Lisa Forster, CIPFA Consultant
The use of the Teckal exemption is complex and subject to challenge, therefore the council and the local authority trading company (LATC) must ensure that the company is within the Teckal parameters. The following provides further detail.
To be Teckal compliant there are two key tests:
- the control test
- the functional test
The local authority must control all of the shares in the company and must also exercise effective day-to-day control over its affairs; in other words, the same as the relationship between the council and one of its internal directorates. This can be achieved through the governance structure.
The company must be “inwardly and not outwardly focused”. The directive requires that at least 80% of the activity of the Teckal company – that is, over 80% of its turnover – must be for its public sector owners. Any contracts with other public sector bodies or private sector entities will not benefit from the Teckal exemption and the company will have to tender in the ordinary way for such contracts in accordance with any applicable procurement legislation.
Changes to the EU procurement regulations in 2015 mean that local authorities can now undertake 20% trading (previously this was only 10%) with third parties outside of their ‘Teckal’ contract. This is calculated based on three years' turnover – so allows for some smoothing over these years.
It should be noted that for the company to be Teckal compliant the courts always turn to the detail of the company structure and constitutional documents. Any LATC therefore needs to ensure that the council still has the power to issue directions and that the autonomy of the board does not supersede council powers. Some key points around Teckal compliance, based on previous cases and court judgments, are:
- The council has the power to issue directions to the LATC on “strategic matters or important issues of policy”.
- If the articles of the LATC say that non-authority board members could be appointed, the council must retain the express right to remove any such directors at any time.
- The constitution must consider the level of autonomy of the board and the authority must have the power to exert control over the LATC.
- That the local authority holds all of the share capital in the company will usually (but not always) be indicative of control.
The risk of challenge
If a local authority operates a Teckal company, and this is solely to provide a service back to the council(s), it may not want to charge for some of the overheads that the company uses – as this is essentially a circular transaction and under IFRIC 12 could be classed as a service concession and trigger some unwelcome accounting such as sale and leaseback. However if the LATC is also trading with third parties (ie up to its maximum 20% of turnover) it must be mindful that it is not breaching state aid and/or transfer pricing regulations, ie by the fact that its prices are lower than those of competitors as a result of it not having to bear certain overheads.
In order to ensure transparency and competitiveness with the private sector and, importantly, to avoid breaching these rules, the company must not be subsidised by the authority and thus given a ‘competitive advantage’. This means that the authority must recover the costs of any accommodation, goods, services, employees or any other support it supplies to the company. It will be necessary to set up suitable systems and financial controls to ensure this is the case and to demonstrate independence of the company from the authority.
State aid does have a de minimus threshold (200,000 euros over any rolling three-year period) and certain block exemptions. Further information on state aid can be found here.
As we see more councils looking at establishing separate legal entities to trade under, private organisations are increasingly looking closely at the impact of these bodies on their market share. A complaint by a company against the local authority (ie that aims to demonstrate that its interests are adversely affected by the local authority granting its own company state aid) has the potential to cause significant disruption to a project.
The best-case scenario is that this is simply a small delay for the local authority, however at the other end of the spectrum the European Commission could initiate a lengthy investigation and order repayment of any aid, which could potentially be catastrophic for the LATC and make it unsustainable.
What is trading?
Trading outside the Teckal is permitted up to 20% of turnover, based on a three-year average (so in one year you may exceed this amount, as long as the average across the three years is only 20%). Trading outside the Teckal contract refers to trading beyond your public sector owners, ie academies, NHS, voluntary and community sector etc.
One aspect to consider is if the initial contract is established without difficulty and the company makes use of the Teckal exemption, the position may not be quite as straightforward when the contract comes up for renewal. If the company has diversified its activities and more than the 20% of its (three-year) turnover relates to non-local authority business, then the exemption will not be available and the company will need to bid in competition for the renewal of the core contract. If that core contract remains critical to the stability of the company’s financial position, then failure to win the contract may mean the trading company ceases to be viable. Any business case, therefore, for the establishment of a trading company which is initially reliant on council anchor business does need to have a medium term strategy to enable the company to become sufficiently cost effective and resilient so that it has a realistic prospect of winning future business in competition when its initial anchor contract expires.
One way to mitigate this risk is to create another trading company. The true cost to this new wholly commercial trading company of any support services assets or resources provided by the council to enable the company to operate would need to be charged to the company in accordance with private company accounting principles. The council could not therefore artificially subsidise the trading company to enhance its competitiveness to bid for work, as this would represent unfair competition.
If the Teckal company operates for a period of time and then decides it should become an employee-owned mutual (or co-op), the council will need to sell the company to the employees and at this point any contracts it has with the Teckal company will need to be retendered, as the Teckal exemption would no longer apply once the ownership and control change. It should be noted that there is no guarantee that the newly formed co-op or mutual would succeed in winning the contract.
Further information on Teckal can be found below:
CIPFA's Alternative Service Delivery Network can also offer advice on Teckal.