which the guidance is issued

1. The statutory guidance is issued under section 12(2)(b) of the Local Government in Scotland Act 2003 [proper accounting practices – specified in guidance by Scottish Ministers]. A local authority is required to apply the guidance where the authority has approved the use of capital receipts to fund qualifying expenditure on a transformation project.

2. This guidance only applies where full Council has approved the use of capital receipts to fund transformational projects. Where the full Council of a local authority has not approved the use of capital receipts to fund qualifying expenditure on a transformation project the guidance has no application.

Application

3. The flexibility offered is time limited. It only applies to the financial years 2018-19 to 2022-23. Only capital receipts held in the severance adjustment account at 31 March 2018 and capital receipts received in the period 2018-19 to 2022-23 may be used to fund qualifying expenditure on a transformation project.

4. Any capital receipt held in the Capital Fund/ Capital Receipts Reserve may only be used for the purposes set out in Schedule 3 of the Local Government (Scotland) Act 1975. It is therefore not possible to transfer capital receipts from the Capital Fund / Capital Receipts Reserve to the Capital Grants and Receipts Unapplied Account.

5. To be available to fund qualifying expenditure on a transformation project, a capital receipt must be transferred to the Capital Grants and Receipts Unapplied Account in the year the capital receipt is received. This is the variation of proper accounting practices i.e. the statutory adjustment. This means that whilst capital receipts received in the financial years 2018-19 to 2022-23 are available to fund qualifying expenditure on a transformation project, the decision to transfer the capital receipts to the Capital Grants and Receipts Unapplied Account must be made in the year the capital receipt is received.

6. It is not possible for a local authority to subsequently decide that a capital receipt received in a prior year is to be made available to fund qualifying expenditure on a transformation project even if that capital receipt was received in the period 2018-23.

7. To provide as much flexibility as possible the guidance allows capital receipts received in any financial year during the period 2018-2023 to be used to fund qualifying expenditure incurred not only in the same or later financial year but also in a previous financial year (subject to any previous year being within the 2018-2023 period). This means that in any financial year during this period the transfer of capital receipts from the Capital Grants and Receipts Unapplied Account may be greater than the qualifying expenditure for that year. However, within the 2018-2023 period, capital receipts transferred to the General Fund / HRA cannot exceed qualifying expenditure incurred within the 2018-2023 period.

Types of qualifying expenditure

8. Qualifying expenditure is expenditure on any project that is designed to generate ongoing revenue savings in the delivery of public services and/or transform service delivery to reduce costs and/or transform service delivery in a way that reduces costs or demand for services in future years for any of the public sector delivery partners. Within this definition, it is for individual local authorities to decide whether or not a project qualifies for the flexibility.

9. Set up and implementation costs of any new processes or arrangements can be classified as qualifying expenditure. The ongoing revenue costs of the new processes or arrangements cannot be classified as qualifying expenditure. In addition, one off costs, such as banking savings against temporary increases in costs/pay cannot be classified as qualifying expenditure.

10. With respect to redundancy payments, qualifying expenditure will be limited to those amounts that are necessarily incurred as statutory redundancy payments provided the other requirements of qualifying expenditure are met.

Qualifying disposals

11. For the 2022-23 financial year, for the purposes of the statutory guidance, a qualifying disposal is an asset sale by the local authority to an entity outside the local authority’s group structure. An entity is considered to be part of an authority’s group structure if it falls within the definition of a joint venture, associate or subsidiary of the authority as defined in the Code of Practice on Local Authority Accounting. This is consistent with the entities that fall within the scope of “group accounts” as defined in the Code of Practice on Local Authority Accounting.

12. Any such entity meeting the definitions in paragraph 49 is, for the purposes of the guidance, considered to be within an authority’s group structure whether or not, in practice, the entity is consolidated into the authority’s group accounts and irrespective of whether the authority produces group accounts. For the avoidance of doubt, where an authority has subsidiaries, associates or joint ventures which are not consolidated on the basis that they are not considered material for consolidation purposes, these are still part of the group structure and disposals to such entities are not qualifying disposals.

13. This requirement applies prospectively from 1 April 2022 for the 2022-23 financial year. There is no requirement to retrospectively apply the restriction to capital receipts from group entities prior to 1 April 2022.

14. The intent of this condition is that capital receipts which are to be used by authorities under the flexibilities afforded by the direction should be from genuine disposals of assets by the authority. Where an authority retains some control of the assets, directly or indirectly, and retains exposure to the risks and rewards from those assets, the disposal does not give rise to a capital receipt that can be used in accordance with the statutory guidance.

Accountability and transparency

15. The statutory guidance sets out that full Council is required to approve the use of capital receipts. An annual report to full Council is required which provides, on a project by project basis, details of the project, the costs and savings and the value of capital receipts to be used to fund qualifying expenditure for each project. The guidance does not set any timetable as to when this must be presented to full Council but we recommend that this would normally be prior to the start of each financial year and be aligned to the budget setting process.

16. Each authority should disclose the individual projects that will be funded or part funded through the capital receipts flexibility to full Council or the equivalent. This requirement can be satisfied as part of the annual budget setting process, through the Medium-Term Financial Plan or equivalent.

17. A final report must be presented to full Council on conclusion of the 2022-23 financial year to set out, on a project-by-project basis, the value of capital receipts applied, the projects undertaken, and the value and period of the savings to be realised.

18. For the 2022-23 financial year the report should contain details of all projects, including those approved in previous years, the value of capital receipts applied in all years and is to include a commentary on whether planned savings and service transformation/redesign have been/ are being realised in line with the initial estimates.

19. This report is to cover the period the savings/service transformation/redesign have been/are to be achieved.

20. A revised report seeking to change existing projects or to add new projects can be submitted to full Council for approval at any time. 

Statutory reporting requirements

21. The statutory reporting requirements are included to ensure that local authorities account for the statutory adjustment in a consistent way and that there is transparency in the use of capital receipts. An analysis of the movements in capital receipts is required to provide that transparency.

Scottish Government
Local Government Finance and Analytical Services Division
20 February 2023

Part 2: statutory guidance issued by Scottish Ministers under section 12(2)(b) of the Local Government in Scotland Act 2003 [proper accounting practices]

Definitions

'Local authority' means a Council constituted under section 2 of the Local Government etc. (Scotland) Act 1994 (c.39).

'General fund' means the fund detailed in section 93(1) of the Local Government (Scotland) Act 1973. The Housing Revenue Account (HRA) is a statutory account forming part of the General Fund which a Council may be required to keep in accordance with the Housing (Scotland) Act 1987.

'Financial year' is a year which commences 1 April and ends 31 March.

'Proper accounting practices' are as defined in section 12 of the Local Government in Scotland Act 2003.

'Accounting code' – the CIPFA-LASAAC Code of Practice on Local Authority Accounting in the United Kingdom. 

A 'transformation project' is a project designed to transform service delivery, including through service redesign, in a way that reduces costs and/or demand for services in future financial years.

'Qualifying expenditure' means expenditure on a project where incurring up-front costs will generate ongoing savings. The main part of this guidance details the types of projects that will generate qualifying expenditure.

A 'qualifying disposal' is an asset sale made within the period for which the direction applies, by the local authority to an entity outside the local authority’s group structure. The main part of this guidance defines group structure and provides further detail on what constitutes a qualifying disposal.

Application

1. This statutory guidance applies to the financial years 2018-19 to 2022-23.

Proper accounting practices

2. Proper accounting practice is varied for capital receipts where a local authority (full Council) has approved the use of capital receipts to fund qualifying expenditure on a transformation project. Qualifying expenditure and transformation project are as set out in this guidance. This variation is subject to compliance with the conditions as set out in this guidance.

Qualifying expenditure

3. Qualifying expenditure is non-recurring expenditure on a transformation/ service redesign project where incurring up-front costs will generate on-going savings. This is subject to the following:

4. To be qualifying expenditure the expenditure must be incurred in the financial years 2018-19 to 2022-23.

5. Qualifying expenditure is expenditure on any transformation or service redesign project, to transform service delivery in a way that reduces costs and/or demand for services in future financial years. It is for each local authority to determine whether their project is a transformation/service redesign project. The key criteria in deciding whether the expenditure is qualifying expenditure is whether the project will generate ongoing savings to that services net revenue expenditure. 

6. Qualifying expenditure includes the set up and implementation costs of any new processes or arrangements, but not the ongoing revenue costs. 

7. Examples of transformation projects include, but are not limited to:

• setting up a shared back-office or administrative services with one or more other Council or public sector bodies
• service reform feasibility work e.g. setting up pilot schemes
• service redesign – includes for example reconfiguration, restructuring or rationalisation where this leads to ongoing efficiency savings or service transformation
• expanding the use of digital approaches to the delivery of services or interactions between the local authority and the public
• improving systems and processes

8. Equal pay settlements cannot be qualifying expenditure and must not be capitalised as transformation expenditure.

Redundancy costs

9. Discretionary redundancy payments cannot be qualifying expenditure and must not be capitalised.

10. An authority may capitalise redundancy payments that are necessarily incurred, but this is limited to the amounts of statutory redundancy payments.

Retirement costs

11. Expenditure on severance costs if it relates to a teacher is not qualifying expenditure. 

12. Qualifying expenditure for non-teacher severance costs is limited to those costs that:

• are directly linked to transformation or service redesign to deliver efficiencies and not reducing costs by just applying cuts to the service
• arise through the application of statute which provides an individual with a right to a payment for redundancy or to the immediate payment of a retirement pension arising from redundancy or business efficiency. Qualifying expenditure is limited to lump sums due either to the individual or the pension fund and not any future recurring payments 

13. Discretionary payments to enhance severance packages are not qualifying expenditure.

Qualifying capital receipts

14. From 1 April 2022, capital receipts generated by a disposal to an entity that is within the local authority’s “group structure” are not qualifying capital receipts and may not be used to fund transformation projects. 

15. “Group” in this context has the same meaning as defined in “group accounts” in the Code of Practice on Local Authority Accounting. This comprises an authority’s subsidiaries, associates and joint ventures. This is intended to provide clear boundaries on what constitutes a qualifying disposal, based on definitions that are consistent with accounting practices and are well-understood by local authorities and local government auditors.

16. Some local authorities may have interests in entities that meet the definition of subsidiaries, associates or joint ventures but might not produce group accounts or not consolidate specific entities into their group accounts or not consolidate specific entities into their group accounts, where they are not deemed material for the purposes of consolidation. For the purposes of the statutory guidance, however, such an entity is still part of the local authority’s group structure irrespective of whether it is, in practice, consolidated into group accounts. For the avoidance of doubt, disposals to such entities are not qualifying disposals.

17. This requirement applies prospectively from 1 April 2022 for the 2022-23 financial year. There is no requirement to retrospectively apply the restriction to capital receipts from group entities that have been used for transformation expenditure prior to 1 April 2022.

Accountability and transparency

18. It is for each local authority to demonstrate that a project qualifies as a transformation or service redesign project. 

19. A report is to be presented to full Council for approval, on an annual basis, to use capital receipts to fund, or part-fund, qualifying expenditure on a transformation or service redesign project. The report to full Council shall provide details of each transformation or service redesign project to be funded, or part funded, from capital receipts. 

20. As a minimum, the report shall list each project that has made or will make use of the capital receipts flexibility and should, on a project-by-project basis, set out the total estimated cost of each project and the expected savings/service demand reduction to be achieved from each project. The report shall detail the types of qualifying expenditure and the amounts and the value of capital receipts the authority plans to use to fund qualifying expenditure. 
21. The report should also outline the impact on the local authority’s Prudential Indicators for the forthcoming year and subsequent years.

22. For the 2022-23 financial year the report should contain details on projects approved in previous years, the value of capital receipts applied in previous years and should include a commentary on whether the planned savings or service transformation have been/are being realised in line with the initial analysis.
23. This report is to cover the period the savings/service transformation/redesign have been/are to be achieved.

24. A revised report may be presented to full Council at any time for approval. The report must include details of all projects, not limited to changes to previously approved projects or new projects. This will ensure transparency and identify the full value of capital receipts to be used to fund qualifying expenditure on transformation or service redesign projects. 

25. The report may include other matters the authority considers relevant. Approval of full Council must be gained before proper accounting practices can be varied. 

26. Once approved the report is to be made available online to the public free of charge.

Accounting for capital receipts

27. Schedule 3 of the Local Government (Scotland) Act 1975 (1975 Act) permits a local authority to establish a Capital Fund and places legal restrictions on the use of capital receipts held in the Capital Fund, requiring it to be used “for defraying any expenditure of the authority to which capital is properly applicable, or in providing money for repayment of the principal of loans (but not any payment of interest on loans)”.

28. Where a Capital Fund is not established, the Accounting Codes requires capital receipts to be credited to a Capital Receipts Reserve. 

29. The statutory guidance varies proper accounting practice to allow capital receipts, at the point they are recognised, to be transferred to the Capital Grants and Receipts Unapplied Account to allow them to be available to fund qualifying expenditure on a transformation or service redesign project.

30. Those capital receipts set aside in the Severance Provision Statutory Adjustment Account to meet severance costs as at 31 March 2018 may continue to be held to fund qualifying expenditure on transformation or service redesign projects. These capital receipts are to be held in the Capital Grants Unapplied Account, which is to be renamed as the Capital Grants and Receipts Unapplied Account. A retrospective restatement is required so that the balance on the Capital Grants and Receipts Unapplied Account as at 31 March 2018 is restated to include the capital receipts and renamed at that date. 

31. The account should continue to be named the Capital Grants and Receipts Unapplied Account until the year that the last capital receipts are used. In the following year it should revert to the Capital Grants Unapplied Account unless it still contains capital receipts for equal pay (see Local Government Finance Circular 1/2019). 

32. The variation to proper accounting practices is available for those Capital receipts recognised in 2018-19, 2019-20, 2020-21, 2021-22 and 2022-23. Capital receipts may be transferred to the Capital Grants and Receipts Unapplied Account as a statutory adjustment (as part of the statutory adjustment for gains and losses on the disposal of assets) but only in the same financial year that they are recognised. Capital receipts transferred to the Capital Fund/ Capital Receipts Reserve during this period cannot, in a subsequent financial year, be transferred to the Capital Grants and Receipts Unapplied Account. For example, capital receipts transferred to the Capital Fund/ Capital Receipts Reserve in 2018-19 cannot subsequently be moved from the Capital Fund / Capital Receipts Reserve to the Capital Grants and Receipts Unapplied Account in 2019-20, 2020-21, 2021-22 or 2022-23. 

33. There is no restriction on moving capital receipts from the Capital Grants and Receipts Unapplied Account to the Capital Fund or Capital Receipts Reserve. This is a transfer in usable reserves. If a local authority transfers capital receipts from the Capital Grants and Receipts Unapplied Account to the Capital Fund or Capital Receipts Reserve, they cannot subsequently be transferred back to the Capital Grants and Receipts Unapplied Account.

34. The value of capital receipts transferred to the Capital Grants and Receipts Unapplied Account in any of the financial years 2018-19, 2019-20, 2020-21, 2021-22 and 2022-23 can exceed the value of qualifying expenditure in the same financial year. This means that capital receipts recognised in the period 2018-2023 can be used to fund qualifying expenditure in the period 2018-2023 and the transfer of capital receipts from the Capital Grants and Receipts Unapplied Account to the General Fund /HRA in any financial year may be higher than the qualifying expenditure for that financial year. The statutory reporting requirements set out below require a separate disclosure for any transfer of capital receipts to fund qualifying expenditure in a prior financial year. 

35. Over the period 2018-2022 the value of capital receipts transferred from the Capital Grants and Receipts Unapplied Account cannot exceed the value of qualifying expenditure over the period 2018-2023. 

36. Capital receipts held for qualifying expenditure on a transformation or service redesign project may not be used for equal pay.

37. Capital receipts may not be transferred directly to the General Fund / HRA to fund qualifying expenditure. All capital receipts must first be credited to the Capital Grants and Receipts Unapplied Account as a statutory adjustment.

38. All unused capital receipts held in the Capital Grants and Receipts Unapplied Account which have been set aside to fund qualifying expenditure are to be transferred to the Capital Fund / Capital Receipts Reserve as at 31 March 2023. This is a transfer in usable reserves.

Annual accounts – statutory reporting requirements

Statutory adjustments

39. All statutory adjustments are to be reported in the Adjustment between Accounting Basis and Funding Basis section of the Movement in Reserves Statement. The Accounting Code requires an analysis of statutory adjustments either in the Movement in Reserves Statement itself or in a note. The analysis of the statutory adjustments shall clearly identify each of the statutory adjustments made as required or permitted in this guidance. 

40. The statutory adjustment for transformation or service redesign projects is to transfer the capital receipts to the Capital Grants and Receipts Unapplied Account when an asset is sold.

Capital receipts

41. The transfer of capital receipts held in the Capital Grants and Receipts Unapplied Account to either the General Fund / HRA or the Capital Fund / Capital Receipts Reserve is not a statutory adjustment. This transfer is to be reported in the Transfer to/ (from) other statutory usable reserves section of the Movement in Reserves Statement. 

42. An analysis of the reason for each transfer of capital receipts from the Capital Grants and Receipts Unapplied Account to the General Fund / HRA or to the Capital Fund / Capital Receipts Reserve shall be made either in the Movement in Reserves Statement itself or in the notes.

43. For the transfer of capital receipts to fund all or part of the qualifying expenditure on a transformation or service redesign project in any financial year the suggested descriptor for the analysis is “Use of capital receipts to fund qualifying expenditure on service transformation or service redesign projects in [state financial year]”. For the transfer of capital receipts to fund qualifying expenditure in a prior financial year the suggested descriptor for the analysis is “Use of capital receipts to fund qualifying expenditure on service transformation or service redesign projects in [state financial year/s]”.

44. As part of the disclosure in the Annual Accounts for the Capital Grants and Receipts Unapplied Account a local authority is required to identify, separately, the amount held in that account for capital grants and the amount of capital receipts held for service transformation projects. The amount of capital receipts held for equal pay, as permitted by Finance Circular 1/2019 and which expired on 1 April 2020, is to be disclosed separately from those capital receipts held for transformation or service redesign projects for the applicable financial years. 

Scottish Government
20 February 2023
Victoria Quay, Leith, Edinburgh EH6 6QQ