Meeting of the Commission

Meeting date: Thursday, October 10, 2013

Official Report 184KB pdf

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Audit Scotland Autumn Budget Revision 2013-14

Agenda item 3 is Audit Scotland’s autumn budget revision for 2013-14. I welcome from Audit Scotland Caroline Gardner, Auditor General for Scotland; Ronnie Cleland, chair of Audit Scotland’s board; Russell Frith, assistant auditor general; and Diane McGiffen, chief operating officer. I understand that the Auditor General must leave by 10.50 in order to catch a plane, and that Audit Scotland’s other representatives will remain here, if necessary, to answer questions that we might still have. I invite the Auditor General to make an opening statement.

Thank you, convener, for your flexibility over timing. I will, of course, remain for as long as the commission requires me this morning. I had flagged up to the clerks that I had booked a flight for later but that it could be changed, if necessary.

Since we submitted our autumn budget revision, the Scottish Government’s finance team has raised a timing issue with us about the submission itself. First, it has advised us that the pensions element of the submission can be treated as annually managed expenditure, or AME. Until now, all of Audit Scotland’s budgets and budget revisions have been treated as falling within the departmental expenditure limits, or DEL. Treating that as AME has advantages for the overall Scottish budget position with Her Majesty’s Treasury, but the level of AME cover for Scotland as a whole is redetermined only once a year in late autumn and agreed changes to the Scottish total are then included in the spring budget revision. The Government’s finance team has therefore requested that we defer this element of our proposal until the spring budget revision, when the finance team will have received confirmation of the revised AME total from the Treasury. We are content to accept that, subject to the SCPA’s agreement.

Secondly, the Government’s finance team has asked whether we would defer the remaining proposal for £160,000 within our submission, which covers the contingent liability that is recognised in our 2012-13 accounts, in order to provide more time for the finance team to assess the emerging picture of prospective underspends and pressures. That element will likely remain a DEL requirement. Having had discussions with the Scottish Government’s finance team, we are on this occasion prepared to defer our autumn budget revision proposals until the spring budget revision, on the clear understanding with the Government’s finance team that this is entirely a timing issue for this year and that the proposal will be included in the SBR in full and be subject to the established arrangements for scrutiny by the SCPA. Our proposals and the reasons for them will remain unchanged.

The timing of the request from the Scottish Government means that we have not been able to reflect it in our submission to the commission. We have been in discussion with the Government finance team over the past few days, which led to my letter to the convener yesterday asking you not to consider our proposal at today’s meeting but instead to note that the proposal will be resubmitted for the spring budget revision later this year, as our need for the resources will remain unchanged.

Thank you. As you have stated, we received a request from you late yesterday afternoon to defer consideration of the matter. Obviously, it was too late to do that because it was already an agenda item that was in the public domain. However, the liabilities remain, even if they are deferred, so there is an opportunity for members to discuss that and to get a better understanding of it. When we move into private session, members can decide whether they are comfortable with deferring consideration, as you have requested.

My first question is this: can Audit Scotland explain why the £160,000 was not provided for in the 2012-13 balance sheet but was instead disclosed as a contingent liability, given that the amount was agreed, finalised and paid over—I think—to HM Revenue and Customs?

Russell Frith will talk you through that. As you will know, it has been a long-standing matter of discussion with HMRC, and the accounting treatment was a matter of some discussion with our auditors.

When the accounts are prepared, we and our external auditors have to take a view on the likelihood of particular items becoming actual liabilities. At the point at which we were forming those judgments, we made provision for an element of what we were discussing with HMRC, but we were still hopeful that we would be able to limit the liability to the amount that we had provided in the accounts, while recognising that there was a possibility that it could increase up to £160,000. It was a judgment call that we discussed extensively with the external auditors; we were both comfortable that we had got the right balance between provisions and contingent liabilities.

As it turns out, within a couple of months of the accounts being finalised we reached agreement with HMRC, and the liability was at the upper end, so the £160,000 stopped being a contingent liability and became an actual liability.

In your letter of 13 September 2013 to the convener you highlight that interest and penalties might arise from backdated VAT, although that is still to be confirmed by HMRC. Can you provide an update on the position with regard to penalties and interest and can you offer us an assurance that those costs will be met from Audit Scotland’s existing approved budget?

Certainly. Again, Russell Frith will talk you through the detail.

We have provided all the information to HMRC to allow it to come to a view on the amount of interest and penalties, but it has not yet come back to us with the amount that it will require. Our understanding of the various ranges of penalties that HMRC applies and the circumstances in which it applies them suggests that the penalties will not exceed about 15 per cent. We have covered that within the provisions that we have already made.

Are you telling the commission that you think that the £160,000 that has been set aside will, if necessary, cover any interest or penalties.

That is what we expect.

Alex Johnstone is next.

Have we covered question 8?

Yes. No. I am sorry—it is me that is going adrift, here. Angus MacDonald is next.

I will stick to the same theme. The commission is aware of the on-going negotiations between Audit Scotland and HMRC, as has been confirmed this morning. Can Audit Scotland provide the commission with an update on negotiations with HMRC, and with further information about the basis of HMRC’s challenge? For example, is HMRC challenging the VAT status of the Accounts Commission?

As the commission will be aware, there are two VAT issues under discussion between us and HMRC. The first is the issue that is related to registration of Audit Scotland for business activities, which has been a matter of discussion in relation to our annual accounts with the commission over the past couple of years, and for which a contingent liability was registered in our accounts and discussed with the commission earlier this year.

That contingent liability of £160,000 is now crystallising, although we are pleased to be able to say that that issue is now closed down and we are simply waiting for confirmation of the charges that HMRC will apply within the £160,000 that we have discussed. Unfortunately, however, HMRC has recently raised a new issue with us that relates, as you said, to the tax status of the Accounts Commission.

Audit Scotland was formed in 2000 by merging the former Accounts Commission for Scotland with the National Audit Office’s activities in Scotland. The new body, Audit Scotland, covers all audits of public bodies in Scotland. Before the merger, the Accounts Commission had what is called section 33 status, which enabled it to reclaim input tax on the audit fees that were charged to local government for audit activity in that sector. We entered into discussions with HMRC’s predecessor body about continuing that status since the Accounts Commission’s responsibilities were unchanged under the new arrangements. The Accounts Commission continues to exist and Audit Scotland carries out activity on its behalf, but the statutory functions remain with the Accounts Commission.

We discussed the issue with HMRC over a long period and reached an agreement in 2006 that reflected the Accounts Commission’s continuing status and activity and enabled us to reclaim input VAT on its behalf, which we have been doing since then.

HMRC has now raised a question about the standing of that agreement and we are in continuing discussions with it about its application over the past seven years and its application in the future. It is still a matter of very live discussion between us and HMRC. The commission will understand that the extent to which we can air that in public is limited. However, we would be very happy to give in private any extra information that the commission might find helpful.

Thank you. Do you have any indication from HMRC on the timescale for further negotiation?

It is very hard to predict that. We responded to HMRC’s original raising of the issue very quickly and are waiting for a response. The timescale after that will depend on the response that we receive from HMRC and what further work it requires.

Can I follow up on that?

Sure.

If HMRC does not change its view and there is future liability, are there any options for service delivery that would avoid that liability?

10:00

The scale of the amount that we are talking about makes it very difficult to see how we would do that. The scale of the past liability, which is in question, is more than £4 million. The amount that we have reclaimed during that period has been between £400,000 and £500,000 a year. The commission is aware that we have just been through a four-year budget strategy under which we have reduced the cost of audit by more than 20 per cent. In doing that, we have been very conscious of the need to demonstrate that we are applying the same discipline to ourselves as we expect of the rest of the public sector and to ensure that we are not damaging our ability to carry out the range and quality of the audit work that is more than ever required in the current financial climate. I struggle to see how we could again reduce costs by anything approaching that amount. We will obviously continue to apply pressure, but the options that we would have would be to ask the SCPA for funding, or to look at recovering the money through local government fees, neither of which is palatable.

I was not so much asking how you could reduce your costs to cover liability as trying to establish whether there is another way of delivering the service that does not end up incurring that liability. Would the cost of services provided directly by Audit Scotland still be recoverable, and those of services provided by external auditors not be recoverable?

If HMRC continues in its current direction of travel with this issue, we will have to look at other models of service delivery and consider their VAT and other implications; VAT implications are not the only aspect that we would need to explore.

At the moment we have a commitment to five-year audit appointments for the in-house teams and for the firms with which we work, and we would need to continue with that. I have, in any case, asked Russell Frith, as the assistant auditor general, to start looking at options for service delivery. We will play the VAT implications into that; those implications cannot be seen in isolation.

Have you considered at this stage the potential costs and benefits of engaging specialist advice, including funding the fees of an adviser?

Yes. We are trying to strike a balance. On the one hand are the interests of the bodies that we audit and the SCPA in ensuring that we get a good outcome to this particular VAT issue but, on the other hand, we are conscious that there is a potentially high cost for professional advice and that we are spending public money. So far, we have responded clearly to HMRC about the grounds on which we believe its challenge is wrong, but we have also made sure that we will be able to draw quickly on professional support if the need to do so becomes apparent. It is a fine balancing act for us; we are talking about public money, so we are looking to manage it as well as possible.

I will ask you to speculate again, I suppose. What consideration have you given so far to how you might seek the resources that are necessary to deal with the situation if your challenge is unsuccessful?

It is very hard to predict that, especially given how difficult it is to predict what direction the discussions with HMRC might take. We are comfortable that, within the current scale of the issue, we can absorb the cost using this year’s resources, but we would need to come back to the commission if, during the next few months, it becomes a more significant issue than we hope.

I will come back to the issue that I raised earlier about other ways of ensuring that there is no future liability. One option might be to allow external firms directly to invoice local government. What would be the implications of external firms directly billing local authorities for audit work that they perform on behalf of the Accounts Commission?

I am reluctant to speculate on that because we are discussing live issues. I ask Russell Frith to give you a high-level response to that.

I will give a response that is entirely VAT-related rather than one that takes account of the wider implications of the suggestion.

When we discussed the potential agreement with HMRC back in the early 2000s, we raised that specific point. HMRC’s view at the time was that if we were to switch the arrangement such that firms would bill audited bodies directly, it would not regard that differently in VAT terms from the arrangement that we have.

I will ask a question about the pensions adjustment. Why does Audit Scotland have to rush to fill the pensions gap when there are many pensions deficits around the country as a result of, for instance, changes in accounting requirements and the reduced yield on bonds? I have not heard of other public bodies rushing to try to fill that gap, so why does Audit Scotland?

That is because of a combination of unusual circumstances, which has led to the accounting adjustment having a different impact on us than on—[Interruption.]

Somebody obviously has a mobile phone or something switched on. I ask everyone to check and make sure that their phones are dead, please.

I apologise.

Not at all, convener. Thank you.

We have a particular combination of circumstances that mean that the technical accounting adjustment has a different impact on Audit Scotland than it does on most public bodies.

We are governed by the central Government Treasury public bodies accounting framework, which means that we are not able to carry forward surpluses or reserves from one year to another. The only way that we can access underspends is through requesting end-year flexibility through the auspices of the commission.

However, at the same time, most of our staff are members of the local government pension scheme, which, unlike the civil service pension scheme, is a funded scheme that contains significant assets that are invested to cover future pensions liabilities as they become due, and which is governed by the international financial reporting standards, which means that there must at each year end be an accounting adjustment to reflect the value of the liabilities within the scheme.

Most bodies in the local government scheme are faced with the same accounting adjustment and have access to reserves that they can build up and run to enable them to cover the implications of that adjustment on their accounts. Most bodies that are under the same accounting framework as we are have staff in the civil service pension scheme, which is unfunded and does not require that accounting adjustment. Our challenge is that we straddle both and have, therefore, to deal with the impact of the accounting adjustment, but lack the flexibility to run reserves to cover it.

In broad terms, that is the nub of why it is an issue for us in a way that it is not from most other bodies. It is also worth saying that it is hard to predict the scale of the adjustment. Our actuaries do not inform us of it until after the year end, as at 31 March each year, and small changes in the interest rates that are applied can have significant impacts on the size of the accounting adjustment that is needed.

In the second-last paragraph on page 2 of the ABR, you say:

“This bid seeks to access as an ABR the funds retained by the consolidated fund in respect of pension adjustments in the past seven years.”

Is the consolidated fund a general pot or is there within it a special pot for Audit Scotland that you expect to tap into?

It is very much a general pot.

I direct members’ attention to the table on page 3 of the autumn budget revision, where they will see the adjustments that have been made since 2006-07 to our pensions accounting, which come out at a net £8.6 million favourable adjustment where we have not sought to access the funding when the accounting adjustment has moved in our favour. You will see that, on a couple of occasions, the adjustments have been significantly in our favour: £6.5 million in 2010-11 and £875,000 in 2006-07. Because it is purely an accounting adjustment, we have been content for that money simply to return to the pot and be used for other purposes. There is not a particular pot marked “Audit Scotland”, like a savings account on which we would want to draw.

It is also important to say that we have flagged up the issue with previous commissions, in our submissions and at meetings, as something that we expected would come to pass at some point, depending on movements in the scale of the pensions liabilities and changes in the valuation arrangements. [Interruption.]

I am just checking my phone—I am okay.

Has Audit Scotland had any preliminary discussions with the Scottish Government about availability of the resource?

That has been the subject of the discussions that I referred to in my opening statement. Russell Frith will talk you through those discussions.

Once the Scottish Government was aware of our autumn budget proposal, and in particular the pensions element of it—this is the first time we have looked for any form of budget revision for an unfavourable pensions movement—it identified that under the budgeting rules between Scotland as a whole and the Treasury, it would be able to classify the adjustment under the AME rules rather than the DEL rules. That is favourable for Scotland as a whole, because AME is the type of expenditure that the Treasury, at United Kingdom level, does not expect bodies to be able to predict as accurately as they would the fixed normal running costs of an organisation.

The Government as a whole therefore has the opportunity to redetermine AME with the Treasury later in the autumn—they do that only once a year. In effect, Scotland should therefore be able to obtain an addition to its overall resources to cover the adjustment. If the adjustment was treated as being within DEL, Scotland’s limit would not be going up and the resources to meet it would have to be found somewhere else within the existing Scottish block, if you like. However, because the Scottish Government has identified that it can regard the adjustment as AME for budgeting purposes, it should be able to increase the overall amount of resource that is available to Scotland to cover the adjustment.

I have a more general question, although I do not know whether the witnesses are in a position to answer it. Given the debate about a switch to AME from DEL in this case, are other significant areas of expenditure being switched to AME from DEL?

Other areas of expenditure are within AME and have been for some years. Indeed, the possibility of doing this if there was an unfavourable pensions movement has existed for a little while, but it is not a situation that anybody has had to deal with before now.

Yes, but given that you are saying that a number of areas of activity are already classified as AME, are there any areas that are currently being considered for switching from DEL to AME?

I am not aware of any.

Okay.

There are no more questions. I remind members that the letter from HMRC on the VAT issue is confidential and should remain so.