Report to COUNCIL Workshop for discussion

Transcription

1 Subject: Prepared by: Revenue & Finance Policy Commercial & Business Activities Mike Drummond (Group Manager Corporate Services) Meeting Date: Workshop 29 July 2011 Report to COUNCIL Workshop for discussion SUMMARY This report covers Councils commercial and business activities. It looks at the current funding streams associated with these activities. In light of the TAFM reforms it also suggests a rationale, risk assessment and return policy for each business unit. Council business units (including GHL) utilise over $77m of assets. The current overall return on these assets is lower than desirable. In the past the income from business units has been used to offset the costs in activities funded through the UAGC. The mechanism for this was a negative UAGC charge to these business units. This approach is not transparent. Also the practice does not send good signals to business unit managers who should be concentrating on the bottom line and focusing on paying a dividend to Council. For these reasons the proposal is to have each business unit (and GHL) pay dividends to the Council Treasury activity. This is more transparent and will highlight the value these units provide through their income streams reducing rates requirements. As part of the Councils Revenue & Finance Policy Councillors will need to determine what area of Council Operations (if any) to apply this income to as by default it will reduce General rates. The proposed single funding stream is: FS12-XX Councils Commercial and Business activities All Councils Commercial and Business Activity dividends (including CCO s, CCTO s) are paid into the Treasury activity. These income streams are utilised (in order) to 1. Cover the interest cost on the Consolidation (Holding Company) Loan. 2. Cover the interest costs on any additional CCO investment loans. 3. Be applied to specific activity funding as determined from time to time in the Annual Plan or Long term Plan. 4. Be applied to reduce the undifferentiated General rate based on CV. Mike Drummond Group Manager Corporate Services Keywords: TAFM, business unit, dividend, commercial, CCO, Page 1 of 15

2 1. BACKGROUND Council s commercial activities are being reviewed in light of the TAFM reforms and an additional focus on operating these in a fully business-like manner. This review includes determining the rationale for holding these investments and the use to which the income streams are put. It has been identified that there needs to be a higher degree of transparency around the management and income streams from Councils business operations. Like many other business they are facing increased competition and the effects of the current economic climate. This has lead to reduced income levels for Council. Council s Commercial operations comprise of: Gisborne Vehicle testing Waikanae Top 10 Holiday Park Commercial Forestry Commercial Property Councils CCO s (Gisborne Holdings Ltd and its subsidiaries, BOPLASS) Day to day responsibility for these business activities rests with the Commercial Manager Matt Feisst. In regards to the commercial outcomes from these activities the Commercial Manager reports directly to the Group Manager Corporate Services. Commercial Property has only recently been formally separated out from other Community Property. This is to improve the focus on obtaining the maximum return. Council s Municipal Buildings have been included in Commercial Property as this non-specialised accommodation could be provided by the private sector and to ensure that management are focused on the real costs of this accommodation. Currently each of these activities (except Commercial Property and GHL) have a negative rates allocation i.e. they are budgeted to break even after making a contribution to rates. This contribution is not disclosed in a transparent way. There are strong reasons to treat the income from commercial activities in a transparent and consistent manner. With the exception of GHL each commercial activity does not have a formal dividend policy that defines what level of their profit they return to Council. Due to the economic downturn and increasing competition commercial operations have been using reserves to continue to provide the budgeted level of income to off set rates. This is not a sustainable practice. Some activities like Commercial Forestry have long periods of investment followed by harvesting - this gives rise to a cyclical income stream. Commercial activities run directly by Council are exempt from income tax. For activities run through CCOs they are subject to income tax unless the CCO qualifies as a charity. Council s borrowings to capitalise GHL generates an interest cost that can be offset against any taxable income received through GHL. To minimise Councils tax liability, wherever possible GHL also pays fully imputed dividends to Council. Council has accumulated tax losses in relation to GHL to off set against future profits. As GHL s forest harvesting comes on-stream there is likely to be a significant increase in income from that group. Careful tax planning in conjunction with GHL will be required to legitimately minimise the tax paid in the future. Careful structuring business activities through CCO s can achieve improvements in commercial focus but still remain tax effective. While not the focus of this paper a review over the next three years of the business structures being used for commercial operations is desirable. Page 2 of 15

3 Business plans are being developed for each of the Commercial operations. They have been completed for the Waikanae Top 10 Holiday Park and Gisborne Vehicle Testing. A plan for Commercial Forestry is currently in progress. This plan will take into account the impacts of the ETS. A business plan for Commercial Property is scheduled for completion by December Gisborne Holdings and its subsidiaries do not require business plans they are covered by their respective Statements of Corporate Intent (SOI s). These are formally reviewed and agreed with Council annually. Council has an investment in each of its Commercial operations (Business Units). The LGA now requires Council to periodically assess the expected returns from investing in, or undertaking a commercial activity and to satisfy itself that the expected returns are likely to outweigh the risks inherent in the investment or activity. This is good practice and will be incorporated into the Council s performance management framework. The changes to the requirements around the Funding Impact Statement for groups of activities means that the income stream from each commercial operation would need to be split into each activity that it contributes to as a source of funds. This is not an insignificant piece of work and adds considerable complexity if the current practice of negative rating is retained. For each of its investments including those in commercial activities Council will need to formalise its rationale for holding the investment. That rationale will need to reflect both the returns and risks inherent in retaining the investment. Council s investment policy, in accordance with good practice, anticipates that Council will manage its investment risks by having a diversified portfolio of investments. This involves determining the limits on the maximum % of total investments that a single investment can represent and the maximum % of the total investment assets that a single investment can represent. Councils current investments and commercial operations represent legacy assets rather than deliberate investment decisions. Council does not yet have an overall formal financial strategy in regard to its investments. This strategy could include both growing the portfolio or exiting some lower performing investments. The redevelopment of the GHL SOI has provided for the holding company to have a specific role in identifying CCO and investment opportunities for the Council. Currently Council runs businesses both in-house and through its CCO s. The choice of operating structure is important in creating an environment that is conductive to success. A stronger commercial focus and improved returns may be achieved by transferring existing commercial operations to a new or existing CCO. Such a move would require the use of the special consultative procedure. This would normally be done as part of the Long Term Plan consultation. Appendix 1 is a copy of a section from the PWC Tough Times, Hard Choices presentation. It succinctly sets out critea and considerations that should be taken into account when determining if an activity should be carried out: in-house as a Business Unit through a CCO. This is provided as a background paper as at this time there is no plan to restructure Councils business operations unless there is a clear signal from Council that a review of the existing structures is required. Page 3 of 15

4 2. DISCUSSION and OPTIONS Assuming that the Commercial operations of Council remain in-house then it is appropriate that as part of the Revenue and Financing Policy review that the treatment of their income streams and the related internal dividend policies is formally determined. Commercial operations contribute to Council in three ways. 1. They are charged a share of Council overheads. These overheads are higher than they would be if the businesses were stand alone. The primary reason for this is that they need to comply with Local Government and corporate business practices. These higher overheads impact negatively on their reported investment returns compared to other businesses in the same industry. 2. They pay rates along with normal Council fees and charges on an arms length commercial basis. 3. Their budgeted income is used to offset rates, primarily the activities funded by the UAGC. Any surplus due to higher than budgeted income is transferred into specific reserves. Deficits are also funded from these reserves. The size and contribution of each Commercial Activity is detailed below. Estimated Estimated Assets 2011/12 Annual Reserve Internal Commercial Employed Budgeted Balances Loans Staff FTE Operation ($000s) contribution to ($000s) ($000s) (30/06/10) Council Income (30/6/11) (30/6/11) Gisborne Vehicle Land $ 0 Depn Reserve Testing Buildings $ 0 Reserves Plant $ 5 Waikanae Top 10 Land $ 0 Depn Reserve Holiday Park Buildings $ 0 Reserves Plant $ 52 Commercial Land $ 3,124 Depn Reserve Forestry Forests $ 1,022 Reserves Other $ 77 Commercial Land $17,221 Activity Bal Property Buildings $18,233 Depn Reserve Plant $ 0 Reserves $120 $350 $ $240K $580 $ 11 8 $190K $(114) $ 0 $ 0 0 $0 $836 $397 $ $0 $352 $948 Gisborne Holdings Land $24,685 N/A $14,098 $981K Ltd and its Buildings $ 3,023 subsidiaries) Plant $ 287 Forestry Livestock $ 2,487 $ 7,224 Totals Land Buildings $45,030 $21,256 Activity Bal Depn Reserve $397 $1, $1,411K Plant $ 421 Reserves $2,020 Forestry Livestock $ 3,509 $ 7,224 Other $ 77 GRAND TOTAL $77,517 $3,469 $15,078 $1,411K Page 4 of 15

5 The basis of the following rationale and return section is Council s January 2009 Treasury Management Policy. This Policy includes in Appendix III - the objectives for Commercial and Semi Commercial Investments. Under the TAFM reforms Council needs to formally determine its rationale for holding each investment, the return expected and its use of those returns. Current Funding Streams The currently 9 related funding streams in the Finance and Revenue policy are as follows: FS09-07 Consolidation (Holding Company Loan: Used to restructure Council debt and fund the capitalisation of the Gisborne Holdings. Funding $1.566m pa from general rates. FS09-08 Farm and Investment Dividends: $500k income (interim dividend) used to pro-rata a reduction in each of the general rate funding streams. FS09-09 Municipal Buildings 100% UAGC: Internal charges based on space occupied are set to make nominal surplus. Currently FS09-50, FS09-49 and FS09-09 are being combined so income from the commercial property assets is offset against the community property costs. The net cost of $404k is funded through the UAGC. FS09-15 Gisborne Airport funded from general rates. Operating surplus is returned to the ratepayer as reduced UAGC charges. Income $2kpa. FS09-47 Forestry Operations: When profits arise balance goes to Capital Development reserve. FS09 49 Leased properties: 100% fees and charges to the third party leasing the buildings. Income offset against municipal buildings/community property costs. FS09-50 Managed properties including Quarries: 100% internal cost recovery where the public is the client, cost is covered by the Community Facilities unit through their budget (rates) The costs here are primarily community property. Costs are recovered through FS Municipal Buildings. FS09-70 Warrant of Fitness Registration and Licensing Centre: Gisborne Vehicle Testing. 100% fees and charges, profits are returned to the ratepayer through reduced UAGC charges. $240k income. FS09-82 Waikanae Holiday Park: 100% fees and charges profits are returned to the ratepayer through reduced UAGC charges. $190k income. Proposed Investment Rationale and Dividend Policies 1. Gisborne Vehicle Testing a. Rationale for this investment: i. To provide a competitive business that provides quality, affordable services to the local community and benefits the Gisborne ratepayers. ii. To ensure there is a competitive low cost vehicle certification service for local residents. iii. Top provide local employment. iv. To retain the economic benefits of the activity within the local community. v. To generate income that reduces the cost of rates to the Gisborne district ratepayers. Page 5 of 15

6 b. Risks assessment i. Reduced returns through increasing competition. ii. Under utilisation of facilities with high fixed costs if sales volumes fall below set levels. iii. Variable income levels affecting rates incidence year on year. c. Expected return - Operations i. ROR (return on revenue) in the range (before contribution to Council overheads) of 5% to 10% pa. Expected return - Property i. Return on assets employed in the range 2% to 4%. d. Internal dividend policy i. 80% 0f the operating surplus returned to Council. ii. The remaining 20% of the surplus to be retained in a general reserve to fund future requirements including capital expenditure. e. Capital Expenditure i. Operational Funded from the 20% of surpluses retained within the business, internal loans and funded depreciation. ii. Property - Funded from within the Commercial Property Business Unit 2. Waikanae Top 10 Holiday Park a. Rationale for this investment i. To stimulate economic activity by providing a range of quality, affordable and temporary accommodation that attracts visitors and holidaymakers to the Gisborne Region. ii. To maximise the financial return from the valuable beach-front reserve the Holiday Park occupies. iii. To generate income that reduces the cost of rates to the Gisborne district ratepayers. b. Risks assessment i. Reduced returns through increasing competition and changes in preferred accommodation types. ii. Over capitalisation due to seasonal nature of the accommodation industry. iii. Impact on the desirability of the site due to increased traffic movements on the adjoining state highway particularly logging trucks and other heavy vehicles. iv. Variable income levels affecting rates incidence year on year. v. Exposure of the site to natural hazards e.g. Tsunami Page 6 of 15

7 c. Expected return i. ROR Return on Revenue (before Contribution to Council Overheads in the range 12% to 16% ii. RevPOR Annual Revenue per Occupied room. iii. RevPAR Annual Revenue per Available room. (to be confirmed 2011/12) Accommodation Type RevPOR RevPAR From To From To Tourist Units $90/day $113/day $57/day $78/day Ranch Houses $42/day $53/day $20/day $25/day Beach House $105/day $114/day $73/day $80/day Sites $27/day $33/day $4.50/day $6 /day d. Internal dividend policy i. 80% 0f the operating surplus returned to Council. The remaining 20% of the surplus to be retained in a general reserve to fund future requirements including capital expenditure. e. Capital Expenditure i. Operational Funded from the 20% of surpluses retained within the business, internal loans and funded depreciation. ii. Property - Funded from within the Commercial Property Business Unit 3. Commercial Forestry a. Rationale for this investment i. To generate income from Council land holdings. ii. To protect the Councils water supply dams. iii. To utilise legacy land holdings throughout the district. iv. To generate income that reduces the cost of rates to the Gisborne district ratepayers. b. Risks assessment i. Long term fluctuations in log and input prices. ii. The impacts of ETS on replanting. iii. Potential uneconomic size of some plantations. c. Expected return i. Forestry Joint Venture with Juken Nissho net proceeds on harvest 16.75% to GDC 83.25% to Juken Nissho. ii. Other forestry blocks - the Internal Rate of Return (IRR) 5-7% (excluding CPI inflation). iii. Proceeds from the sale of excess carbon Credits. Page 7 of 15

8 d. Internal dividend policy i. 90% of the cash operating surplus returned to Council. e. Capital Expenditure i. Operational Funded from the 10% of surpluses retained within the business, internal loans and funded depreciation. 4. Commercial Property a. Rationale for this investment i. Industrial Land Holdings 1. To purchase and consolidate land holdings for resale as industrial holdings to encourage regional capital investment and industrial development. 2. To ensure that suitably zoned and serviced land is available when industry needs it. ii. Municipal Buildings 1. Tto provide cost effective accommodation for council activities and certainty of tenure. iii. Other commercial Property 1. To obtain a commercial return on property acquired for supporting Councils other services and long term plans. 2. To support strategic activities in the region eg Gisborne Airport. 3. To maximise the return on legacy property assets prior to disposal. iv. General 1. To generate income that reduces the cost of rates to the Gisborne district ratepayers. b. Risks assessment i. Lack of a geographically diversified property portfolio i.e. concentration of the property holdings within the Gisborne city. ii. Inclusion of legacy assets within the portfolio which may not be able to generate a good commercial return compared to alternative investments. iii. Inability to divest some low performing assets due to encumbrances. iv. Variable income levels affecting rates incidence year on year. c. Expected return i. Market based returns 4-6% return on investment. ii. Municipal Buildings small return 1-2% to off set future capital requirements and to smooth fluctuations in operating costs. iii. Properties supporting Council business units (eg GVT, Holiday Park) market based returns after taking into account encumbrances on the land. iv. All disposals at current market rates based on independent valuation. Page 8 of 15

9 d. Internal dividend policy i. 90% of the cash operating surplus returned to Council. e. Capital Expenditure i. Funded from the 10% of surpluses retained within the business unit, internal loans and funded depreciation. 5. Gisborne Holdings Ltd a. Rationale for this investment i. Gisborne Holdings Ltd holds through its subsidiary Tauwhareparae Farms Ltd, farm and forestry operations at Tolaga Bay. These farms are a legacy asset and were provided by the Crown to give financial support the Gisborne Port. The Council has since sold the Port but retained the farms. ii. Gisborne Holdings is intended to be a vehicle for potential CCO undertakings and establishment opportunities. A specific objective under the SOI is to report to Council on CCO establishment opportunities, and other investment opportunities that have the potential to enhance the economic well-being of the region, and to provide an adequate return. iii. To generate income that reduces the cost of rates to the Gisborne district ratepayers. b. Risks assessment i. Without a diversified portfolio of investments GHL has difficulty maintaining a consistent dividend stream to Council. ii. The company through TFL is exposed to the cyclical nature of farming profitability. iii. Income can be translated into increases in the capital value of the farming assets. This can only be released through the sale of all or part of the operations. c. Expected return i. An interim dividend of $500k paid in February each year. The final dividend making a total of 70% of the net distributable income will be paid in October. Estimated dividends disclosed in the 2011 SOI range from $784k $940kpa d. Capital Expenditure i. The Directors advise they do not foresee a need for capital expenditure at this time. Capital expenditure will be funded from within the GHL group. 6. New Zealand Local Government Insurance Corporation Ltd (Civic insurance) a. Rationale for this investment i. The shares were acquired by virtue of the Council being a local authority. The purpose of the corporation, in which most local authorities are shareholders, is to ensure that adequate insurance arrangements are available to local authorities at the lowest possible cost. Page 9 of 15

10 b. Risks assessment i. The shares in the Corporation continue to be held, as they are not readily transferable. The amount involved is immaterial relative to Councils total investments. c. Expected return i. Revenue earned from the shares in the Corporation is minimal 7. Bay Of Plenty Local Authority Shared Services ( BOPLASS ) a. Rationale for this investment i. The shares were acquired by Council to enable participation in BOPLASS. The objectives of BOPLASS are: Working together with the full support and involvement of staff to provide benefit to councils and their stakeholders through improved levels of service, reduced costs, improved efficiency and/or increased value through innovation. ii. Reduced costs through joint procurement and shared services. b. Risks assessment i. The shares in BOPLASS continue to be held, as they are not readily transferable. The amount involved is immaterial relative to Councils total investments. c. Expected return i. No revenue is earned from the shares. Benefits flow through reduced costs to Council. Proposed Funding Stream It is proposed to replace the current 9 related funding streams in the Finance and Revenue policy with a single funding stream as follows: FS12-XX Councils Commercial and Business activities All Councils Commercial and Business Activity dividends (including CCO s, CCTO s) are paid into the Treasury activity. These income streams are utilised (in order) to 1. Cover the interest cost on the Consolidation (Holding Company) Loan. 2. Cover the interest costs on any additional CCO investment loans. 3. Be applied to specific activity funding as determined from time to time in the Annual Plan or Long term Plan. 4. Be applied to reduce the undifferentiated General rate based on CV. Currently there is insufficient income from business and commercial activities to cover the interest on the Holding Company loan. This loan was used to capitalise Gisborne Holdings Ltd. Effectively the funds raised were used by GHL to purchase the farms from Council. In turn Council used the funds to repay borrowings. This extinguished a number of loans that would have been paid off by various Council activities Not directly utilising the income from some business units to offset the UAGC does not impact on the current practice of maximising the rates income coming through the UAGC mechanism. Currently the funding requirements for Council activities funded through the UAGC exceed the 30% cap. When this occurs the balance (above 30%) has to be funded through General rates. Page 10 of 15

11 Reducing the negative UAGC rates will cause a larger portion of these activities to be funded through the General Rate. This increase in General rates is directly offset by the additional dividend income now received into the Treasury activity which is itself funded by General rates. 3. CONSULTATION The Local Government Act 2002, Section 102 Funding and Financial Policies requires Council to utilise the special consultative procedure in adopting a Revenue and Financing Policy. Council normally does in conjunction with the 10 Year Plan consultations. The Local Government Act 2002, Section 56 Consultation required before Council controlled organisation established requires Council to utilise the special consultative procedure before establishing or becoming a shareholder in a CCO. Council would normally do this in conjunction with the 10 Year or Annual Plan consultations. 4. LEGAL The Local Government Act 2002, Section 14 Principles relating to local Authorities was amended in 2010 as part of the TAFM reforms to include in addition to undertaking any commercial transactions in accordance with sound business practice and new section: 14(1)(f) a local authority should periodically (i) assess the expected returns to the authority from investing in, or undertaking, a commercial activity; and (ii) satisfy itself that the expected returns are likely to outweigh the risks inherent in the investment or activity; and Page 11 of 15

12 5. APPENDICES 1. PWC Tough Times, Hard Choices presentation - using Council Controlled Organisations Page 12 of 15

13 APPENDIX 1 PWC Tough Times, Hard Choices presentation Page 13 of 15

14 Page 14 of 15

15 Page 15 of 15