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Publication - Report

Non-domestic tax rates review: Barclay report

Published: 22 Aug 2017
Part of:
Business, industry and innovation, Economy
ISBN:
9781788511636

Report of the external Barclay review into tax rates for non-domestic properties, with recommendations for rates system reform.

140 page PDF

1.6MB

140 page PDF

1.6MB

Contents
Non-domestic tax rates review: Barclay report
Annex B: Other Ideas Considered - Options for Changing the Way in which Revaluation Works.

140 page PDF

1.6MB

Annex B: Other Ideas Considered - Options for Changing the Way in which Revaluation Works.

B.1 Many stakeholder groups raised concerns with us about the 2017 revaluation and the significant disruption it caused ratepayers in certain areas and sectors. There has also been extensive media coverage of instances where bills increased significantly as a result of the 2017 revaluation although we note very little coverage of instances where bills reduced significantly. Of course, any revaluation of non-domestic rates will result in "winners and losers" - and it is typical (and understandable) that those who "lose" as a result of the changes complain loudly, while "winners" are typically far quieter. Such changes were more marked in the 2017 revaluation partly because of the extended gap following the previous 2010 revaluation.

B.2 While the outcome of the 2017 revaluation was outwith the scope of our remit, we did note that the stakeholders we consulted often sought to reduce the uncertainty that is inherent within a revaluation - or to change the balance of risk between Government and ratepayers.

B.3 Our recommendations set out a clear plan to try and minimise the disruption that revaluations will cause for ratepayers. Shortening the revaluation period to 3 years, and reducing the time between the 'tone date' and the revaluation itself to one year, should ensure that changes in revaluation are less volatile.

B.4 Suggestions and ideas were also put to us about changing the way that revaluation works. This section briefly sets out the main ideas that were discussed:

B.1: Annual valuations - with consideration given to a fixed rate of tax.

B.5 Typically, revaluations in Scotland have occurred every 5 years, with the most recent revaluation cycle lasting 7 years. Revaluations are designed to be revenue neutral in terms of the overall amount of tax they raise - the purpose of the revaluation is to redistribute the existing tax burden rather than to reduce or increase the overall size of the tax burden [16] .

B.6 Large changes in bills at revaluation occur where the change in valuation for one property varies dramatically from the changes seen across the tax base as a whole. For example, where valuations for some sectors show values increasing dramatically more than the average change seen at revaluation, that sector will see bill rises. The reverse is also true. The more extreme this divergence, the larger the change in bills that will be seen by the properties affected.

B.7 Reducing the amount of time between revaluations should reduce the likelihood of large bill changes at revaluation. Over a shorter time period, divergences in valuations between one sector or area and the tax base as a whole should be smaller than they would be over a longer time period. Even where a long term divergence in valuations is likely, shorter revaluation periods will allow bills to rise more gradually, rather than for large one off changes to occur. Valuations that are vulnerable to short term shocks may still see large changes in bill, but the frequency of these changes should be lower with a shorter revaluation period.

B.8 More frequent revaluations may also enable more certainty over the rate of tax that ratepayers can expect to pay.

B.9 A number of consultation responses mentioned that non-domestic rate could be made to resemble income tax, or introduce some of the common features of income tax. Key features highlighted in these submissions are that other taxes such as income tax do not typically see their rates change each and every year and that they are pro-cyclical - meaning that typically, when the economy is doing well, government asks taxpayers to pay more, as the tax base ( i.e. income, sales, profit etc.) is growing. On the other hand, when the economy is doing less well and the tax base is shrinking, tax liabilities will reduce. This relies on frequent, measurable changes in the tax base, and a relatively stable tax base.

B.10 Non-domestic rates has typically operated differently - relatively infrequent changes to the value of the tax base (via revaluations) and frequent changes to the rate of tax (poundage).

B.11 Internationally there is wide variation in the period of time between revaluations for property taxation - with some countries carrying out revaluations more frequently than Scotland. For example, in both Iceland and the Netherlands properties are revalued on an annual basis, with a "rolling revaluation" implemented whereby reappraisals are staggered over a 2 year period in Denmark [17] .

B.12 It would be feasible in principle to achieve annual revaluations, although we recognise that this would require a significant improvement in data availability and some reform of the way that property values are assessed. However, we can envisage a time in the future when annual revaluations may become the norm for Scotland too - and if this were the case, then it would offer the opportunity to structure non-domestic rates in a different way - for example to make it similar to income tax - characterised by relatively stable tax rates, and a relatively fluid tax base.

B.13 Under a scenario where annual valuations are achieved, valuations themselves can change from one year to the next, and so the rationale for an inflationary increase in the tax rate is less clear. For example, Government could leave the tax rate fixed, and let revenues vary with the value of the tax base. A pro-cyclical tax arrangement would - by definition - have non-zero revenue implications - and so assuring that any changes along these lines achieved revenue neutrality would be very difficult. It should be noted that government could also continue to pursue "revenue neutral revaluation" from one year to the next, or pursue other policy goals.

B.14 We are not convinced that changes in rateable value from one year to the next would be significant enough to justify annual revaluations. In the first instance, moving to 3 year revaluations (see recommendation 3) should reduce the volatility in bill changes at revaluation. Consideration of annual revaluations should therefore only be given if these problems persist.

B.2: Constraining the changes that can happen at revaluation - transitional relief.

B.15 There is an established method of helping to provide ratepayers with a degree of certainty at revaluation: "Transitional Relief". For example, the UK Government is required by law to implement Transitional Relief schemes alongside revaluations. These schemes ensure that those with large bill increases will not face their full bill increases immediately at revaluation. Instead, bill rises will be capped during the revaluation period such that a ratepayer with a large increase in their rates liability will experience a gradual transition toward their full bill.

B.16 A major drawback of Transitional Relief is that it costs a significant amount of money to limit bill increases. Typically, these schemes are funded by limiting bill decreases. In the same way that a ratepayer with a large bill increase will not have to face the full effects of that bill increase at revaluation, properties that would see a large reduction in their bill will have this reduction limited - the resulting surplus is used to fund the cap on bill increases, creating a revenue neutral scheme.

B.17 As such, Transitional Relief can place a significant burden on parts of the tax base that may be experiencing difficulties - reflected by their lower valuations. As a result, there is a risk that Transitional Relief imposes an additional tax burden on those ratepayers with the least ability to pay. There are other potential options for funding transitional relief that don't target individual ratepayers who would see their bills go down otherwise - for example, an across the board premium on poundage would treat everyone equally, but would have implications for the perceived "competitiveness" of non-domestic rates in Scotland.

B.18 In order to design a revenue neutral Transitional Relief scheme, the characteristics of a revaluation need to be known in advance. Information such as how many outliers there are, what the overall levels of growth are in the tax base, and what the distribution of bill rises and drops in bills is.

B.19 The Scottish Government decided not to implement a typical Transitional Relief scheme in Scotland following the 2017 revaluation. Instead it provided relief to properties in specific sectors that were seeing bill rises, and forwent capping bill decreases to fund this. As such, unlike a typical transitional relief scheme, this one is forecast to cost money. Scottish Government analysis suggests that this will cost the public purse as much as £45 million in 2017-18.

B.20 Table B1 (below) looks at the likely winners from a typical transitional relief scheme - properties with an increase in gross bills - at the 2017 revaluation:

Table B1 - Likely winners from a transitional relief scheme at the 2017 revaluation

% of Tax base (in terms of pre-relief bills) No of properties with a 25%+ increase in (pre-relief) bills Total value of 25%+ increase in (pre-relief) bills
£m % of Scotland total
Likely TR Winners - by Sector
Designated Utilities 12% <20 76 43%
Hotels and Pubs 6% 5,000 23 13%
Likely TR Winners - by RV Band
£1 to £18,000* 14% 46,600 44 18%
Likely TR Winners - by Council
Aberdeen City and Shire 12% 7,800 19 11%
Scotland (as a whole)
All Scotland 100% 53,500 179 100%

Source: Review Group Analysis of Valuation Roll Data.
* groups will have a degree of overlap. For example, there are both hotels and pubs in Aberdeen that will be double counted via this table.

B.21 f the £179 million increase in (pre-relief) bills over 25%, almost half is accounted for by less than 20 entries on the roll classed as "designated utilities" [18] . It is clear that in addition to these large utility companies, hotels and pubs would also likely have seen significant bill reductions through a simple transitional relief scheme. Transitional Relief presents a real challenge in funding such schemes.

Table B2 - Likely losers from transitional relief

% of Tax base (in terms of pre-relief bills) No of properties with a 10%+ decrease in (pre-relief) bills Total value of 10%+ decrease in (pre-relief) bills
£m % of Scotland total
Likely TR Losers - by Sector
Shops 23% 10,800 60 47%
Offices 12% 10,500 28 22%
Likely TR Losers - by RV Band
£51,001 to £250,000 26% 5,100 50 39%
Likely TR Losers - by Council
Edinburgh and Glasgow 25% 9,800 41 32%
North and South Lanarkshire 8% 5,400 18 14%
Scotland (as a whole)
All Scotland 100% 38,200 127 100%

Source: Review Group Analysis of Valuation Roll Data.
* groups will have a degree of overlap. For example, there are a significant number of properties with an RV of between £51,001 and £250,000 in Edinburgh and Glasgow.

B.22 The characteristics of the expected "losers" of such a scheme - those properties with decreases in their bills - are described in Table A2 (above). The likely funders of a typical transitional relief scheme would have been drawn from the retail and office sectors, from medium sized properties in rateable value terms and from Edinburgh and Glasgow and North and South Lanarkshire.

B.23 While the analysis above indicates that properties with smaller rateable values would benefit from Transitional Relief, this might not necessarily be the case. Many smaller properties already benefit from the Small Business Bonus Scheme, which reduces or eliminates bills for a large number of properties.

B.24 This illustrates another drawback of Transitional Relief schemes - they are very complex, and ensuring that they are revenue neutral is challenging. For example, statistics on schemes run in England in both 2005 and 2010 show that, in total, these schemes have "lost" around £1 billion over the course of their respective revaluation cycles [19] . This is due to a variety of reasons, including the interaction with other reliefs discussed above.

B.25 Due to this complexity, Transitional Relief schemes typically require a significant amount of rates knowledge to understand.

B.26 It is clear that there are benefits to transitional relief schemes - and the reassurance that they can provide to ratepayers that any large shocks to their bills will be phased in rather than being imposed suddenly is significant. On the other hand, these schemes are complex, hard to understand and involve significant costs - both for government in terms of unexpected deficits on these schemes and for those ratepayers who end up funding the schemes by forgoing decreases in their bill. On balance, therefore, we consider it appropriate to continue with a situation where the government of the day can review the both the characteristics of a revaluation, and the distribution of winners and losers at a revaluation, before judging whether or not to implement transitional relief, based on the merits of any schemes proposed.

B.3: Constraining the changes that can happen at revaluation - a "cap and floor" scheme for rateable value changes.

B.27 Another way of constraining changes at revaluation would be to place a cap which limits the maximum amount a rateable value can increase (and possibly a floor which limits the maximum amount a rateable value can decrease) on the amount of change in valuations at a revaluation. The proposal would involve setting an upward and downward limit on the amount that rateable values (and therefore bills) could increase by at revaluation. In doing so, this could help provide certainty for ratepayers ahead of revaluation.

B.28 They key difference with Transitional Relief is that a cap and floor scheme could provide longer term certainty for ratepayers. However, this would necessarily involve re-baselining subsequent revaluations. Unlike in a Transitional Relief scheme where a property can transition to its correct value/bill over time, the constrained value/bill for the property would inform the cap and the floor for future revaluations. As such, where the valuation of a property is showing consistently strong growth (or a consistent decline), bills would not depend on the current valuation of that property, but on the original valuation, and the limits of the cap and floor scheme.

B.29 In order to provide a significant level of certainty for ratepayers, a cap and floor scheme would likely need to place quite a restrictive cap on how much valuations could change at a revaluation.

B.30 A revaluation re-distributes tax liability from those properties that do not see a strong increase in valuations to those whose valuation increased by a greater amount. If a cap and floor scheme limited valuations to a band of + or - 50%, this could still lead to large changes at bills with revaluation. Table B3 looks at maximum possible bill changes for properties affected by a cap and floor given other changes seen in the tax base:

Table B3: Maximum possible bill rises for a ratepayer affected by cap and floor scheme

Change Seen Across Wider Tax Base (after effect of cap and floor) -50% -25% 0% 25% 50%
Max Change in Bill for individual property affected by cap (of +50%) 150% 67% 25% 0% -17%
Max Change in Bill for individual property affected by floor (of -50%) 0% -33% -50% -60% -67%

Source: Review Group Modelling.

B.31 In practice, it may be easier to cap valuations after the fact - taking account of the average changes seen, and the distribution of these changes. This idea is more in line with Transitional Relief (discussed above). In the absence of this arrangement, a cap and floor scheme would likely have a significant impact on revenues. For example, Table B4 looks at the distribution of RV changes at the 2017 revaluation and likely implications for any cap and floor scheme:

Table B4 - Analysis of rateable value changes at 2017 revaluation

Rateable value Change No of Properties* Total (2017) RV RV That would be affected by a RV Change Cap / floor**
(+/-) 25% Floor (+/-) 50% Cap
reduction of 50% or more 3,000 £30m £9m £31m
reduction of between 25% and 50% 10,000 £290m £43m
reduction of less than 25% 42,000 £1,780m
no change 28,000 £400m
increase of less than 25% 71,000 £2,540m
increase of between 25% and 50% 34,000 £1,100m £86m
increase of 50% or more 29,000 £820m £227m £326m

Source: Valuation Roll (comparison of snapshots before/after April 2017).
* Properties / RV doesn't add to published VR totals as a number of properties can't be matched.
** Costs of this sort of cap and floor mechanism would clearly be dependent on a number of other features - notably whatever constraint on the tax rate was introduced.

B.32 More properties saw a rateable value increase at revaluation than a rateable value decrease, and significantly more rateable value would have been caught by a cap than by a floor. Even a relatively low floor (-25%) would not have funded a relatively high cap (+50%). Assuming no other changes from draft budget policies for 2017-18, as an example a cap constraining RV changes of more than 50% would have cost over £80 million per annum, while a scheme aimed at capping RV changes at no more than 25% would have cost over around £130 million per annum.

B.33 The cost of similar schemes at previous revaluations would have likely been substantially higher - as a result of rateable value growth in general being substantially higher ( e.g. average rateable value growth of 20%+ at the 2010 revaluation would have meant a much larger proportion of the tax base being captured by the "cap", and less properties being captured by the "floor").

B.34 A second issue with this sort of proposal would be that it risks divorcing tax bills from up to date valuations in a scenario where the rental market for a particular sector or area significantly over or underperforms relative to the tax base as a whole. Chart B1 looks at how rateable value could differ from up to date valuations assuming different levels of growth in valuation.

Chart B1 Growth in valuations over time - and the effect of a cap on rateable value growth.

Chart B1 Growth in valuations over time - and the effect of a cap on rateable value growth.

Source: Review Group Modelling

B.35 For example, If a property were to see steady growth in rental value of 50% each revaluation period, a 25% cap would seem moderate in the first revaluation - the "error" would be just £25 for every £125 of rateable value - 20%. However, by the fourth revaluation, the "error" introduced by this constraint would be over 100% of the value that is ascribed to the property. This can be seen in Chart B1 - where the purple line grows dramatically faster than the blue line.

B.36 While this suggestion would provide long term certainty, it would come at a large cost. The revenue foregone at revaluation would be significant, and the proposal would damage the transparency and accountability of the tax system if long term divergences between tax liability and rental values were created. While ratepayers who benefit from the "Cap" element of a cap and floor scheme would be likely to be content with the proposals, it would be more difficult to justify higher tax bills to those ratepayers affected by the "Floor" element. As such, while we are attracted to a simple solution to large bill changes at revaluation, we recognise that a cap and floor scheme would be too blunt a policy tool to achieve this.

B.4: Less frequent revaluations - or sale/occupier based valuations.

B.37 One suggestion that was brought up more than once - but not widely supported - was to have less frequent revaluations for non-domestic rates in order to provide rate payers with more stability. In principle, this would be akin to the council tax in Scotland which has not been revalued since it was introduced in 1992 and where revaluation to take account of any expansion or modernisation in a property only takes place on the sale of that property.

B.38 The Review Group support neither less frequent revaluations nor the suspension of revaluations - and nor did any property professionals we spoke to, although a minority of ratepayers did. Although we do accept that less frequent revaluations may provide greater levels of certainty for property owners it would mean that tax bills became more and more divorced from property values and as new industries emerge accurate valuations may become harder to accurately compile. Furthermore, the value assigned to any new builds, extensions etc. would have a tone date that would become increasingly less relevant, the longer the time period between revaluations.

B.39 Finally, if the tax base becomes fairly static at a historic point in time, the poundage rate would have to rise year on year to raise the same amount of revenue. This would mean that businesses in Scotland would eventually pay a substantially higher tax rate than counterparts in England and, while the reasons for doing so are that average rateable values would be lower, many (particularly those looking at new investment) could simply be dissuaded from doing so by the headline tax rate.

B.40 A related suggestion - also made relatively infrequently - was that properties would only be revalued when there was a discrete reason to revalue, such as a property sale, change of occupier or physical change to a property. The Review Group understand how this could be attractive to some ratepayers - providing greater certainty about future rates liabilities for ratepayers at the point when decisions are made over whether to occupy/build etc. a new premises. However, the Review Group considers that the drawbacks of this sort of approach would be severe for other ratepayers. Many properties are not frequently subject to these sorts of changes, and therefore ending regular revaluations would mean that their tax bill would be divorced from up to date property values - much like a "no revaluation" scenario outlined above. Furthermore, this sort of scheme would distort investment and occupancy decisions. Where a rates liability is deemed to be good value, incentives to invest or change the occupier of a property would be reduced. Conversely, where a rates liability is deemed to be too high, there would be an incentive for ratepayers to move on from a property - both to get a better deal elsewhere, and to increase the rental/capital value of the property by reducing the rates liability of the existing site.

B.41 Overall, the Review Group therefore did not see merit in reducing the frequency with which properties are revalued in order to provide greater levels of certainty for ratepayers.


Contact

Email: Marianne Barker, marianne.barker@gov.scot

Phone: 0300 244 4000 – Central Enquiry Unit

The Scottish Government
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