dated June 2014
Local Government Association
Report on the options and models available to local authorities wishing to develop new housing
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Report on the options and models available to local authorities wishing to develop new housing
1.1As part of the Local Government Association's Investment in Housing Project we have been asked to prepare a report outlining the legal perspective on the options and models available to local authorities wishing to develop new housing. The report is to complement the viability study being carried out with Social Finance in relation to new housing development delivered without public subsidy but using debt instruments in order to deliver mixed tenure schemes.
1.2We are therefore looking at housing outwith the Housing Revenue Account (HRA) and therefore the HRA debt cap.
1.3For the purpose of this report we have discounted the option of a joint venture with a registered provider (RP) or other third parties. This could be the subject of a separate report but here we focus on local authority vehicles which are "on balance sheet" or "off balance sheet".
1.4In particular, the structures we consider in this report are as follows:
1.4.1A wholly-owned council special purpose vehicle (SPV);
1.4.2An "on balance sheet" SPV between two local authorities; and
1.4.3An "off balance sheet" SPV.
1.5We consider each of these options in turn below.
2Wholly-owned council SPV
Cleared land for market sale
Cleared land for affordable housing/market rent
Grant from market sale receipts
Wholly-owned Council SPV
This model takes the land to be developed outside the council's HRA, with land to be developed for affordable housing and/or market rent sitting in the wholly-owned council SPV. Funding would be provided by a private lender (supported by a council guarantee) and potentially also by subsidy from the land sold to the developer/building contractor for market sale units.
The wholly-owned council SPV could take any corporate form but the most suitable ones are likely to be a company limited by guarantee (CLG) or a company limited by shares (CLS). A CLS may offer certain flexibilities in future (e.g. restructuring, investment, partnership) and stamp duty land tax (SDLT) relief may be available on transfers of land from the council to the SPV if it is set up as a CLS. However, if it proposed that the SPV would be an RP and/or a charity a CLG would be the more typical corporate form for such a vehicle.
Consideration would need to be given as to whether the SPV should be a charity (assuming that it would be carrying out activities which are capable of being charitable, which would depend in part on who it is to house – clearly the provision of market rent accommodation would not be a charitable activity). The key advantages are the basic exemptions from SDLT and corporation tax in relation to charitable activities. The key disadvantages are the restriction on the SPV's activities and an additional layer of regulation by the Charity Commission. A financial analysis would be required to determine whether the advantages outweigh the disadvantages. The Charity Commission would, amongst other things, need to be satisfied that the proposed charity is independent of the State in order to confirm its registration as a charity. If the council was the sole member and also had control of the appointment of directors it is unlikely that the Charity Commission would approve registration.
HRA or General Fund
2.3.1Whether any property is to be accounted for in the HRA or the General Fund depends upon what powers a council uses to develop the property. If a power under Part II of the Housing Act 1985 (the 1985 Act) is used then the development must be accounted for in the council's HRA.
2.3.2There are however two other available sources of power which a council might use to develop properties through an SPV, namely Section 1 of the Localism Act 2011 (the 2011 Act) and Section 12 of the Local Government Act 2003 (the 2003 Act). If either or both of these powers were to be used then the relevant properties would be General Fund properties.
2.3.3It is important to note however that there is a distinction between having a power available and the reasonable use of that power. A council would be required to provide reasonable justification for using either Section 1 of the 2011 Act or Section 12 of the 2003 Act rather than the principal housing powers under Part II of the 1985 Act which might seem more obvious or appropriate. There would be a risk of challenge on the grounds of unreasonable exercise of power and/or breach of pre-commencement restrictions limiting the use of the general power of competence under Section1 of the 2011 Act, most likely from central Government, if it viewed a scheme as simply a mechanism to avoid HRA ring-fencing or the HRA debt cap or to avoid the Right to Buy. Public law consideration in relation to the exercise of powers by local authorities (including those highlighted in the line of cases cited in paragraph 2.3.4 below) would need to be properly followed as they would amount to pre-commencement restrictions on the exercise of the general power.
2.3.4The line of case law including Hazell v Hammersmith & Fulham LBC  2 AC 1, Crédit Suisse v Allerdale Borough Council  QB 306 and Crédit Suisse and Another v Waltham Forest LBC  QB 362 highlights the importance for councils to ensure that they act within their powers and discharge their functions in a way permitted by statute. That said, local authority powers have changed since these cases were decided. Although at the time it was found that councils did not have a power to discharge the relevant functions through a company and guarantee the company's obligations and/or indemnify it against losses suffered, councils now have much broader powers. This was recognised by Neill LJ in his Court of Appeal judgement in Crédit Suisse v Waltham Forest LBC  as he stated that later similar schemes may have or will become within the powers of local authorities but he was there constrained to look at the position in October 1988. Indeed, under Section 1 of the 2011 Act councils are now required to carry out activities which are for a commercial purpose - which would include development of housing for market rent - through a company.
2.3.5It may be that there is reasonable justification for providing housing, particularly where it differs from a council's HRA general needs housing, within an SPV; for example, the council may wish to differentiate between its general needs stock and housing that it develops for intermediate or market accommodation which it provides either for investment purposes or, say, to economically active individuals in order to achieve wider community and regeneration objectives. It would be more difficult to justify the provision of general needs housing at social rent levels through an SPV. It is important to highlight that each particular project would need to be subject to an individual vires review to ensure that the council was acting within its powers in providing housing through an SPV and in particular that public law considerations, including those enunciated in the cases cited in paragraph 2.3.4, are fully met. For completeness the general power of competence does not itself confer a power to a local authority to do anything which it is unable to do by virtue of a pre-commencement limitation or post commencement limitation.1
Section 1 of the 2011 Act – general power of competence
2.3.6Subject to the above considerations, a council may use its general power of competence under Section 1 of the 2011 Act to develop housing in the General Fund through an SPV, although its application must be carefully considered and appropriate in the relevant circumstances.
2.3.7As mentioned above, there is a general requirement that if the exercise of the Section 1 power is for a "commercial purpose" then a council must use a company to do so; the SPV would fulfil this requirement. Shared ownership or affordable rented properties provided to people who could not otherwise afford to rent a property on the open market and where the provision of accommodation is meeting a specific need probably would not be classified as a commercial purpose but the letting of housing at market rents is likely to be deemed to be so. As stated at paragraph 2.3.5, it is likely that a council wishing to provide "social rent" level housing through an SPV will find it more difficult to justify the reasonable use of Section 1 of the 2011 Act.
Section 12 of the 2003 Act - investment power
2.3.8Councils may also be able to use their investment power under Section 12 of the 2003 Act, if they are able to satisfy themselves that the development of the properties is an investment rather than a commercial purpose. Under Section 15 of the 2003 Act, before exercising the power to invest a council must have regard to guidance issued by the Secretary of State. This is set out in the Department for Communities and Local Government "Guidance on Local Government Investments" published on 11 March 2010. Councils should also consider related guidance published by CIPFA under "Treasury Management in the Public Services: Code of Practice and Cross Sectorial Guidance Notes" and "The Prudential Code for Capital Finance in Local Authorities".
Transfer of council land
2.3.9A council's power to transfer land – both to the SPV and to the developer/building contractor of any market sale element – are contained in Section 32 of the 1985 Act for HRA land and Section 123 of the Local Government Act 1972 (the 1972 Act) for General Fund land. Unless the land to be transferred is General Fund land and it is being disposed of for consideration that is the best that can reasonably be obtained, the Secretary of State's consent to the disposal would be required, which may be either a specific or general consent.
If any HRA or General Fund land is to be disposed of at an undervalue for the purpose of the SPV providing accommodation to be let on the land, this will be regarded as financial assistance and/or gratuitous benefit under Sections 24 and 25 of the Local Government Act 1988 (the 1988 Act). Again, the prior consent of the Secretary of State is required under Section 25 but there are some general consents which may be available. If consent is given under Section 25 then it is likely that no other consent under either Section 123 of the 1972 Act or Section 32 of the 1985 Act will be required (depending upon the terms of the Section 25 consent).
2.4.1If the SPV is to obtain the finance directly then a key issue would be satisfying the funder that it has sufficient security cover and the SPV has sufficient repayment capacity, bearing in mind the absence of a track record.
2.4.2It should be noted that Section 4(1) of the 2003 Act provides the Secretary of State with the power to impose restrictions in relation to borrowing by local authorities and under Section 4(2) the Secretary of State can, by direction, set limits on borrowing by a particular authority for the purpose of ensuring that that authority does not borrow more than it can afford. There is therefore a risk that the Government might in future impose borrowing caps nationally and/or locally in relation to General Fund borrowing. Given that an SPV which is controlled by a council would have its accounts consolidated with the council's accounts, this cap might also impact upon the SPV's borrowing capabilities.
2.4.3The power to provide grant funding (perhaps from market sale receipts) from a council to an SPV or for the council to give a guarantee to the SPV's funders where the SPV is to provide rented accommodation is contained in Section 24 of the 1998 Act (subject to consent under Section 25). If the funding or guarantee is to relate to housing accommodation for sale then Section 24 of the 1988 Act will not apply and the council would need to use another power, potentially Section 1 of the 2011 Act subject to the considerations outlined at paragraph 2.3 above.
2.4.4Local authorities are of course subject to a duty to obtain value for money pursuant to their best value duty under Section 3 of the Local Government Act 1999. Any local authority choosing to carry out a function (in this case through an SPV) using a particular source of funding, particularly if funding is cheaper elsewhere, would have to be able to justify why pursuing a particular funding source (e.g. institutional investment) over another funding source (council borrowing from the Public Works Loan Board and on-lending it to the SPV), which might be cheaper, was the preferred route.
2.4.5A further point to note regarding the wholly-owned council SPV model is that a council would not be able to make its retained RTB receipts available to such an SPV. This is because the form of retention agreement between local authorities and Government in respect of RTB receipts provides that any body to which the local authority pays some or all of the retained amounts must not be a body in which the authority holds "a controlling interest".
The RTB would not apply to any units owned by a wholly-owned council SPV by virtue of the council not being the Landlord.
2.6.1Financial modelling would be required to determine how much corporation tax would be payable by the SPV and, therefore, whether charitable status should be considered.
2.6.2SDLT would be payable upon transfers of land from the council to the SPV unless a relief can be claimed. A relief may be available if the SPV is set up as a CLS, as a non-profit RP or as a charity.
2.6.3VAT would also need to be considered, particularly bearing in mind that the SPV would need to obtain services from third parties.
2.7.1With regard to any transfer of land by a council to either a developer/building contractor for market sale or to the SPV, if it a pure disposal of land then it would not be subject to advertisement under the EU procurement rules – this is known as the "land exemption". However, if the agreement between the council and the recipient of the land imposes specific requirements of the council as to what is to be developed on the site, it is likely to be reviewed as a "public Works contract" rather than a pure land disposal.
2.7.2Nevertheless, with regard to any transfer of land by a council to its wholly-owned SPV, even if the agreement does amount to a public works contract it is likely that in these circumstances the "Teckal exemption" will apply. The Teckal exemption allows public contracts in relation to works, services or supplies to be let by a council to a third party without following a competitive process under the EU procurement rules where (i) the council exercises over the third party a level of control similar to that which it exercises over its internal department; and (ii) the third party carries out the "essential part" of its activities for the council. A new EU procurement Directive, which is due to be implemented in the UK through regulations in 2015 or 2016, will codify the Teckal exemption. It should be noted that, under the Directive, in order to satisfy the second limb of the Teckal exemption, no more than 20% of a third party's activities should be provided to organisations other than the relevant council.
2.7.3The wholly-owned council SPV may also be a "contracting authority" and, as such, would itself be subject to the EU procurement rules. This means that it would need to procure any construction or refurbishment works and housing management which it wishes to outsource in accordance with the EU procurement rules. We would note, however, that the so-called "reverse Teckal" exemption - which is codified under the new procurement Directive - could apply in relation to any works or services which the SPV contracts from its parent council.
If a council provides grant to the SPV, provides a guarantee to the SPV's private funders and/or it transfers land at an undervalue then this is likely to constitute State Aid. However, if the aid is given in relation to the provision of social or intermediate housing a "services in the general economic interest" exemption may apply, subject to certain conditions being satisfied. This exemption would not apply however if the housing were to be developed for letting at market rent.
2.9Financial return to the Council
The form of corporate structure chosen will largely determine the ability of the Council to receive a financial return from the SPV. If the SPV is constituted as a charity or RP (or both) then there can be no distribution of profits to members, all profits would be reinvested in pursuit of the objects of the SPV. Whilst it is technically possible for a CLG to be set up so as to distribute profit to members this is not a common approach and most CLGs are non-profit distributing organisations. A CLS would be able to distribute profits to its members and with the Council as Sole Shareholder it would be the sole beneficiary of such distribution under this route. It should be noted however that it is the directors who would be required to make any decision on whether a distribution should be made and only after being satisfied that there are distributable profits available.
The Council could also receive payments through the provision of services to the SPV and such services could be provided irrespective of the corporate form. There are however limitations on the amount that the Council could charge for the services depending on the powers being used to provide the services. If the services were being provided under the Local Authority (Goods and Services) Act 1970 then the SPV would be required to be a 'public body' for the purposes of the Act and the Council and the SPV would be entitled to agree the terms as to payment as they consider appropriate. The most likely route would be the power to charge (section 93) or trade (section 95) of the Local Government Act 2003. A Council can charge for the services it provides (which it is able to provide but not legally required to provide) but is limited to recovering its costs of provision. If a Council wanted to trade with the SPV and thus make a 'turn' on the provision of services it is likely that in order to do so, either using the trading powers in the Local Government Act 2003 or the general power to competence in the Localism Act 2011, it would be required to provide those services through a company.
3"On balance sheet" SPV
Again, this model takes the land to be developed outside of the council's HRA, with the land to be developed for affordable housing this time sitting in an SPV which would be jointly owned by two (or more) local authorities. Again, in addition to the private funding accessed with the LGA's support, further cross subsidy for the affordable housing might come in the form of land sold to a developer/building contractor for market sale. Most of our advice in section 2 above applies equally to this "on balance sheet" SPV so we have only highlighted the differences below.
In addition to the corporate forms described at paragraph 2.1 above, if there are to be at least 3 local authority owners of the SPV it could also be set up as a community benefit society (CBS), as industrial and provident societies will be known from August 2014. If the SPV were to be an RP and also a charity, the CBS would have a key advantage because currently RPs which are CBSs would be exempt from registration with the Charity Commission. However, if the SPV is to carry out housing for market rent then it would not be a charity and there is no obvious advantage in adopting a CBS corporate form. It is therefore still likely that the SPV would be set up either as a CLS or a CLG. It should be noted that the advantage of setting up a CLS to benefit from SDLT relief, as noted at paragraph 2.1 above in relation to the wholly-owned council SPV, would be unlikely to apply to the "on balance sheet" SPV as this relief only applies where the party transferring the land owns at least a 75% share in the transferee.
Whether a council who is a member of the SPV could make its retained RTB receipts available to the SPV will depend upon whether that particular council has a "controlling interest" in the SPV. This will depend upon the share which the council in question holds in the SPV and any other rights it has to direct the SPV's actions – for example, the right to appoint and remove board members or to direct the SPV to take or withhold from taking any action.
The tax issues for the "on balance sheet" SPV will be similar to those for the wholly-owned council SPV. However, as noted at paragraph 4.1 above, the SDLT relief which would apply where the council transferring land owns at least a 75% share in the SPV may not be applicable to the "on balance sheet" SPV model. It may be therefore that SDLT would be payable on transfers of land from the council to the SPV unless it is set up as a non-profit RP or as a charity.
The new EU procurement Directive which codifies the "Teckal exemption" also extends the scope of the exemption to bodies which are jointly controlled by two or more contracting authorities.
3.5Financial return to the Councils
The matters highlighted in paragraph 2.9 apply equally here albeit that a shareholder's agreement would set out the arrangements for distribution of dividends between the Member Councils.
4"Off balance sheet" SPV
Most of our advice in section 2 above applies equally to this "off balance sheet" SPV so we have only highlighted the differences below.
The "off balance sheet" SPV would, by its nature, not be controlled by a council. A council would therefore need to be comfortable with the reduced control compared to an "on balance sheet" or wholly-owned subsidiary SPV model. On the other hand, this model provides the opportunity for stakeholder involvement in the SPV as tenants could be involved on the board or, alternatively (or in addition), independent individuals with the relevant expertise could be brought in. If a council has retained a substantial amount of RTB receipts to be used for the provision of social housing, this model may also be worth considering.
As for the "on balance sheet" SPV model, if there are to be at least 3 owners of the SPV it could be set up as a CBS as well as a CLG or CLS. The same considerations would apply however as set out at paragraph 3.1 above.
4.2Off balance sheet accounting test
4.2.1The provisions regarding proper local authority accountancy practice are set out in CIPFA's "Code of Practice on Local Authority Accounting in the United Kingdom" (the Code). Under the Code, if a council's controls over a company include holding a majority of the voting power of the company or the council owns half or less of the voting power of the company but it has:
(a)the power over more than half of the voting rights by virtue of an agreement with other stakeholders in the company;
(b)the power to appoint or remove the majority of directors;
(c)the power to cast the majority of votes at board meetings; or
(d)the power to govern the financial and operating policies of the company,
then is it likely to be treated as a subsidiary of the council and included in the council's accounts.
4.2.2In order that the SPV is not controlled by the council (and is therefore not "on balance sheet") both board membership and ownership of the SPV should demonstrate independence from the council. This means that the board should comprise a majority of independent board members (who might be individuals with relevant experience or perhaps some council tenants) who are not associated with the council. With regard to the ownership of the SPV, one option would be for the ownership of the SPV to reflect the board membership of the SPV, in which case the independent (possibly including tenant) board members would be the majority owners of the company. In any event a council would need to be mindful that there could not be any agreements in place which effectively provide the council with control over more than 50% of the membership voting rights in the SPV, the power to appoint or remove the majority of directors, the power to cast the majority of votes at board meetings or the power effectively to run the SPV since otherwise it may be deemed to be controlled by the council, which would give rise to "on balance sheet" treatment.
4.3.1The main advantage of the "off balance sheet" SPV model is that any borrowing by the SPV will not be consolidated with the Council's accounts. It would therefore not be taken into account if any General Fund borrowing cap is imposed by the Government in future.
4.3.2Another particular advantage of the "off balance sheet" SPV is the fact that the council would be able to make available its RTB receipts to the SPV as it would not have a "controlling interest".
Again, the tax issues would be similar as for the other models described in this report but, unlike the wholly-owned council SPV, the "off balance sheet" SPV would not be able to benefit from the SDLT relief that could apply where a council owns at least 75% of an interest in the SPV which is set up as a CLS. SDLT would therefore be payable unless the SPV is set up as a non-profit RP or as a charity.
We noted at paragraphs 2.7 and 3.4 above that the Teckal exemption may potentially apply in respect of works and services provided between a council and the SPV if the structure described in Section 2 or Section 3 above were to be adopted. This exemption would not apply in respect of this "off balance sheet" structure as the council would not exercise the necessary degree of control over the SPV to satisfy that exemption. Therefore, if any contracts are let by the council to the SPV or vice versa then the EU procurement rules will apply.
4.6Financial return to the Council
The matters highlighted in paragraph 3.5 apply equally here with the shareholder's agreement setting out arrangements for distribution of dividends between the different shareholders.
This report covers a broad range of issues and is a summary only. The key differences between the models we have considered is the ability of the "off balance sheet" (and potentially the "on balance sheet") SPV to receive the council's RTB receipts and for the "off balance sheet" SPV to borrow without increasing the council's overall General Fund debt, which is subject to the risk of being capped in the future by Government and, depending on the nature of the particular scheme to be operated by the SPV, an "off balance sheet" SPV is likely to be less susceptible to the risk of challenge. On the other hand, the "off balance sheet" model inevitably means that the council has a smaller degree of control over the SPV than under the wholly-owned council SPV model. Under all three models however the council would be able to have some involvement at board membership and at membership level in contrast to the "traditional" model of developing new housing through RP partners.
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