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A revolution in devolution?
By Kevin Muldoon-Smith and Dr Paul Greenhalgh | 24-11-2015 | 07:00
Kevin Muldoon-Smith and Dr Paul Greenhalgh consider how the
recent business rates announcements will affect the commercial
property sector
A recent flood of announcements concerning the devolution of government powers to
local areas signals the greatest transfer of power from Whitehall in a generation.
Devolution, growth and city deals are now the order of the day, while the Northern
Powerhouse and Devo Manc have been welcomed as a revolution in devolution for local
authority working. These changes in the way government is organised have been broadly
welcomed by civic leaders and commentators alike as an opportunity for local areas to
exert control over their destiny and stand on their own two feet.
So far, there has been very little debate surrounding what these changes mean for the
commercial property sector. This deficit is particularly notable with respect to the
chancellor’s announcement, at the Conservative Party Conference 2015, of the full
localisation of business rates. The statement took many by surprise (the SNP quickly
announced similar proposals in Scotland) and initially received considerable attention.
After a brief spike in media coverage, interest in the matter has subsequently dwindled
to a disappointing level.
Make no mistake, following devolution, local business rates, and by extension the
performance and potential growth of local commercial real estate markets, will become a
central concern not only for local authority financial planning and investment but the
wider business sector and local electorate.
The reality of the situation is difficult to fathom at the time of writing, ahead of the
impending public spending review. However, what is positive is the recent exposure of
this traditionally esoteric issue and the opportunity for debate. This article reflects on
some of the uncertainties, assumptions and ambiguities in the recent business rates
announcements and the potential challenges and opportunities for public service
provision and the commercial property sector.
Commercial real estate
The original business rate retention scheme, introduced in 2013, gave local authorities
the potential to retain 50% of business rate income and up to 50% of any growth in
business rates revenue, synonymous with construction of new employment (commercial
and industrial) floorspace. The remainder was returned to central government and
redistributed in England in a similar way to the previous formula grant method of
funding. The chancellor’s recent announcement has extended the 50% principle to 100%,
but what is the actual impact of this?
The reality is that local authorities are only really able to benefit from business rate
retention via new additions to the statutory rating list. This is because they already
receive empty property rates (notwithstanding the problem of empty property rate
avoidance) on existing property, while any relative value uplift on existing property is
stripped out during the national revaluation exercise. This means that any location that
does not have the space to accommodate new construction, or does not have the
underlying rental values to support new development, will be at a disadvantage and face
an uncertain future.
A new flexibility
The chancellor has suggested that local authorities will now have the power to lower the
rate of business rate taxation in order to attract new businesses. This is potentially a
positive development for businesses and landlords. However, it is important to note that
the uniform business rate has not been abolished it will still exist; all that has changed
is the ability for local authorities to lower this rate at the local level if they so wish. It is
difficult to imagine most local authorities, which are already facing severe budgetary
pressures, agreeing to further decreases in local taxation. Presumably, only those
authorities with a budget surplus will have sufficient financial tolerance to accommodate
potential change.
There is also some uncertainty concerning the flexibility of any reduction in the local
business rate level. Will it be uniform at the local level or will local authorities have the
ability to adjust taxation for different types of property, businesses and locations? For
instance, it is unclear if it will be possible to remove small businesses from business rate
taxation all together or to vary the level of empty property rates faced by commercial
landlords.
The Scottish administration announced a degree of flexibility where local authorities will
be able to lower the business rate against local criteria, such as the type of property, its
location, occupation and activity. So far, this level of detail has not been released in the
English proposals.
Missed opportunity for reform
Surprisingly, the recent announcements have largely ignored the issue of empty property
rates. Under business rate retention, the higher rate of empty property liability means
that local authorities are not rewarded with any additional income from attracting new
businesses into existing vacant premises (eg small businesses pay a lower rate of
business rate taxation).
Failure to take account of empty property rates is a missed opportunity. If government
abolished this charge, or if local authorities had the power to alter the rate, local
authorities would be incentivised to promote indigenous economic growth by being
rewarded for creating conditions whereby vacant space is reoccupied, rather than getting
penalised in the current situation. This would provide a welcome boost to small
businesses and the managed work space sector that supports this new economy.
No taxation without representation
Moreover, how will the new mayoral local infrastructure fund work in practice? At first
glance, it looks like a classic business improvement district (“BID”), where businesses in
a defined area agree to pay an extra level of business rates, after a local ballot, to fund
local improvements.
Importantly, under a BID, a majority of businesses in a defined area have to vote in
favour of an uplift in property tax. However, under the infrastructure levy there is no
provision for a local ballot. An elected mayor would only need to secure the agreement
from a majority of private sector local enterprise partnership members. This opens up a
debate around the democratisation of fiscal decentralisation, especially regarding who
decides and who pays for new local infrastructure.
All or nothing or all of nothing?
It is worth noting that there is no new funding in the chancellor’s announcement, only
the potential for business rate growth. The issue of risk is particularly pertinent in
relation to the rateable value appeal process. Local authorities are liable for the cost of
any successful appeal backdated to 2010 (and beyond where historical appeals have not
been resolved), three years before the existing business rate retention scheme went live
in 2013. In the current scheme, they are only liable for 50% of this liability; after 2020 it
will be 100%.
Many local authorities already find that the cost of successful backdated appeals more
than outweighs the proceeds of any growth. Without revision, the new proposals will only
make this issue worse.
There is still a great deal of uncertainty in relation to the 2020 business rate changes and
what the practical implications will be in local authorities up and down England (Scotland
is moving ahead even quicker). What seems certain is that change is around the corner
in England (and in the devolved administrations) and that local authorities will be
expected to fend for themselves through a new model of civic financialisation and
entrepreneurialism.
It is now likely that local authorities will pursue capital development programmes in order
to stimulate business rate growth. However, this will not be uniform, as some local
authorities are more able to engage in this process while all locations will now be subject
to the arbitrary whim and cyclicality of the commercial real estate market.
Consequently, local authorities (and the valuation office agency) will need to foster close
working relationships with property advisors, planners and the investment community to
ensure that they get these new development schemes “right” and that the correct mix of
employment premises is retained in local areas.
Most commercial property agencies already employ rating specialists, yet the traditional
emphasis has been on mitigating rate liability on behalf of the landlord, particularly
navigating the complex rules and regulations involved in valuation for rating purposes,
submitting appeals and negotiating with the valuation office agency. In the future the
same rating specialists may also operate on behalf of the local authority, only the roles
will be reversed, with the emphasis firmly on rateable value growth and retention.
Kevin Muldoon-Smith is an associate lecturer and Dr Paul Greenhalgh MRICS is a reader,
both in the Department of Architecture and Built Environment at Northumbria University;
they are co-founders of R3intelligence, a new consultancy service offering commercial
real estate research and advice.
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