PFI: The STEPS deal 01. It was a very serious blow indeed for the Inland Revenue to have entered into a contract with tax avoiders. The Departments knew that Mapeley was owned by shareholders based outside the UK, but did not clarify the company’s tax plans, or find out that it intended to hold the properties offshore until late in the procurement process. Departments should as far as possible discount gains from tax avoidance that may be factored into a PFI bid, since any price advantage to the Exchequer is likely to be offset by lower tax revenue.
Treasury Minute
HMRC (the Department) accepts this recommendation and agree that the Departments should have sought to prevent the off-shore arrangements which occurred in the STEPS contract. As the Chairman of the Committee’s press statement acknowledges, ‘In this case, the savings represented by the Mapeley bid far outweigh the potential tax loss.’
The Treasury has issued guidelines to all departments, which indicates that it is possible for departments to make it a contract condition (notified in advance when advertising the contract) that the successful bidder will be prohibited from using particular tax arrangements, including offshore tax havens, provided such a restriction would not in fact be directly or indirectly discriminatory between European Community/Government Procurement Agreement bidders.
02. For its part, Mapeley had always intended to hold the properties offshore to avoid paying tax. Yet the company was less than open with the Departments, only making its intentions known to members of the Departments’ project team very late in the procurement process.
Treasury Minute
The department is constrained to offer no comment, as this is more appropriate for Mapeley to answer.
03. Faced with Mapeley’s financial difficulties, the Departments’ negotiating position was weak and led to the prolonged negotiations following deal signature. Ahead of signing the contract, the Departments had not given a high priority to analysing the possible termination scenarios or developing a fall-back position to ensure business continuity. Departments need to ensure that they retain a real option to terminate a deal in the event of contractor default.
Treasury Minute
The Department accepts this recommendation and agrees that it could have done more to understand the termination provisions in the contract from the outset. It has now remedied this and has a much more complete understanding of the risks associated with the STEPS contract and its options for managing them. In particular:
• The Department has a professional contract Director in place, who is now managing the contract and the commercial negotiations end-to-end.
• Mapeley has shared with the Department its financial model so that it has a much clearer view of their business dynamics and commercial position.
• The Department has engaged with Mapeley along with its investors and bankers to ensure a shared understanding of the financial and commercial risks and issues.
• The Department has used consultants with specific and extensive property and investment banking expertise to help examine the financial structure of the deal in order understand the risks over the life of the contract and the options for managing them.
• The Department is continuing to develop its Business Continuity Plan to allow for a variety of contract scenarios.
Since May 2004 HM Treasury has made compliance with its ‘Standardisation of PFI Contracts’ document mandatory for all PFI projects in compliance. This document contains mandatory wording on issues such as termination rights to ensure that the public sector is properly protected through contractual terms.
04. Nearly four years into a 20-year deal, negotiations between the Departments and Mapeley have still to be concluded. It is important that they should now meet their objective of concluding the current negotiations by Spring 2005.
Treasury Minute
The Department agrees with this recommendation. In December 2001 Mapeley advised the Departments that it faced a serious annual shortfall of some £27m, based on errors in pricing, variations to the contract since contract signature and claims arising from the procurement process. The Departments rejected the claim and no unauthorised non-contractual payments have been made to Mapeley.
The outstanding historic claim issues between the Department and Mapeley were resolved in June 2005. The Department has agreed to pay Mapeley a small additional balancing amount of £0.5m per annum and a one-off sum of £2m in respect of goods and services received under the contract. This settlement relates strictly to issues where there is a clear contractual obligation on HMRC to pay and tangible benefit for services received.
05. The current negotiations should aim to agree a performance measurement system that balances rewards and reductions in payments. Mapeley signed up to the performance measurement system suggested by the Departments even though it considered some aspects to be punitive. A performance measurement system can only function effectively when all parties are agreed on the criteria for, and the value of, deductions for poor performance.
Treasury Minute
The Department agrees with this recommendation. The original contractual Performance Measurement System never operated satisfactorily to incentivise the contractor to perform service delivery well. A revised PMS has been formally agreed by the Department and Mapeley. This came in to operation on 1 July 2005, following a three-month trial. The revised system is now properly and proportionately incentivising the contractor. This has established the necessary platform for robust contract management moving forward.
06. After the STEPS deal was signed, a number of key staff in the Departments moved on and there were management changes at Mapeley. Departments should avoid moving contract management staff unnecessarily, and contractors should commit to an appropriate degree of staff continuity between the procurement process and the operational phase of a PFI project.
Treasury Minute
The Department agrees with this recommendation. In the case of the STEPS contract the Department had expected a significant turnover of staff after contract signature because different skills were required to manage the contract to those needed to procure a PFI contract. With hindsight, the Department accepts it should have recruited a professional contract manager sooner. However a professional contract management team has now been in place for 18 months and is managing the contract robustly.
Treasury Taskforce Guidance (Technical Note 6) provides best practice guidance on ensuring continuity of staff between procurement and operational phases of PFI contracts.