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A revolution in devolution?

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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