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Review Board For Government Contracts

Volume 78: debated on Tuesday 30 April 1985

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asked the Chancellor of the Exchequer if he will make a statement on the outcome of the report on the first annual review by the Review Board for Government Contracts.

The review board in its report on the fourth general review proposed that the triennial reviews of the target profit rate should be supplemented by limited annual reviews so that changes in the rate of return elsewhere in the economy and in other economic circumstances can be reflected more quickly in the profit rate. The review board submitted the first of these interim reviews to the Treasury in the middle of March. The two principal matters dealt with in the report are the target rate of profit for Government non-competitive contracts, and a study of the capital employed in these contracts.The review board recommended the target rate of profit be increased from the present 11 per cent. to 13 per cent. on capital employed in semi-CCA terms, with an assumed average CP/CE ratio of 2·35 to 1.On the question of capital employed, the board found that although there was not sufficient data to support the view that Government profit formula work generally required less capital than the contractors' other work, there were some significant divergencies in individual cases arising almost entirely from a small number of large and exceptional projects, both defence and non-defence. The board recommended that these divergencies should be addressed by negotiating more relevant units for the calculation of CP/CE ratios rather than by adjusting the target rate of return in the profit formula. Meanwhile, a transitional adjustment should be made to the average CP/CE ratio to avoid distortion by the exceptional projects referred to. Hence the observed ratio of 2·24 to 1 should be increased to 2·35 to 1.After careful consideration, and consultation with the negotiating committee of the CBI representing contractors, the Government accept in principle the board's main recommendation as to the treatment of the divergencies in capital employed and are examining with the contractors the practicalities. Meanwhile, however, it is essential that the overstatements of capital employed identified by the board should be fully reflected in the profit formula. This can only be done at present by a full adjustment of the target rate of profit affecting both the cost-based element and the capital-based element. Accordingly, the Government have decided to set the target rate of profit at 12 per cent. on capital employed on a semi-CCA basis, accompanied by the observed average of CP/CE ratio of 2·24 to 1. These new arrangements will be implemented with effect from 1 May 1985.Copies of the review board report have been placed in the Library.