Managed equipment service (MES) contracts have long been used by the NHS as a means to replace medical equipment without capital expenditure. The contract usually involves the MES supplier providing equipment within a package of services including maintenance and provision of consumables, paid for by the customer from operating expenditure. In addition, it is often possible for the customer to recover VAT through the contracted out service rules. However, the two main features of a MES, avoidance of capital expenditure and recovery of VAT, are about to become more challenging to achieve due to the implementation of IFRS 16. This article explores the issues and proposes a solution for some situations. Recovery of VAT for contracted out services (COS) has never been straight forward as there is no COS category for managed equipment services (apart from pathology under COS 31). Usually VAT for a MES is recovered under COS 45, operation of hospitals, healthcare establishments and healthcare facilities and the provision of any related services. This is the same COS heading used for VAT recovery of PFI deals, and it follows that any MES deal will need to look like a mini-PFI deal for the use of this COS heading to be successful. Therefore, the MES supplier will not only need to deliver an equipment service but will need to take on the provision of the healthcare facility that the equipment service is delivered within. For example, the MES supplier will need to provide hard and soft facilities management (FM) services such as cleaning, security and if relevant IT support and catering, either via its own staff or via sub-contracts. The healthcare facility could be an operating theatre or suite of theatres, an imaging room or suite of rooms, for example, but must be a discrete, well defined area. In the past, MES contracts have successfully recovered VAT without the FM component but HMRC is now taking a stricter interpretation of the rules.
As long as the MES supplier is delivering and maintaining a fully working facility with the associated risk transferred to the supplier then VAT recovery under COS 45 should still be possible. Although structuring a MES contract along the lines of a mini PFI can achieve VAT recovery, keeping the MES assets off balance sheet and not counting against capital expenditure limits is about to become more difficult with the implementation of IFRS 16. The implementation of IFRS 16 in the NHS is planned for April 2022, after being deferred from April 2021 and April 2020. IFRS 16 effectively brings all leases onto balance sheet. Currently finance leases are on balance sheet and operating leases are off balance sheet. IFRS 16 will treat them the same. This means that if a MES contract meets the definition of a lease it will need to be split between capital and operating costs, and the capital costs will be treated as a fixed asset. This will add capital charges to the customer's income and expenditure account, over and above the payment made to the MES supplier, and the capital element will also count towards an NHS customer's capital expenditure limit. Under IFRS 16 a lease is defined as ‘a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration’. A contract can be (or contain) a lease only if the underlying asset is ‘identified’. Having the right to control the use of an identified asset means having the right to direct and obtain all of the economic benefits from the use of that asset. These rights must be in place for a period of time, which may also be determined by a specified amount of use. Therefore, if the NHS customer controls the use of an identified asset for a period of time, then the contract contains a lease. This will be the case if the NHS customer can make the important decisions about the use of the asset in a similar way it makes decisions about the use of assets it owns outright. In such cases, the customer (ie the lessee) is required to recognise these rights on its balance sheet as a ‘right-of-use’ asset. In contrast, in a service contract, the supplier controls the use of any assets used to deliver the service and so there is no right-of-use asset to recognise. After the implementation of IFRS 16 in the NHS, if a MES contract can be structured around performance standards of a healthcare facility e.g. availability of the facility, and the contract allows the MES supplier to scale up or down the equipment to meet the performance standards, it is likely to be outside of IFRS 16 as the supplier has control of the assets. This is likely to be the only workaround to allow MES contracts to be off balance sheet and not impact on capital expenditure limits. This approach will have its limitations though, as it is difficult to see how large pieces of equipment e.g. CT or MRI scanners. could be scaled up or down under the MES supplier’s control to meet performance standards. Copyright © 2021 Magrath Consulting Limited, all rights reserved.
2 Comments
Carol Sumner
9/9/2021 08:10:23 am
Excellent and interesting article Mark. Be good to chat through contract options for imaging and pathology with you.
Reply
Your comment will be posted after it is approved.
Leave a Reply. |
Mark Magrath MBAI am a management consultant with 12 years experience as an executive director in an NHS Foundation Trust, including 10 years as Deputy Chief Executive. I only write blogs on projects and assignments that I have personally led. My aim is to write amazing content that combines real world experience with insightful advice. Categories
All
Archives
August 2021
|