20 June 2007
UK National Accounts
Case law on classification of quasi-corporations
By Martin Kellaway & Helen Shanks (ONS)
1.
Summary
1.1
The National Accounts are an accounting framework that records the activities taking
place in a national economy. To do this it divides the participants into sectors and subsectors of the economy. For example, the accounts bring together corporate entities
into the non-financial corporate sector, and financial institutions into the financial
corporations sector.
1.2
The process of sectorisation involves focusing on economic behaviour rather than
legal form. Given the importance of National Accounts in the measurement of fiscal
aggregates this has particular relevance for the area of the public sector.
1.3
Although it is relatively straightforward to identify public corporations operating in
the market place as part of the corporate sector it is also important to identify those
areas of general government which are providing market products. This is where
National Accounts identification of 'quasi-corporations' becomes relevant. Quasicorporations are so called because they do not exist as separate legal entities but
behave like corporations selling products.
1.4
The article explains ONS’s approach to identifying and classifying both private and
public sector quasi corporations in the UK National Accounts and provides
information on the resulting impact on the General Government Net Borrowing
statistical measure.
2.
Contents
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Summary ----------------------------------------------------------------------------------------- 1
Contents ------------------------------------------------------------------------------------------ 2
National Accounts and the fiscal measures -------------------------------------------------- 2
The process of sectorisation ------------------------------------------------------------------- 3
Institutional units -------------------------------------------------------------------------------- 3
Quasi-corporations ------------------------------------------------------------------------------ 5
Private sector quasi-corporations-------------------------------------------------------------- 5
Public sector quasi-corporations -------------------------------------------------------------- 6
The distribution of quasi-corporation surpluses --------------------------------------------- 8
Context ------------------------------------------------------------------------------------------ 11
Quasi-corporations of the European Union ------------------------------------------------- 11
3.
National Accounts and the fiscal measures
3.1
The National Accounts are a comprehensive, integrated and consistent set of
macroeconomic accounts that describe a national economy. In particular, a set of
National Accounts "shows the economic behaviour of the economy's participants, their
interrelationships and the results of their economic behaviour"1. They need to be
based on a set of internationally agreed concepts, accounting rules, classifications and
definitions, both for the production of time series that show how an economy is
changing and for international comparability. The international standards are set out
in the United Nations’ 1993 System of National Accounts (SNA93), and for the
European Union in the 1995 European System of Accounts (ESA95). These standards
have evolved through time to facilitate analysis of decision making and form an
important input into economic decision making. For example, both fiscal and
monetary policies are increasingly based on National Accounts statistics.
3.2
To adequately describe the behaviour of the participants in the economy it is necessary
to classify the participants into sectors, and subsequently sub-sectors, based on the
similarities in their economic behaviour. This sectorisation involves, amongst other
criteria, distinguishing whether units are public or private sector and whether they
operate as market or non-market producers.
3.3
In its fiscal policy framework (see HM Treasury’s June 1998 Economic and Fiscal
Strategy Report), the United Kingdom Government uses key statistical indicators for
the public sector. The public sector comprises the general government sector and
public corporations, as illustrated in Figure 1 below.
Figure 1
Public
Sectors
Sub-sectors
1
Public Corporations
QuasiCorporations
Preface to SNA93
2
General Government
Central
Government
Local
Government
3.4
The European Union’s fiscal policy framework similarly uses key National Accounts
based statistical indicators, this time using the general government sector. The 1992
Maastricht Treaty on European Union and the 1997 Stability and Growth Pact oblige
member states to avoid excessive budgetary deficits. The Excessive Deficit Procedure
defines reference values for General Government Deficit and Debt as ratios of Gross
Domestic Product. ONS produces the statistical estimates of these measures for the
European Commission
4.
The process of sectorisation
4.1
In practice the classification of economic units into these institutional sectors can be
difficult. Some will fall clearly into one category, whereas others will exhibit
behaviour common to more than one sector. It could be imagined that units are
distributed, according to their behaviour, along a continuous linear scale with one
sector at one end and another at the other end2. The process of classification attempts
to draw a discrete boundary line on this continuous scale. This continuum, however,
can be problematic as the classification of units close to the boundary often relies on
judgement. The guidance in international manuals designed to assist such judgements
can be insufficient, and even contradictory, and will thus require careful interpretation.
The guidance is also evolving over time.
4.2
The classification process is particularly sensitive given the interaction between
National Accounts and economic policy making. A case in point in the UK is that of
Network Rail, where a policy requirement in creating this unit was that it must be in
the private sector, and thus the legal constitution of the unit reflected the National
Accounts criteria for private sector classification. Other pressures, however, led to
transport agencies wanting as much influence as possible over the unit's activities,
leading to a unit that is close to the boundary between public and private sectors3.
4.3
So, the main classification issues for the National Accounts statistician are concerned
with units close to the boundary between sectors. However, before investigating these
boundaries, it is worthwhile to first define an institutional unit.
5.
Institutional units
5.1
Firstly, it should be noted that there can be a difference between the legal status of a
unit and its economic status. For example, take a charity shop selling goods in the
High Street. Its legal status is that of a charity but its economic behaviour is like the
neighbouring shops which sell a similar range of goods. The economic view taken in
National Accounts is that it behaves like other shops in the corporate sector and so
should be classified in the same way.
2
In practice this is an over-simplification as we are dealing with a multi-dimensional situation rather than a
linear scale
3
Documentation detailing the classification of Network Rail is available at www.statistics.gov.uk/nrail .
3
5.2
Paragraphs 2.12 and 2.13 of ESA95 define institutional units as:
2.12. Definition:
The institutional unit is an elementary economic decision-making centre characterised
by uniformity of behaviour and decision-making autonomy in the exercise of its
principal function. A resident unit is regarded as constituting an institutional unit if it
has decision-making autonomy in respect of its principal function and either keeps a
complete set of accounts or it would be possible and meaningful, from both an economic
and legal viewpoint, to compile a complete set of accounts if they were required.
In order to be said to have autonomy of decision in respect of its principal function, a
unit must:
a) be entitled to own goods or assets in its own right; it will therefore be able to
exchange the ownership of goods or assets in transactions with other
institutional units;
b) be able to take economic decisions and engage in economic activities for which
it is itself held to be directly responsible and accountable at law;
c) be able to incur liabilities on its own behalf, to take on other obligations or
further commitments and to enter into contracts.
In order to be said to keep a complete set of accounts, a unit must keep accounting
records covering all its economic and financial transactions carried out during the
accounting period, as well as a balance sheet of assets and liabilities.
2.13. The following principles apply whenever entities do not clearly possess both the
characteristics of an institutional unit:
a) households always enjoy autonomy of decision in respect of their principal
function and must therefore be institutional units, even though they do not keep
a complete set of accounts;
b) entities which do not keep a complete set of accounts, and for which it would
not be possible or meaningful to compile a complete set of accounts if required,
are combined with the institutional units into whose accounts their partial
accounts are integrated;
c) entities which, while keeping a complete set of accounts, have no autonomy of
decision in the exercise of their principal function are combined with the units
which control them;
d) entities which satisfy the definition of an institutional unit are treated as such
even if they do not publish their accounts;
e) entities forming part of a group of units engaged in production and keeping a
complete set of accounts are deemed to be institutional units even if they have
partially surrendered their autonomy of decision to the central body (the
holding corporation) responsible for the general direction of the group; the
holding corporation itself is deemed to be an institutional unit distinct from the
units which it controls, unless b) is applicable;
4
f)
quasi-corporations keep a complete set of accounts and have no independent
legal status. However, they have an economic and financial behaviour that is
different from that of their owners and similar to that of corporations. Therefore
they are deemed to have autonomy of decision and are considered as distinct
institutional units.
5.3
ESA95 paragraph 2.12 thus introduces the importance of: i) uniformity of behaviour,
and ii) the ability to compile a complete set of accounts. These concepts are at the
heart of ONS's judgements when identifying public sector quasi-corporations.
6.
Quasi-corporations
6.1
ESA95 paragraph 2.13f introduces the concept of a quasi-corporation. These “notional
units” are identified in the National Accounts because their economic behaviour is
different to that of the rest of the legal entity. The notional unit is separated out and
classified in its own right alongside other units that exhibit similar behaviour. The key
criteria for creating a quasi-corporate unit are that:
(i)
it has no independent legal status4;
(ii)
it keeps a complete set of accounts5;
(iii) its economic and financial behaviour is different from that of its owners;
(iv) its economic behaviour is similar to that of corporations.
6.2
The above criteria lead to the conclusion in ESA956 that "therefore they are deemed to
have autonomy of decision and are considered as distinct institutional units."
7.
Private sector quasi-corporations
7.1
In the private sector there are units that fall near the boundary between the household
and corporate sectors and are subsequently classified as quasi-corporations. These are
legally unincorporated businesses that act more like large corporations than small
businesses. The key distinction is whether economic decisions are taken with regard
to the business or the household. The previous version of the European System of
Accounts, ESA79, had a criterion of 100 or more employees for identifying a quasicorporation, but this was removed in the 1995 version.
7.2
Paragraphs 14 and 15 of ONS’s Non-financial Corporations Sector Report 1998 Q2,
reproduced below, sets out the ONS's practical approach to classification in this area.
There are two types of unincorporated businesses in the United Kingdom:
partnerships and sole traders. It is practically very difficult to distinguish whether a
4
As explained in paragraph 5.1 economic status is more important than legal status for National Accounts.
Presumably for consistency with earlier paragraphs this should be expanded to cover the situation where
accounts could be compiled.
6
Paragraph 2.13f
5
5
business is acting independently from its owners. For example, it could be assumed
that a one-man window cleaner business would make business decisions based on the
wealth of his household. This will probably be true of most sole traders, although not
all. Similarly, most partnerships will probably be sufficient large to act independently
of their owners, although once again there will be exceptions such as husband-andwife partnerships.
For practical reasons the ONS has chosen to sectorise all partnerships as quasicorporations and all sole traders as part of the household sector. It is recognised that
there will be misallocation in both but at least part of this will cancel out. There are
practical reasons for assuming partnerships as a proxy for quasi-corporations. The
main sources of data, such as The Inland Revenue7, Bank of England, Customs &
Excise7, the Inter-Departmental Business Register, can separately identify
partnerships. The result of this assumption is that accountancy firms and dental
surgeries etc. become part of the private non-financial corporations sector (they were
previously in the former personal sector) but window cleaners, painters and
decorators etc. remain part of the household sector.
7.3
Private sector quasi-corporations are also identified when an enterprise resident in the
rest of the world maintains a branch, office or production site in the UK in order to
engage in production over a long period of time, but without creating a subsidiary
company. Examples of these quasi-corporations can be seen in the financial
corporations sector where foreign banks maintain a UK branch office, and also in the
construction industry when a foreign company is involved in a long-term construction
project.
8.
Public sector quasi-corporations
8.1
Paragraph 2.68 of ESA95 defines the general government sector as being made up of
"units which are other non-market producers...". Other non-market producers are
defined in ESA95 paragraph 3.26 as "units whose major part of output is provided free
or at not economically significant prices." Economically significant prices are defined
by the 'market versus non-market test' (referred to hereafter as the market test), where a
criterion threshold of half of production costs being met by sales is used to separate
entities into market or non-market producers.
8.2
Although general government is made up of public sector units that behave in a nonmarket fashion, it can be observed that governments are increasingly behaving in a
more "business-like" manner, for example, by trying to extract value from their assets
such as charging for roads, and thus the boundary between government and
corporations becomes more blurred.
8.3
Where governments engage in market activity the international manuals give three
options for recording this activity: i) as legally constituted public corporations, ii) as
quasi-corporations, or iii) within the general government sector. The first two result in
classification to the corporate sector, the latter does not. Classification of legally
constituted public corporations is straightforward, although checks are carried out to
ensure that the market test is passed, and hence confirming the economic reality
7
Now HM Revenue & Customs
6
irrespective of the legal form. The final option, of recording the market activity within
the non-market general government sector is at odds with the general approach to the
classification of similar units within an economy.
8.4
As a result it is necessary to identify these public sector quasi-corporations. The
following are judged to qualify as public quasi-corporations in the UK:
(i)
local government housing;
(ii)
local government trading services;
(iii) road charging / parking fees8.
8.5
In the case of local government housing, market rentals are charged and the activity
is similar to that of corporations. Each local authority ring-fences its housing activity
and compiles a 'Housing Revenue Account', which details the relevant income and
expenditure. The information allows the market test to be carried out. This has
traditionally yielded results that show all production costs being covered by rental
receipts. Here it is relevant that central government provides social benefits, known as
rent rebates, to support those needing social assistance. In the National Accounts these
payments are recorded as social benefits to households, which are then used to pay
rentals to the local government housing units. If these rebates were excluded from the
market test then the unit would move from market to non-market. However, in
defining the market test ESA95 paragraph 3.33a includes such payments by
government as sales if they are available to any producer involved in this activity.
Similar payments are made to private sector registered social landlords. As a result
local government housing is a market activity.
8.6
Although these housing units do not have independent legal status, in the last few
years some have converted to become 'Arms Length Management Organisations'
(ALMOs). Although effectively unchanged in economic substance, the ALMOs have
independent legal status and are thus automatically classified as public corporations.
The remaining local government housing units are classified as quasi-corporations.
8.7
Local government trading services and road charging represent trading arms of
local authorities that charge market prices. An assessment is made of these activities,
for each type of activity, en bloc against the market test. This yields some surprising
results, for example sports centres. Here, the consumer will consider they are paying
market prices, but the test is failed as less than half of the production costs are covered
by the sales. This results in a classification as local government. Similar to the
situation with ALMOs, the trend in recent years has been the conversion of these units
into corporations with independent legal status. However, the creation of new legal
entities has no impact on the National Accounts because the economic activity is
already recorded in the public corporation sub-sector. The new entities are just a
change to legal form, not a change to economic substance.
8.8
Denmark’s statistical office undertakes a similar process to ONS by making an
assessment by type of trading activity.
8
These will be explained in more detail in a forthcoming article
7
8.9
In the UK there are also examples of small scale market activity carried out by
government within non-market entities. For example ONS sells publications at prices
the consumer would recognise as economically significant. As these are minor
receipts, there is no reclassification to quasi-corporate receipts on practical grounds.
However, as explained below the decision not to reclassify does not lead to any
misreporting when considering key fiscal measures such as General Government Net
Borrowing.
9.
The distribution of quasi-corporation surpluses
9.1
The economic reality is that any surpluses earnt by these quasi-corporate units are
effectively redistributed to their parents. The D.422 'withdrawals from the income of
quasi-corporations' transaction row is used to redistribute this surplus. ESA95
paragraphs 4.46 and 4.58, reproduced below, defines these withdrawals as follows:
4.56 . Definition:
Withdrawals from the income of quasi-corporations (D.422) consist of the amounts
which entrepreneurs actually withdraw for their own use from the profits earned by
the quasi-corporations which belong to them.
4.58 . When a quasi-corporation makes a trading profit, the unit which owns it may
choose to leave part or all of the profit in the business, especially for investment
purposes. This income left in the business appears as saving by the quasi-corporation,
and only the profits actually withdrawn by the owner units are recorded in the
accounts under the heading withdrawals from the income of quasi-corporations.
9.2
Generally, this leads to the situation where General Government Net Borrowing, the
balance between expenditure and income, is unaffected by the classification of the
units, e.g. whether they are classified outside the general government boundary as
quasi-corporations or within the general government sector boundary. This is because
the net income of the unit ends up in the general government sector regardless.
9.3
However, when considering the withdrawal of income from quasi-corporations it is
also important to note which transactions are excluded. For example, income from
local government housing sales are not considered as part of the surplus. ESA95
paragraph 4.61, reproduced below, explains the basis for this difference.
The heading withdrawals from the income of quasi-corporations does not include
amounts which their owners receive:
a) from the sale of existing fixed capital goods;
b) from the sale of land and intangible assets;
c) from withdrawals of capital (e.g. the total or partial liquidation of their
equity in the quasi-corporation).
These amounts are treated as withdrawals from equity in the financial account.
Conversely, any funds provided by the owner(s) of a quasi-corporation for the
purpose of acquiring assets or reducing its liabilities is treated as additions to its
equity. However, if the quasi-corporation is owned by government, and if it runs a
8
persistent operating deficit as a matter of deliberate government economic and social
policy, any regular transfers of funds into the enterprise made by government to cover
its losses should be treated as subsidies.
9.4
As mentioned above this is relevant for local government housing, where the housing
stock is sold either to individuals under the ‘right to buy’ scheme, or to registered
social landlords under the ‘large scale voluntary transfer’ scheme. These amounts are
classified as withdrawal from equity (F.513) in the financial account. Although
variable from year to year, these sales have been of the magnitude of £3bn a year in
recent years.
9.5
The rationale for the treatment of asset sales is that the owner’s equity value in the
quasi-corporation is equivalent to the net worth of the quasi-corporation, for example
the net worth is the best estimate of the amount the owner would receive if they sold it.
For local government housing this is equivalent to the value of the housing stock. Any
sales are recorded as non-financial transactions (P.51 capital formation) between the
quasi-corporation and the buyer, and financial transactions in (i) equity between the
quasi-corporation (reduction in its liabilities) and local government (reduction in its
assets) and (ii) cash between the buyer (decreases) and local government (increases).
Table A below, showing net receipts in the non-financial account and net asset
transactions in the financial account, shows how this balances for a sale worth £x. LG
denotes local government, and QC the local government housing quasi-corporation.
Table A
9.6
Sector
LG
QC
Buyer
Non-financial account
Capital formation (P.51)
Non-financial net lending
0
0
x
x
-x
-x
Financial account
Cash (F.2)
Equity (F.513)
Financial net lending
x
-x
0
0
x
x
-x
0
-x
Net lending balance
0
0
0
Table B shows the same transactions for the case where a quasi-corporation is not
recognised and instead the activity is consolidated into the local government subsector.
9
Table B
Sector
LG
Buyer
Non-financial account
Capital formation (P.51)
Non-financial net lending
x
x
-x
-x
Financial account
Cash (F.2)
Financial net lending
x
x
-x
-x
Net lending balance
0
0
9.7
General Government Net Borrowing (GGNB) is measured from the non-financial
account. Net borrowing is equivalent to minus ‘net lending’. The only part of General
Government included in these example tables is local government. Hence in table A
GGNB is zero; in table B it is -x.
9.8
So, this treatment for the recording of asset sales leads to a difference in recording for
General Government Net Borrowing depending on whether the units are classified
within or outside the General Government boundary. If classified as General
Government the net borrowing position would be reduced by the asset sale, if
classified outside the General Government Net Borrowing position is unchanged.
9.9
However, this treatment of asset sales is consistent with similar transactions involving
general government and public corporations. When a public corporation makes a oneoff disposal of an asset and redistributes the proceeds to its parent organisation in
general government, this is also classified as withdrawal from equity rather than a
dividend payment.
9.10
At various times the calculation of the local government housing transaction
‘withdrawal from income of quasi-corporations’ has produced negative amounts. As it
is not possible for a ‘negative dividend’ to be distributed to shareholders, this negative
amount is instead recorded as a transaction flowing from local government to the
quasi-corporation.
9.11
ESA95 paragraph 4.165b, reproduced below, suggests this transaction should be
recorded as a capital transfer.
Other capital transfers include the following transactions:
b) transfers from general government to non-financial corporate and quasi-corporate
enterprises to cover losses accumulated over several financial years or exceptional
losses from causes beyond the control of the enterprise;
9.12
From 2004/5 the amounts for ‘withdrawal from income’ have been consistently
negative. This is because the level of capital expenditure has exceeded the gross
10
operating surplus. However, ESA95 paragraph 4.61 reproduced earlier suggests, that
where the transfer of funds to cover losses is made an a regular basis the imputed flow
should be recorded as a D.39 subsidy on production rather than a capital transfer. This
subsidy increases the gross operating surplus of the quasi-corporation and thus
removes the negative amounts from the ‘withdrawal of income from quasicorporations’.
9.13
In the financial balance sheets9 the only ‘other equity’ (F.513) recorded for public
sector quasi-corporations at present reflects the net worth of local government housing.
10.
Context
10.1
For the UK's fiscal policy rules, which are set on National Accounts principles, the
sectoral boundary used is the public sector, so the classification boundary between
general government and public corporations is irrelevant since any non-financial
transactions between different parts of the public sector will net out (e.g. one party’s
receipt is another’s expenditure within the public sector). However, for the EU
Excessive Deficit Procedure rules the sectoral boundary is drawn at the general
government level so the distinction is important. However, the redistribution process
mentioned in the previous section generally leads to the same results for government
deficit, the exception being for the income from asset sales.
10.2
Theoretically, debt raised by general government parent organisations could be
reallocated as the debt of the quasi-corporation, leading to an effect on Government
debt levels as measured under the Excessive Deficit Procedure. As a result, the UK
practice is not to reallocate the debt in this way. Therefore the UK practice leads to
identical government debt results as if the units were classified in the general
government sector.
11.
Quasi-corporations of the European Union
11.1
A recent judgement by Eurostat is that agricultural intervention stocks should be
classified as quasi-corporations of the EU rather than as inventories of national
governments.
9
These appear in the Public Sector Finances version of the financial balance sheets. It was decided not to include
these amounts in the 2007 National Accounts annual Blue Book publication.
11