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18 March 2015

A taxing question of property: what’s really going on with business rates?

To critics business rates are complex, unfair and produce perverse incentives - to others they offer the guarantee of stable and fixed costs. If reform is coming, what should it look like? The New Statesman brought some leading voices together to find out.

By New Statesman

In the run up to last December’s Autumn Statement, 14 major industrial companies wrote to the Chancellor George Osborne urging him to overhaul business rates. In the letter seen by The Sunday Times, organisations including Tata Steel, Siemens and General Motors (the sponsor of this supplement) declared the tax levied on non-domestic properties was “simply not fit for purpose”. In doing so these multinationals joined high street retailers and small businesses in a rejection of business rates by business.

In the event, Osborne didn’t deliver, certainly not in the immediate term. Instead he capped the rates increases at 2 per cent for a second year running and announced a review into the “structure of business rates” that is due to report ahead of the 2016 Budget. And, as all the players are aware, there’s a general election between now and the 2016 Budget.

Speaking at the second of two New Statesman-convened roundtable discussions – entitled Fixing the costs: Making the UK attractive to manufacturers – Osborne’s colleague David Gauke, the financial secretary to the Treasury, said a review was the right approach. “These things are better done when you’ve got a little bit of time to look at it,” Gauke told fellow panelists.

He also cautioned that any reform would have to be fiscally neutral, meaning that the £27-28bn business rates generated (before exemptions and reliefs) would remain the target. In turn that means there would continue to be losers as well as winners. “Unless you are willing to forgo revenue, reaching a consensus of what is the right way forward is going to require a lot of hard work, a lot of thinking, building up a degree of momentum and consensus building.”

So what should the review try to fix? To judge by feedback at both round table events, the answer is quite a lot. The charge sheet against the business rate is lengthy: it’s too complex; it’s too expensive; it acts as a tax on enterprise; it doesn’t reflect the ability to pay; revaluations are too infrequent; subsequent implementation takes too long; and it unaccountably uses the higher of the two measures of inflation. All these were common complaints.

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In addition, there are two characteristics of the tax that large manufacturers want to address: the way rentable value of industrial property is measured and the additional costs associated with implementing changes to an existing site.

If that’s the argument for reform,  doesn’t it smack, at least in part, as special pleading? The government would argue that the UK remains an attractive place to do business. It is the sixth largest trading nation in the world, boasts a transparent and robust tax system, excellent infrastructure (over 70 airports and 40 major ports) and from this year it will have the joint lowest corporation tax rate, at 20 per cent, among G20 countries. 

To that end a KPMG’s 2012 Competitive Alternatives Study declared that the UK was the lowest-cost destination among established markets in which to do business. Or to quote a comment that appeared below that Sunday Times piece on the pre-Autumn Statement letter: “Big companies want to pay less tax, nothing new here. Let’s move on folks.”

The first six participants in the roundtable.

So how does Tim Tozer, chairman and managing director of Vauxhall Motors, respond to the charge of special pleading? Shouldn’t firms like his look at the whole picture and accept the rough (business rates) that comes with the smooth (the rest)? “We absolutely do,” said Tozer, “and that’s why we are being quite measured in saying we don’t expect anything immediately. What we are saying is that there are some rigidities and some anachronisms in a system that has, frankly, seen its day.”

Tozer’s colleague Helen Foord, the company’s government relations manager, added: “This is about us being more competitive against other businesses out of the UK. For us, it’s about ensuring we can be here in the future. We are happy to pay taxes as long as they are fair and balanced.” She added: “One size does not fit all when it comes to business rates and that’s what the government needs to take away. Where there is rentable evidence, use it; where there isn’t use capital value.”

Currently, 60 per cent of all of General Motors’ property-based taxes across Europe are paid in the UK even though the company’s Luton and Ellesmere Port plants represent just 8 per cent of its European manufacturing footprint. General Motors is Vauxhall’s parent company.

“To have a hypothetical rental value as the main driver seems frankly ridiculous,” Tozer argued. He offered an example of another anomaly. Capital investment in equipment – plant and machinery to use the language of the valuation office – pushes up rates. General Motors planned to install solar photovoltaic panels at its Ellesmere Port plant  a decade ago, in order to reduce its environmental impact and save money. In the event, the company abandoned the plan because any cost savings would have been outweighed by the increased rateable value of the plant as well as what GM’s real estate manager Julian Lyon calls the “impact of failure”. In other words, the company would have been tied into a 15 year contract with an energy company and higher rates even if the company stopped producing cars there. “So we have solar panels in all our plants across Europe but not in the UK,” explained Lyon.

General Motors believes that this disincentive to invest is perverse. It was a view supported by a number of other panelists. Jagjit Singh Srai, head of the Centre for International Manufacturing at the University of Cambridge, said that rather than driving the right patterns of behaviour, the current business rates regime “encourages the hollowing out of our companies”. He argued that in the UK, “we discourage start-ups, we discourage automation, we discourage new technology investment. We encourage hollowing out and we encourage moving overseas; all of which sounds wrong.”

Chris Sanger, global tax policy leader at Ernst & Young, suggested there was evidence of a foreign direct investment (FDI) black hole as a result. According to EY figures, the UK gets 20 per cent of all FDI projects across Europe but that figure falls to 12 per cent when looking just at manufacturing. “We are clearly missing out,” Sanger said. FDI was worth €223bn in 2013. By fixing these business rate anomalies, the UK could attract an additional €4.6bn into the economy. On the impact of plant and machinery investments, Sanger said: “This is not related to making a profit. It’s related to how much you are going to invest in the infrastructure to make that profit. So the tax itself is penalising investment.”

Yet, some suggest that these plant and machinery problems could easily be fixed by updating the list of items included  rather than abandoning the idea altogether. Meanwhile, the official government line – to quote – is that “plant and machinery adds value to your property.”

“But does it always add value?” asked Blake Penfold, director of business rates at GL Hearn. “If you’re doing something merely to comply with emissions controls are you adding value? You’re merely enabling the value of your property to stand still, to continue to operate.

“Some strange behaviours are being encouraged and some good behaviours are being discouraged.”

Gauke wouldn’t be drawn on whether he supported this view. “When it’s a point that is raised again and again and again, clearly it is something we will want to consider,” he said. “There is clearly a perceived … disincentive on putting up solar panels. But trying to deal with that issue in isolation could result in some perverse consequences.”

Given the hostility towards business rates, perhaps any sort of property-based tax should be avoided altogether. None of the panelists was willing to go that far. Tozer said he didn’t have a fundamental objection to a property tax, while others pointed out the benefits. Mark Higgin, head of ratings at Montagu Evans, argued that business rates were very easy to collect, the target of the tax was easy to identify (“a big car factory is quite difficult to hide”) and it can be used to shape behaviours and the efficient use of property. “So let’s not throw out the baby with the bath water,” he urged.

Penfold agreed. “It’s not a bad tax,” he said. “You can’t escape it very easily and it’s relatively cheap to collect with a strong degree of certainty.” The problem, Penfold said, was not in the principle but in the delivery. “The tax is just too high and disproportionate.” He urged any incoming government to switch the measure of inflation against which business rates are set, from RPI (retail price index) to CPI (consumer price index). The latter is typically lower. “When this tax was first introduced the tax rate was 34.8 per cent – and that made sense in relation to levels of personal and corporation taxation at the time. Next year it will be 48 per cent for smaller businesses and 49.3 per cent for larger businesses. It is now just out of proportion.”

For his part, Gauke said there would be no move from RPI to CPI until the government had dealt with the deficit. “The point I would make is a very familiar one – there is no money left.”

The rest of the NS roundtable participants.

A switch from one measure of inflation to another, however unlikely in the short term, would also please the membership of the employers’ organisation, the Confederation of British Industry. It has to be “a first point of reform”, said the CBI’s principal economist Dilip Shah. Among a shopping list of other reforms, Shah called for an overhaul of the “20th century billing system” that proved a major bureaucratic burden, and urged policy makers to rethink exemptions and reliefs “to properly target them so there isn’t a disincentive towards environmental policy or business investment.”

Unlike other interested parties, however, Shah suggested that many of the CBI’s manufacturing membership preferred the certainty of five-year valuations rather than anything more frequent. He also insisted that despite the need for business rates reform, the lowering of corporation tax was always a priority as it was “more distortive” than other taxes.

Chris Richards, senior business environment policy adviser at the manufacturers’ association EEF, went further pointing out that there was little appetite for reform among his membership. While acknowledging issues that directly impact larger manufacturers and urging the valuations office to update the plant and machinery list, he suggested most members favoured the “stable, fixed cost” that characterises business rates and warned against the unintended consequences of reform.

“What would be the impact of any kind of ripping up the system and starting again?” Richards asked. “It could mean actually more costs to the manufacturers in the UK. It could mean that we created a more volatile tax system.”

Meanwhile Peter O’Connell, local government policy adviser at the Federation of Small Business, said: “A very common complaint from our members is they don’t understand how the rateable value has been arrived at and the process of trying to form some clarity and understanding about the process.” In common with other business groups he said his members were concerned how the overall cost of business rates had risen over time and suggested that a rebalancing of the tax burden away from property tax was worth exploring.

Jerry Schurder, partner at Gerald Eve insisted that it is “wholly appropriate for a government to have within the basket of taxes a property-based tax”. The problem, he said, was in the execution. Business rates had consistently failed to respond to changes to the economy, he said. As a result, when compared to most other nations, the UK’s property tax was highest at nearly 3.5 per cent of GDP (see graph, opposite). Graham Armitage, a partner at KPMG, added: “The UK is pretty cost competitive in total. One of the areas where it really isn’t is property costs. What business rates do . . . is take the area where the UK is arguably least competitive and make it a hell of a lot worse.”

For Mike Heiser, senior finance adviser at the Local Government Association, the perspective is a little different. Business rates account for 19 per cent of local government income, revenue no authority can afford to lose. This doesn’t mean, however, that the LGA is against reform. Heiser said he wants a review of appeals “that take time and destabalise the system”.

He would also like government to look at ecommerce companies that pay little or no business rates and whose computer servers do not fall under the current plant and machinery regime. “What we would like to see in the first 100 days of a new government,” Heiser said, “is local government being given more power and more incentive to set discounts so that they can work with business.”

So what are the main political parties likely to offer ahead of the general election? Both coalition parties are committed to the review announced by Osborne last December, while the Liberal Democrats repeated their broad support for a land value tax in a pre-manifesto document released in September. Beyond that, Gauke said he was unwilling to be drawn on his or his party’s preferences so as not to influence the review (“I’m not going to rule in or rule out what’s going to be in it”) although his party may be tempted to hint at changes as we approach the election in May.

For Labour, Adrian Bailey said his party is committed to reverse the percentage point reduction in corporation tax and use that money to freeze business rates for a year.

Bailey, chair of parliament’s business, innovation and skills committee accepted, however, that this “is only a short term measure” and a review to work out how to “reconfigure” rates was needed. And, like the Conservatives, Bailey insisted the solution would need to be fiscally neutral. “To recommend a reform of business rates that would decimate the contribution to the Exchequer is not realistic in the current financial situation,” he said.

Bailey also said he was keen to look at those plant and machinery anomalies. “If you replace one blast furnace by another,” he said. “I can’t think of any particular reason why there should be an increase in business rates, but obviously there is.”

Assuming it survives beyond the election, the Conservative-Lib Dem Coalition’s review will report back next spring. The implementation of any changes will take longer.

Tozer said he is relaxed about the timing, for now. By the middle of the next Parliament, General Motors will have begun reassigning its presence in Europe. “That timing is fine,” he said. “If it was later than that, it could start to become very dysfunctional to our decision.” 

Two round table discussions were convened by the New Statesman in association with General Motors UK. The first took place on 5 November 2014, the second on 15 December 2014; both at Church House in Westminster.

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