Meeting documents

5 THE ISSUE

5.1 The report describes the proposed future funding arrangements for Heritage Services, including the creation of an informal Advisory Board to monitor and scrutinise investment proposals.

6 RECOMMENDATIONS

6.1 the retention of Heritage Services as an in-house service, with a significant increase in ongoing investment in buildings and facilities financed via planned increases in income;

6.2 the proposal that the Council should borrow to finance major investment in the Roman Baths and Pump Room subject to a detailed annual business case including prudent provision for the costs of borrowing and VAT implications;

6.3 the proposal for an informal Advisory Board and its draft Terms of Reference;

6.4 The proposal for the Service to operate within rolling 5 year profit targets, to be set by Council and included in the Corporate and Financial Plan, with financial performance measured by fully inclusive accounts.

7 FINANCIAL IMPLICATIONS

7.1 Heritage Services generates external income for the Authority of over £9 million p.a. This is planned to increase to £10 million p.a. by 2007. This income is a strategic resource for the Authority, and represents direct contribution to its finances from the local tourism economy. There are also indirect contributions via parking fees and the impact on rental values of Commercial Estate shops.

7.2 The Authority is unique in the country in operating its Museums Service at a profit. The annual profit earned for the Council increased by over £1.7 million p.a. in the eight years since the inception of Bath & North East Somerset Council. During this period the profits earned for the Council from its museums have totalled £21 million. In the current year, the budgeted annual profit of £3.3 million equates to a reduction in each Council Tax bill of £45.

7.3 Sustaining and continuing to grow this level of annual profit will require significant investment: ongoing investment to retain and improve the quality of the attractions and visitor facilities and periodic major investment to significantly improve and / or extend facilities.

7.4 The Best Value Review of Culture and Leisure Time (inspected in 2002) identified two major difficulties facing the Council that would inhibit future investment and therefore profitability:

7.5 Changes to rules governing capital financing that have taken effect from the current year will allow the Council to borrow to finance major investment, subject to prudent provision for the costs of borrowing to be repaid.

7.6 However, any substantial increases in "exempt" expenditure above current levels could cause the Council to exceed its annual VAT "partial exemption" limit, and would certainly do so with a major investment project. Should this occur in any year the cost would be over £700k per annum for which no budget exists. The cost of breaching the limit would be borne by Heritage Services, as we would assume that the breach was directly caused by such investment.

7.7 The loss of VAT recovery will be mitigated by adopting tax management strategies and more detailed analysis of end-year accounts. These will apply to both museums and to other Council activities that earn income that is classed as `exempt' for VAT purposes. This work will require additional officer time. A crude estimate is about 40 man days for the first year of exceeding the partial exemption limit, and 25 man-days in subsequent years. These would depend on the number and types of major spending changes across the authority, and it is believed the extra work could be sourced mainly by reprioritising current VAT work away from day to day monitoring and the provision of general information to Council officers.

7.8 A more detailed explanation of the VAT "partial exemption" rules and the corporate implications of the proposals follows at Annexe 1.

7.9 Both the costs of borrowing and the associated VAT implications were considered in detail as part of the analysis of the options for future service delivery detailed at paragraph 4 below.

8 THE REPORT

8.1 Heritage Services has achieved sustained profit growth, unique in local authority museum services. It has been externally assessed by the Audit Commission as an "excellent" service (the only such service in the country) because of the balance it achieves between its Commercial, Conservation and Customer Care responsibilities. However the growing uncertainty in the travel trade and visitor attractions markets caused by political, economic and environmental `world events' since 2001 have damaged our confidence in profit expectations and Financial Plan assumptions to 2006 have been adjusted to reflect this.

8.2 Nevertheless the visitor attractions industry remains highly competitive. Long term investment is needed to satisfy public expectations of interesting and high quality visitor attractions.

8.3 Alternatives to secure investment funding and Council returns were considered and extensively analysed in order to make a recommendation to the Executive for future funding arrangements.

8.4 A transfer to the private sector was eliminated as an option because financial barriers would restrain profits and the risks significantly outweighed the benefits (refer also to para 7.1 (i) below). The financial effects of three remaining scenarios were then evaluated in detail over a 10 year period to 2012/13. Each scenario includes detailed assumptions on investment, visitor expectations, admission and secondary spend and operating costs, and assesses the impact on the VAT position of the service and the Council as a whole. All Heritage Services buildings are included within the model, including the Guildhall.

8.5 The three Scenarios are:

8.6 In Scenario 1, investment is not available to improve presentation and interpretation and we believe the visiting public will soon notice this lack of investment, adding to the cumulative effects of relatively low levels of investment in previous years. As other tourist venues improve, the Roman Baths' attractiveness and reputation will diminish. This proved to be the experience in York where lack of investment in its Castle Museum caused financial difficulties; whereas Tussauds Group's ongoing long-term investment in Warwick Castle over 25 years has proved profitable.

8.7 Scenario 2 proposes a number of major investment projects, mainly targeted at the Roman Baths and Pump Room site, totalling £10.3 Million over 10 years at inflated prices. There would also be a further 60% increase in planned building maintenance in order to ensure that facilities are maintained to a high standard. and a small (10%) increase in day-to-day "responsive" maintenance. These investments will maintain and increase visitor numbers and all investment costs, including debt charges (interest and principal), and VAT impacts are financed by additional income generated.

8.8 Scenario 3 considers similar levels of investment as in Scenario 2, but uses the NPDO model to benefit from the advantages of that form of service delivery.

The way forward

5.1 However, this marginal benefit is likely to be within the margin of error of the financial forecast. It must also be considered alongside other relevant and controversial features of an NPDO transfer - such as loss of public and community ownership of a national heritage attraction, time and cost involved in contract negotiations (both HBS and Leisure partnerships negotiations cost approximately £500K), obtaining comfort over staff security, managing the media interest (likely to be adverse), ensuring the NPDO contains (unpaid) trustees with an appropriate mix of experience and knowledge etc.

5.2 In the light of these factors the firm recommendation is to pursue the `in-house investment' option (Scenario 2). This option would involve increased capital investment funded by borrowing. These levels of investment will be reviewed and capital investment will be subject to individual business cases. Measures to minimise the adverse VAT consequences will be investigated, and VAT penalties and borrowing costs will be funded from profit growth, secured by offering a continually refreshed attraction.

6 RISK MANAGEMENT

6.1 To improve governance, it is proposed to establish a Heritage Services Advisory Board to add management challenge and scrutiny and to advise the Executive Member for Tourism, Leisure and Culture and Council Executive in Heritage decision making. The following draft Terms of Reference are proposed for this Advisory Board:

- business and finance;

- commercial experience in the visitor attractions industry;

- conservation and the built heritage;

- the local / sub-regional tourism economy.

7 RATIONALE

7.1 Heritage Services operates as a Business Unit, with annual profit targets and investment levels agreed corporately on a rolling three-year basis. The business strategy to achieve these targets is detailed in a Business Plan, reviewed and revised each year. The Plan provides an integrated approach to income generation and the investment necessary to achieve it, and is aligned with the Council's corporate aims and objectives.

7.2 A review of long-term options for service delivery, including externalisation, has been undertaken over the last two years. The review was recommended by the Culture and Leisure Time Best Value Review and was thought necessary as a means of securing future funding, both to maintain and conserve the Council's heritage assets and protect and develop the income streams earned through them.

7.3 The review included the development of a detailed financial model that measured the likely benefits of three alternative options for service delivery. The key assumptions underpinning the model were extensively tested to assess the impact of alternative scenarios.

7.4 The findings of this review were subjected to expert external scrutiny by Lawrence Graham, independent consultants. They concluded that:

7.5 The consultants concluded that, even if all the assumptions are altered in its favour, the "status quo", with minimal investment, is not as financially beneficial as the two options that include additional investment. They concluded that there would be a marginal financial benefit in favour of the NPDO option, although even this conclusion is sensitive to the assumptions used. However, this marginal benefit must be set against the other relevant and controversial features of an NPDO transfer outlined at paragraph 4.12 above

8 OTHER OPTIONS CONSIDERED

9 CONSULTATION

9.1 The report has been sent to the Trades Unions and any response received will be reported at the Executive meeting. The Executive Members for Tourism Leisure and Culture, Resources and Property have been consulted and support the proposed new way of working.

9.2 The proposal was taken to the EYCL Overview & Scrutiny Panel in July to seek its views. The Panel noted the proposal and agreed that its Chair (or his nominee) should sit on the informal Advisory Board.

Annexe 1

1. VAT regulations give privileges to local authorities that are not available to other taxpayers. The special `partial exemption' (PX) regulations give them the right, within limits, to a refund of VAT on the costs of their `VAT-exempt business' activities. However that right is lost in any year when the proportion of VAT spent on such activities is deemed to be `significant'. Customs and Excise currently define `significant' as more than 5% of the total of all VAT incurred across the entire Council.

2. In 2003/04 for example the Council paid about £12.7m VAT to contractors and other suppliers. If the amount attributed to its exempt business activities had exceeded 5% of this, or £635k, it would be required to repay that amount to Customs in October. In fact our current estimate is around £530k, a ratio of just 4.2%. In previous years the ratio has varied from 3.8% to 4.7% so no repayment has ever been made.

3. However even the current position still imposes costs on us as a Council. The cost of exceeding 5% would be very large and the level of external spending on `exempt' and other Council activities is uncertain. Much officer time and some cash are invested each year to ensure that the ratio will not exceed 5% even on the worst likely scenario.

4. Our principal `exempt business' income is from admissions to our museums. Other significant `exempt' activities include many property lettings, cremations, courses run by Training Services and other departments, and many lettings of dual use school facilities to clubs. It is possible that "extended schools" and some external nursery projects will in the future also be seen as significant `exempt business' activities.

5. At the Council's two museum sites the income from admissions, lettings and holiday courses is classed as `exempt' from VAT. This is some 75% of the total received. About 75% of all VAT on external costs therefore counts against the corporate PX limit. The remaining 25% of costs is attributed to the other income (mainly shop sales).

6. Spending on the following is linked to little or no `exempt' income:

7. On current tentative estimates a rise in regular spending in 2006/07 onwards will take the PX ratio to just over 5%, although this forecast is subject to a large margin of error. Key factors are the scale and timing of expenditure on `exempt' activities and other major corporate projects.

8. Substantial spending on major Heritage projects is expected to begin in 2006/07, but not occur in every year. With the exception of a catering proposal, each of these projects is forecast to take the ratio to between 6% and 9%. Under current PX regulations and methods between £800k and £1.2m would need to be repaid to Customs annually.

9. Customs have been reviewing the operation of the special PX rules since 2001. Any changes will require Government approval. We had been told that a series of papers was going to ministers. Customs say that when they receive their Minister's views they will be able to develop, in partnership with CIPFA, the options that they have identified. Some of these will be `straightforward'

10. This review has now been delayed by `external factors' including a possible review in 2005 of EC law on the VAT status of public bodies. There is no guarantee of when the review by Customs will be completed, if at all. If it is completed we do not know what the options will be or whether they will benefit this Council. However we may get the option to separate one or both museums from other activities for the PX calculation. This would save VAT attributed to other `exempt' activities. However up to £300k VAT incurred on museums would be lost even if we did not breach the 5% limit.

11. The PX calculation is currently done on a rough basis because the only concern is to show that the ratio is below 5%. Under the new regime staff resources will need to be given to finding means to minimising actual repayments of VAT on costs.

12. For the museums the Council should:

13. Each of the above has the potential to create a small reduction in repayments due on account if the Council breached the 5% limit.

14. Failure to secure an agreement with Customs will result in the loss of over another £300k per annum incurred on other `partly exempt' business activities. This could be mitigated by appropriate tax management strategies and more detailed analysis of end-year accounts.

15. On current tentative estimates these measures should:

17. The Council would need to record and review the level of `exempt' use of some buildings and civil engineering works where expenditure of more than £250k had been incurred in the past. If the proportion of `exempt' use had risen it would be necessary to repay a small amount of the VAT on those costs.

18. A breach of the 5% limit may also require the repayment of some of the VAT incurred on Pension Fund investment management fees because it is deemed to be linked to `exempt' dividends etc.

19. The estimated time commitment to complete the above work is at least 40 man-days in the first year in which the PX ratio was expected to exceed 5%, and 25 days in subsequent years. This will involve not only central finance staff but also service managers and accountants working in Heritage, Property and other Services.

20. The time requirement will depend in part on the extent of changes to other spending across the authority. This will take staff out of their other work, including service development and the monitoring of other corporate VAT liabilities.

21. Despite these impacts on current staff time, it is believed we can accommodate this extra work within existing resources, i.e. without incurring extra Council cost.