House of Lords - Regina v. Secretary of State for the Environment (Original Appellant and Cross-Respondent), Ex Parte Council of the London Borough of Camden (Original Respondents and Cross-Appelants)

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Session 1997-98
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Judgments - Regina v. Secretary of State for the Environment (Original Appellant and Cross-Respondent), Ex Parte Council of the London Borough of Camden (Original Respondents and Cross-Appelants)

HOUSE OF LORDS

  Lord Browne-Wilkinson   Lord Nolan   Lord Hoffmann
  Lord Clyde   Lord Hutton

OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT IN THE CAUSE

REGINA

v.

SECRETARY OF STATE FOR THE ENVIRONMENT
(ORIGINAL APPELLANT AND CROSS-RESPONDENT), EX PARTE COUNCIL OF THE LONDON BOROUGH OF CAMDEN
(ORIGINAL RESPONDENTS AND CROSS-APPELLANTS)

ON 12 MARCH 1998

LORD BROWNE-WILKINSON

My Lords,
    I have had the advantage of reading in draft the speeches of my noble and learned friends, Lord Nolan and Lord Hoffmann with which I agree. For the reasons which they give I would allow the appeal and make the order proposed by my noble and learned friend, Lord Nolan.

LORD NOLAN

My Lords,
    The Respondent Council ("Camden") is a local housing authority to which the provisions of Part VI of the Local Government and Housing Act 1989 apply. By section 74(1) of the Act local housing authorities are required to keep a separate self contained Housing Revenue Account ("HRA"). The purpose of this legislation broadly stated is to ensure that the cost to local housing authorities of providing housing accommodation is met out of rental income supplemented so far as appropriate by Government subsidy, and does not add to the burdens of council tax payers or business rate payers.
    Section 75 requires the HRA to be kept in accordance with the provisions of Schedule 4. Section 79 authorises the Secretary of State, with the agreement of the Treasury, to pay the HRA subsidy. Section 80(1) provides that the amount of HRA subsidy for any year is to be calculated in accordance with such formulae as the Secretary of State may from time to time determine. This case turns upon the meaning and effect of the formulae determined by the Secretary of State for the year 1994/95,
    This determination applied not only to Camden but to local housing authorities generally. Section 87 authorises the Secretary of State to make special determinations for individual housing authorities. Finally, Item 8 of Part 1 of Schedule 4, which deals with credits to the HRA, and Item 8 of Part II of Schedule 4, which deals with debits to the account, and which are expressed in identical terms reflecting the provisions of section 80, provide respectively for the credit and debit of the following:
"Sums calculated for the year in accordance with such formulae as the Secretary of State may from time to time determine.

In determining any formula for the purposes of this item, the Secretary of State may include variables framed (in whatever way he considers appropriate) by reference to such matters relating to the authority, or to (or to tenants of) houses and other property which are or have been within the account, as he thinks fit."

    One of the functions of the annual determination by the Secretary of State is to ensure that the HRA is debited with a fair proportion of the interest paid by the local housing authority on its borrowings. The amounts borrowed, the periods of the various borrowings, and the rates of interest payable on them are almost infinitely variable. The formulae therefore provide for the calculation of an average rate of interest which is to be used in ascertaining the amount of interest which is to be debited to the HRA. The determinations have provided for the same rate of interest to be used in computing the corresponding element of HRA subsidy which is to be paid to the council by the Secretary of State under section 79. The issue between the parties is whether the calculation should take account of an item described as a prior year adjustment, or catch-up accrual, which in accordance with accepted accountancy requirements fell to be deducted in Camden's accounts for the year 1994/95. Camden submits that (1) the determination for 1994/95 properly construed, requires such account to be taken, but if that is wrong, then (2) the Secretary of State should make a special determination under section 87 requiring such account to be taken and (3) the Secretary of State should make a fresh subsidy determination reflecting the result of the special section 87 determination. In the courts below the Secretary of State opposed all of these submissions. Before Jowitt J. he succeeded on all three points. In the Court of Appeal the Secretary of State failed on the first point, and so the second and third did not arise for decision. One of the reasons why the Secretary of State had opposed the second and third submissions by Camden was that to accept them would create too great a disparity between the treatment of Camden and that of other local housing authorities which had been denied special determinations or subsidies in respect of prior year adjustments. The Secretary of State has indicated, however, that in the light of a frankly admitted mistake within his department about the treatment of other authorities which has come to light since the hearing before the Court of Appeal he would wish to reconsider the second and third points if he succeeds before your Lordships on the first.
    Your Lordships were told that the amount of money at stake is £20.9M. If Camden are right on the first point, this amount will be debited to the HRA but recovered by way of subsidy, pursuant to the determination that the subsidy calculation will proceed in this respect on the same basis as the debit calculation. If Camden fail on the first point but succeed on the second then (subject to the third point) the £20.9M will be debited to the HRA, whose recoupment will involve increases in council housing rents, or a reduction in services to tenants or both. If Camden succeeds on the third point as well as the second, the result will be the same as if it had succeeded on the first point; the cost of the increased subsidy will fall to be borne by the general body of tax payers.
    The prior year adjustment fell to be made because, before 1994/95, Camden had debited interest in its accounts on what is loosely referred to as a cash basis, though it might more accurately be described as a liabilities basis. That is to say, the interest was debited in the accounts on the date when it fell due. From about 1985 onwards, however, accountancy practice had been moving steadily towards the adoption of the accruals rather than the cash basis. The difference can be illustrated by reference to loan interest which falls to be paid half-yearly in arrear on the 1 November and the 1 May. If the accounts are made up on the cash basis for the twelve months to 31 March, they will show the interest payment which became due on the previous 1 November (and also, of course, that which became due on the previous 1 May) but not that which is to become due on 1 May following the end of the accounting year. If the accruals basis is adopted, the accounts will show 5/6ths of the amount due on 1 May and 1/6th of the amount due on the previous 1 May, in addition, of course, to the whole of the six months accrual which became due for payment on the previous 1 November. As appears from the figures put before us the difference between the two methods in any given year taken as a whole may not be great, and may even, because of the accident of timing, result in a higher figure on the cash basis than on the accruals basis. The difficulty comes when there is a change from the cash basis to the accruals basis, as occurred in the present case on 1 April 1994. If one takes as an example the 6 months interest payable in arrears on 1 May 1994, none of it will have been debited in the accounts for the year to 31 March 1994 and only one-sixth of it will fall to be debited in the accounts for the year to 31 March 1995. How is this accrued but undebited 5 months interest, the catch up accrual, to be shown in the accounts?
    The general rule adopted by the accountancy profession, and applicable, as I understand it, to all bodies except for local authorities, is to debit the catch-up accrual to reserves. This seems to me to be eminently sensible because it represents an adjustment of the results shown in the previous accounts. The first annual account drawn up on the new basis will be unencumbered by it, and will correctly reflect the interest accrual during that year and no more. It is common ground between the parties, however, that in the case of prior year adjustments in respect of interest the proper procedure for local authorities is to charge the amount to revenue in the year of change. The 1994 Guidance Notes for local authorities issued by the Chartered Institute of Public Finance and Accountancy explains the position in these terms at paragraph 3.37:
"The 1993 Code requires prior year adjustments to be accounted for in the year that they are identified. This differs to practice adopted by other organisations where prior year adjustments are dealt with by amending comparatives and brought forward balances. The reason for the divergence stems from the recognition that local Government finance is conducted on an annual basis and that all expenditure in a year has to be matched with Government grants and local taxation in that year."

    I confess that I find this explanation hard to follow. The prior year adjustment, by definition, does not represent expenditure of the year in which it is charged.
    That, however, is beside the point. For although much of the debate before your Lordships was concerned with the propriety of the accounting practice adopted by Camden in respect of its interest liabilities during the years prior to 1994/95 the sole issue between the parties turns upon the meaning of the determination by the Secretary of State.
    Both parties accept that no distinction is to be drawn for present purposes between the 1994/95 determination and those made under the Act for previous years. For the years 1990/91 and 1991/92 the average rate of interest, referred to by the letter N, was defined (so far as relevant) as:
"The average rate of interest (expressed as a percentage), calculated in accordance with proper practices payable on the amount outstanding during the relevant year by way of money borrowed by the authority."

    In the determinations for the years 1992/93 and 1993/94 N was defined as:
"The average rate of interest (expressed as a percentage), calculated in accordance with proper practices, which would have been payable on the amount outstanding during the relevant year by way of money borrowed by the authority on the assumption that where, after 1 November 1991

(i) any loan is prematurely repaid or its terms are otherwise varied, and

(ii) that loan is not a variable rate loan from the Public Works Loan Board which is, after November 1991, prematurely repaid or converted to a fixed rate loan without any other term being varied, the terms of the loan had not been varied (and the loan had not been prematurely repaid) after that date."

    In the determination for 1994/95 N was defined as:
"The average rate of interest, calculated as a percentage figure to two decimal places on an accruals basis, which would have been payable on the money borrowed by the authority during 1994/95 (calculated on a weighted average basis which takes into account fluctuations in such amounts outstanding during the year) and on the assumption that were, after 1 November 1991

(i) any amount is prematurely repaid or its terms are otherwise varied, and

(ii) the loan is not a variable rate loan from the Public Works Loan Board which is, after November 1991, prematurely repaid or converted to a fixed rate loan without any other term being varied, the terms of the loan not being varied (and the loan had not been prematurely repaid) after that date."

    It is common ground that the change in the wording from "payable" to "which would have been payable" was made to reflect the two assumptions which had to be made in the years 1992/93 to 1994/95, Neither party suggests that the change has any bearing on the issues which your Lordships have to decide.
    My Lords, once the complication of the change of wording has been removed the opposing contentions of the parties can be shortly stated. The Secretary of State contends that the amount of interest to be taken into account is confined to interest payable on the outstanding amount of the council's borrowing during the year in question. The calculation is to be "in accordance with proper practices" or "on an accruals basis" (the Secretary of State maintains that the two expressions have been synonymous at all material times) but the governing words for present purposes are the words "payable on the amount outstanding during the relevant year by way of money borrowed by the authority" or, in the case of 1994/95 "payable on the money borrowed by the authority" during that year.
    For Camden it is submitted that "proper accountancy practices" call for the prior year adjustment to be charged to revenue in the year in which it is recognised, and that this is consistent with the adoption of the accruals basis. It is submitted that the function of the words "payable on" to the end of the determination is simply to specify the loan debt in relation to which the average rate has to be calculated. The purpose of the calculation is to discover the average rate of interest on the weighted average amount of the fluctuating loan debt. The phrase "payable on the amount" as opposed to the phrase "payable on a particular date or occasion" has no temporal connotation or relationship.
    My Lords this final part of the submissions for Camden represents the departure point between the arguments of the opposing parties. Jowitt J. dealt with the matter in these terms:
"It is not possible to calculate an average rate of interest unless one knows what interest is to be taken into account, what borrowing is to be taken into account and which particular period of borrowing has to be taken into account. To find the answers it is necessary to look at the determination. It speaks of the average rate of interest calculated in accordance with proper practices payable on--and at this stage I interpolate the question, payable on what? I find the answer to my question in the words of the determination which follow--'the amount outstanding during the relevant year by way of money borrowed by the authority.' This means that the relevant interest is that which is payable, whenever it is paid, in respect of the borrowing in the relevant year."

    Roch L.J., giving the leading judgment in the Court of Appeal, substantially adopted the arguments advanced by Camden. He said:
"The evidence is to the effect that proper accounting practice requires, in the year in which a local authority changes from cash based accounting to accruals based accounting, the inclusion in the accounts of the changeover year, of prior year adjustments. Without such entries large sums would be unaccounted for and the local authority's accounts would not present a fair statement of a local authority's financial situation and operations. It follows, in my judgment, that the calculation of average rates of interest 'in accordance with proper practices' would in a change over year include that part of the interest which was "payable" in that year because it was properly included in the interest for that year as an adjustment to the year's interest figure albeit that it accrued in the previous year. The prior year adjustment figure for interest must be used in the calculation unless it is excluded by the remainder of the wording of the formula.

That wording is 'payable on the amount outstanding during the relevant year by way of money borrowed by the authority'. The judge read those words as meaning interest payable during the relevant year in the sense of accruing during the relevant year; arriving at that reading by this route: that the payments had to relate to the borrowing on which interest had accrued during the year to which the account relates, but not the sum of interest represented by the prior year adjustment which was interest payable on the amount of the loan which was outstanding in the previous year.

Here the change in wording for the year 1994/95, which is said by the Secretary of State to be introduced merely to make the formula clearer to the layman and not to effect a change in its meaning, is illuminating, because it makes clear that the amount of money borrowed by the local authority (and the formula is concerned with a local authority's total borrowings) will fluctuate during the year. What is being sought is a figure which represents an average of the borrowings during the year; a figure which would represent at any single moment, the mean of the varying levels of borrowing during the year. The use in the 1994/95 formula of the words 'borrowed by the authority during 1994/95' and the repetition of the words 'during the year' in the clause 'which takes into account fluctuations in such amounts outstanding during the year' shows that the words 'during the year' do not qualify the interest payable, but are intended to direct the reader how the figure of relevant borrowings ('the amount outstanding') is to be ascertained. The borrowings for the year are to be aggregated and the appropriate factor applied so as to produce a single figure to represent the varying amounts of money borrowed throughout the year.

Consequently, in my judgment, the words 'during the relevant year' do not qualify the interest figure; they quantify the borrowings figure."

    In the course of his concurring judgment Ward L.J. said that the issue for him was "how the dividend (the amount of interest) is to be calculated when it may only be calculated on an accruals basis." After quoting from the Code of Practice on Local Authority Accounting in Great Britain 1994 to which I have referred above, and also from a more recent version of the Code, he said:
"It seems to me clear that the effect of those policies is that in the catch up year the amount of interest charged in the accounts kept on an accruals basis in that year would properly include the amount charged in consequence of the prior year adjustment."

    He concluded, in consequence, that the Secretary of State had misdirected himself in his interpretation of the determination.
    My Lords I am unable to accept the views expressed by Roch and Ward L.JJ. They seem to me to attach altogether too much weight to the accountancy practice which calls for the catch up accrual to be debited in the year in which the change to the accruals basis is made.
    It is, I think, essential to remember that the object of the annual determination is to arrive at a fair allocation of the interest burden borne by the local authority between the various accounts which the authority maintains. To this end, the determination specifies an average rate of interest to be calculated on a weighted average of borrowings. This is not a result which accountancy practices of general application are designed or are apt to produce. It can only be achieved by adhering to the language of the annual determination.
    The matter is one of impression which may present and has presented itself differently to different minds, but I can only say that to my mind the language is clear. The meaning appears most plainly from the wording of the 1990/91 determination which speaks of "the average rate of interest . . . payable on the amount outstanding during the relevant year." The words "payable on" plainly do not refer to "the average rate." One cannot pay an average rate: one can only pay real interest, at whatever the appropriate rate may be. Equally, one cannot pay real interest upon a weighted average of borrowings. One can only pay interest upon real borrowings. The starting point for 1994/95 must, therefore, be to discover the amount of interest accruing (and therefore payable) upon Camden's borrowings during that year. That, to my mind, is what the determination plainly requires. I agree with the view expressed by the learned judge in the passage which I have quoted above, and I cannot improve upon his language.
    The contrary view, preferred by the Court of Appeal, requires more than one year's interest to be attributed to the year 1994/95. It includes, as if it were interest accruing in that year, interest which in fact accrued in the year 1993/94, and which was payable upon the borrowings of that year. The adoption of this approach inevitably leads to the average rate of interest for the year 1994/95 being artificially raised, by the bringing into account of interest attributable to a different period of borrowing. Roch L.J. arrived at this conclusion by reading the words "during the relevant year" as governing the borrowings figure but not the interest figure, and by rejecting the notion of a temporal link between interest and the borrowings. But, as it seems to me, the link between interest and the borrowing upon which it is payable is always and essentially temporal. The period of time with which the 1994/95 determination is concerned is that year, and that year alone. The words "during 1994/95" govern the interest accruing no less than the amount of the borrowing.
    It is said that such a reading of the determination will go against the purpose of the legislation, since it will break through the ring-fence surrounding the HRA, and impose (in the absence of a Government subsidy) what is undeniably a housing cost upon the general body of tax payers and rate payers. But that is a matter the Secretary of State will no doubt take into account when deciding whether or not he should make a special determination under section 87, and, consequentially, whether or not he should pay a further subsidy. As I have said, these are possibilities which, without in any way committing himself as to the result, the Secretary of State has said that he will reconsider.
    I would therefore allow the appeal by the Secretary of State and restore that part of the order of Jowitt J. which refused Camden's claim for relief in the form of the declaration sought by paragraph 1 of its notice of application for leave to apply for judicial review dated 1 December 1995. The matter must be remitted to the Secretary of State to reconsider the other forms of relief sought by Camden in the light of the change of circumstances which has occurred since the Court of Appeal hearing. Both of the orders for costs made in the courts below should be set aside. Each party should bear its own costs of these proceedings.

LORD HOFFMANN

My Lords,
    I have had the opportunity of reading in draft the speech of my noble and learned friend Lord Nolan, with which I agree. The point at issue is a very short one. One of the components in the calculation of the Housing Revenue Account subsidy is a factor called the Consolidated Rate of Interest. This is defined in the General Determination of the Item 8 Credit and Item 8 Debit (Consolidation) 1990 as:
"the average rate of interest (expressed as a percentage), calculated in accordance with proper practices, payable on the amount outstanding during the relevant year by way of money borrowed by the authority."

    The plain and obvious meaning of this formula is that it requires the interest payable on the amount outstanding by way of borrowing during the relevant year to be expressed as an average percentage rate. I therefore do not understand how the Court of Appeal was able to construe it so as to permit a calculation which takes into account interest payable in a previous year on borrowings then outstanding. They seem to have read "average rate of interest . . . calculated in accordance with proper practices" to mean that one should include all interest which under proper accounting practices would be debited in the accounts for the relevant year, including interest added by way of a previous year adjustment, and then to express that interest as an average rate in respect of borrowings during the relevant year alone. One therefore obtains an "average rate" by including interest payable in a previous year and ignoring the borrowings in respect of which it was paid. The result is certainly a quotient but can hardly be called an average and I do not believe it can have been what the Secretary of State intended. The same is true of the 1994-1995 Determination.
    I would therefore allow the appeal and restore that part of the order of Jowitt J. proposed by Lord Nolan.

LORD CLYDE

My Lords,
    I have had the advantage of reading in draft the speeches prepared my noble and learned friends Lord Nolan and Lord Hoffmann, with which I agree. For the reasons which they give I would allow the appeal and make the order proposed by my noble and learned friend, Lord Nolan.

LORD HUTTON

My Lords,
    I have had the advantage of reading in draft the speeches of my noble and learned friends Lord Nolan and Lord Hoffmann, with which I agree. For the reasons which they give I would allow the appeal and make the order proposed by my noble and learned friend, Lord Nolan.

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