Using deficit financial statements

Luke Oliver considers deficit financial statements and their appropriate use in debt advice

This article was originally published in the March/April 2017 issue of Adviser magazine and was correct at the date of publishing.

Background

Should advisers use deficit financial statements? This is an ongoing question amongst debt advisers which continues to provoke strong opinion and lively debate. Many advisers argue that deficit or negative statements are misleading as they do not reflect the client’s actual expenditure, unless they are incurring more debt or are supported by family and friends. Other issues are: a deficit statement cannot be used to persuade a creditor or a court that a payment offer is sustainable and that its use as a budgeting tool is also limited to demonstrating that a client is not living within, or cannot reasonably live within, their means. These debates are not new to the debt advice sector and have been explored in journals before.(1)

However, in the current climate of welfare cuts, stagnating wages, rising living costs and bleak economic forecasts, many people do not have enough money to cover a basic standard of living, let alone pay their debts. In November 2016 the Joseph Rowntree Foundation published an updated report - a Minimum Income Standard for 2016. This ‘minimum income standard’ is based on what members of the public think is needed for an acceptable standard of living. It concluded that a single person without children is required to earn at least £17,100 per annum to meet the minimum income standard. A person relying on safety net benefits only meets 39% of this need.(2)

The future impact of Brexit is also set to put increasing pressure on indebted families’ ability to budget. The National Institute of Economic and Social Research think tank predicted in November 2016 that ‘The economy will grow 2 per cent in 2016 before slowing to 1.4 per cent in 2017; with the triggering of Article 50 there are downside risks to next year’s outlook’ and that ‘Consumer price inflation will accelerate, peaking at around 4 per cent in the second half of 2017, and this will impact on real disposable income’.(3)

In addition, 2017 will see the continuation of benefit cuts such as the reduction in the benefits cap introduced in November 2016,(4) restrictions on Tax Credit and Universal Credit entitlement beyond the first two children for children born after April 2017(5) and rises in council tax.(6) To further underline the severity of hardship facing many families, in November 2016 the Trussell Trust confirmed it had distributed 500,000 food bank parcels within a six-month period in 2016 and expected to distribute the highest number of food parcels in its 12-year history during 2016/17.(7)

For many debt clients, particularly those in low-paid work and receiving benefits, the reality is that there is often a significant gap between their income and the essential expenditure required for an acceptable standard of living. At a time when the debt advice sector is eagerly anticipating the launch of the Standard Financial Statement (SFS) on 1 March 2017,(8) it seems a good time to revisit the issue and to discuss how deficit financial statements can be used in an appropriate fashion to help clients facing such hardship.

The regulatory framework and best practice

The regulatory rules for the preparation of financial statements are contained in chapter 8.5 of the Financial Conduct Authority Consumer Credit Sourcebook (CONC). CONC 8.5.1 R states ‘firms must ensure that a financial statement sent to a lender on behalf of a customer is accurate and realistic and must present a sufficiently clear and complete account of the customer’s income and expenditure, debts and the availability of surplus income…’(9)

Some might argue that deficit statements do not meet the requirements of CONC because the expenditure is incorrect and therefore not accurate or realistic (assuming the client is not borrowing more to fund the deficit or not actually making essential payments and therefore accruing further arrears). However, it could also be argued that a financial statement is only realistic when it demonstrates sustainable levels of essential expenditure that genuinely meet the needs of the client and their family.

The Money Advice Service makes no direct reference to the use of deficit statements either in its case review criteria in Section 6, Appendix A of the peer review scheme, or Activity 2.11 within Section 3.5 of the Debt Advice Quality Framework, both of which deal with preparing financial statements.(10) However, a peer review scheme source has confirmed that ‘where a client presents with a deficit budget, the scheme expects to see evidence that the reason(s) for this have been explored (e.g. undeclared income, over-estimated expenditure, use of standard expenditure figures which do not reflect the client’s actual expenditure) and/or how the deficit is funded (e.g. use of credit, priority expenditure in arrears) and/or that the deficit has been addressed (as far as possible) (e.g. by maximising the client’s income).’

The scheme also expects that the use of a deficit statement should trigger appropriate signposting for financial capability support, and where a deficit statement is presented to a third party, an explanation should be provided to them or at least noted in the case record. Where a deficit statement is used to make an offer of payment, the scheme expects the statement to be clear on how such an offer will be funded. Otherwise, such an offer would appear to be unsustainable and likely to fail, leading to possible client detriment. Such an offer would not be in the client’s best interests and therefore inconsistent with CONC 8.5.3.

The Child Poverty Action Group Debt Advice Handbook 11th Edition at page 51(11) acknowledges that a deficit statement may occur because it includes amounts that should be spent if the client is able to do so. The handbook also makes clear that the reason for such a deficit should be explained to creditors if required.

The approaches outlined above are consistent with CONC 8.5.2 G, which provides further guidance on interpreting 8.5.1 by confirming that financial statements ‘should be uniform and logically structured in a way that encourages consistent responses from lenders and reduces queries and delays’. The key issue when sending deficit financial statements to creditors is to include an explanation (either in the form of a covering letter or in the notes/comments box on the form) as to why the statement is in deficit and what appropriate action has been taken to remedy the situation. This would be consistent with CONC 8.5.4 (2), which requires advisers to ‘seek explanations if a customer indicates expenditure which is particularly high or low’.

Where this best practice has been followed through the course of preparing income and expenditure details with a client and the subsequent result is a deficit statement, then it is appropriate to consider how this information can be used to address the client’s hardship rather than strive to balance the budget by making unsustainable reductions in the client’s essential expenditure.

CONC 8.3.2 (1)(a) requires that ‘all advice given and action taken by the firm or its agent or its appointed representative has regard to the best interests of the customer’. Where attempts are made to balance a personal budget and financial statement by reducing essential expenditure to levels below the amounts generally considered reasonable, advisers should think carefully if such action is in the best interests of their client. This is particularly relevant if such an approach potentially eliminates possible options for alleviating hardship, such as the examples discussed below.

When is a deficit financial statement necessary?

One example where the use of deficit financial statements would be appropriate is for applications for discretionary reduction of council tax liability under S 13A(1)(c) of the Local Government Finance Act 1992.(12) In the Valuation Tribunal England Presidential Decision SW & CW v East Riding of Yorkshire Council(13) such an application was refused by the local authority and appealed to the Valuation Tribunal England. The Tribunal commented at paragraph 54: ‘The simple fact is that there is no surplus income to meet this bill. The respondent (the local authority) accepts that. It is difficult to imagine a clearer case for discretionary assistance …’ and ‘only full remission of the residual council tax for the year makes any sense in view of the absence of any funds to meet their liability.’

In the same appeal another application for discretionary reduction was refused. In that case the taxpayer had a very small amount of available income according to their financial statement, despite the Tribunal acknowledging they were in hard-pressed financial circumstances.

Many Debt Relief Order (DRO) Authorised Intermediaries and advisers will have advised debt clients who are desperately in need of debt relief but whose current income situation may change in the medium term due to a pending benefits claim or appeal. Often such clients will be in severe hardship, struggling to pay rent, heat their homes and buy food, and are relying on food banks.

The Insolvency Service DRO Team have confirmed that it is acceptable to submit deficit income and expenditure details in a DRO application where the debtor has reasonable expenditure needs which are unmet by their current income but where they expect their future income to meet this expenditure when an anticipated change occurs.

The reason for this unmet need might be a pending benefit claim or appeal due to be resolved during the DRO moratorium, or there may be a current attachment of earnings order or deduction from benefit in force which will cease when the DRO is made.

Income and expenditure should be prepared in line with the common financial statement (or from 1 March 2017 the SFS) principles and trigger figures. An explanation of why deficit income and expenditure figures have been used should be provided to the DRO Team either within the DRO application or in a separate email at the time of submission. Following the approval of the DRO, and when the debtor has received the increase in income, they will need to notify the DRO Team and submit a revised financial statement which reflects the reasonably anticipated household expenditure in the DRO application. This approach has been suggested as an appropriate solution to this problem by Citizens Advice Specialist Support (now the Expert Advice Team).(14)

This position is supported by Rule 5A.3(2)(j) of the Insolvency Rules 1986 (Information to be contained within the DRO application), which provides that the application must state the ‘particulars of the expenditure which the debtor claims is necessary to meet the monthly reasonable domestic needs of the debtor and the debtor’s family, including the object and the amount of that expenditure (see Rule 5A.8(2))’.(15) The regulations do not specify that these particulars of expenditure must be an amount which is covered by the client’s current income.

In fact, it seems that in cases such as these, failing to use a deficit financial statement could have dire consequences for the client. In the judicial review case Howard, R (on the application of) v The Official Receiver [2013] EWHC 1839(16) a debtor challenged the Official Receiver’s (OR’s) decision to revoke her DRO, which was made on the basis that she had received backdated lump sums of Working Tax Credit and Employment and Support Allowance (ESA) and an ongoing award of ESA during the moratorium period.

At that time (August 2011), the OR treated such lump sums of benefit as income (see paragraph 10 of the judgement) and apportioned them as weekly income over the period of entitlement to which they related. Therefore, based on the income and expenditure details submitted in the DRO application, this income increase took the claimant over the £50 per month surplus income parameter. In that case the claimant’s income and expenditure at the date of DRO application had shown a surplus income figure of nil rather than a deficit figure. The OR was not sympathetic to the claimant’s arguments that at the time of the DRO application the client’s required expenditure had been scaled down to prevent an ‘overspend’ resulting in a deficit financial statement, and that had she been getting these benefits at the time of the DRO application, her expenditure would have increased to a more reasonable and acceptable level (see paragraphs 20 and 50 of the judgment).

In the event, the judicial review application was dismissed on other grounds - contrary to the claimant’s arguments, the judge held that a public sector equality duty under s 149 Equality Act 2010(17) did not apply to the OR because she was exercising a ‘judicial’ rather than a ‘public’ function within the meaning of that Act in revoking the DRO. Therefore the OR was not obliged to give consideration as to whether she had made reasonable adjustments for the client’s disability, nor was she obliged to take steps to ensure that she did not treat the claimant less favourably because of something arising in consequence of her disability.

In light of its decision on this principal issue, the court deemed it unnecessary to consider the arguments regarding the claimant’s surplus income in relation to the DRO application in any detail. However, at paragraph 215 the court expressed scepticism that these arguments would succeed in light of the OR’s evidence. Had the claimant submitted deficit income and expenditure details at the time of the DRO application, it seems likely the OR would not have revoked the DRO.

Another appropriate use of deficit financial statements is in support of requests that creditors ‘write off’ outstanding balances. The Lending Code at paragraph 213 provides: ‘Token offers should be accepted where the customer has demonstrated they have no surplus income available for their “non-priority” creditors.’(18)

In reality, to have any funds to actually make token offers a debtor will need some surplus to cover those token payments. Many advisers will be familiar with the experience of requesting write-offs from creditors with a supporting ‘balanced’ financial statement showing nil surplus income, only to have creditors respond by questioning whether expenditure can be trimmed down slightly to free up money to make token offers, despite such requests being contrary to the Code (see paragraph 223).

The Code goes on to state at paragraph 224 that ‘where the subscriber considers the customer’s personal and financial circumstances to be exceptional and unlikely to improve, the subscriber may … consider writing off or not pursuing part or all of the customer’s debt(s).’ The financial hardship experienced by many debt clients is exceptional to what would be considered by most to be a reasonable standard of living. A deficit financial statement which clearly demonstrates the extent of this hardship, coupled with evidence that the circumstances are unlikely to improve, is arguably more likely to persuade a creditor to write off a debt than one which suggests the customer could just about afford token offers.

It is also the author’s experience that some local authorities will only consider applications to reduce the recovery of Housing Benefit overpayments on the basis of hardship if the applicant’s income and expenditure figures show a deficit with the current rate of recovery applied. Such councils would take a similar approach when assessing applications for Discretionary Housing Payments.

Another example where a deficit financial statement is useful to clearly demonstrate hardship is for applications to charitable funds. Some of the larger of these charities receive thousands of applications each year and are limited in the number of people they can help. A deficit financial statement summarises the extent of the applicant’s hardship and communicates this succinctly.

Conclusion

It is likely that the subject of deficit financial statements and the debate about if and how they should be used will continue. The Money Advice Trust is running a new course on the subject which will no doubt provide invaluable guidance on navigating this difficult issue.(19)

It is the author’s view that if used properly, with transparency and within a holistic debt advice process (which includes income maximisation, exploration of the causes of the deficit, referrals for financial capability and budgeting advice where appropriate), deficit financial statements are a vital tool for the debt adviser to demonstrate hardship.

An innovative feature of the forthcoming SFS is that it has a new savings category. This is to be lauded as a positive and progressive step which will help many debts clients along the way to building some financial resilience. However, for many others suffering hardship this new category will not be used and instead their SFS will continue to show a deficit.

Luke Oliver is a debt expert in the Expert Advice Team at Citizens Advice.

Endnotes

1. See the Quarterly Quarrel, ‘Deficit Financial Statements - Do they make sense?’ in issue 14 of the IMA’s Quarterly Account, Autumn 2009
2. https://www.jrf.org.uk/report/minimum-income-standard-uk-2016
3. http://journals.sagepub.com/doi/full/10.1177/002795011623800102
4. http://www.bbc.co.uk/news/business-37873922
5. http://www.bbc.co.uk/news/business-33429390
6. https://www.theguardian.com/money/2016/dec/15/council-tax-bills-can-rise-by-3-for-two-years-to-help-fund-social-care-says-javid
7. https://www.trusselltrust.org/2016/11/08/half-million-emergency-food-parcels-distributed-trussell-trust-foodbanks-six-months/
8. https://www.moneyadviceservice.org.uk/en/corporate/press-release-standard-financial-statement
9. https://www.handbook.fca.org.uk/handbook/CONC/8/5.html
10. https://www.moneyadviceservice.org.uk/en/corporate/raising-standards
11. The Child Poverty Action Group Debt Advice Handbook (11th Edition)
12. http://www.legislation.gov.uk/ukpga/1992/14/section/13A
13. https://www.valuationtribunal.gov.uk/wp-content/uploads/2016/02/Judgment_-_SC_and_CW_v._East_Riding_of_Yorkshire_Council_-_discretionary_appeals_final_for_publishing_purposes-2.pdf
14. See the ‘Q & A with Specialist Support’, p22-p23, issue 17 of the IMA’s Quarterly Account (Summer 2010)
15. http://www.i-m-a.org.uk/wp-content/uploads/2013/03/Part-5a-Insolvency-Rules-1986.pdf
16. http://www.bailii.org/ew/cases/EWHC/Admin/2013/1839.html
17. http://www.legislation.gov.uk/ukpga/2010/15/part/11/chapter/1
18. https://www.lendingstandardsboard.org.uk/wp-content/uploads/2016/06/The-Lending-Code-Mar-2011-revised-2015-1.pdf
19. http://www.moneyadvicetrustblog.org/2017/01/30/helping-advisers-to-support-clients-with-deficit-budgets/