Monday 9 March 2020 5:00 pm EY Talk

Reforming business rates – is Land Value Tax really a viable alternative?

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Alex is an Associate Partner in EY's Business Rates team.
and Chris Sanger
Chris Sanger is a Partner and Head of Tax Policy at EY, Chair of the Financial Secretary to the Treasury’s Tax Professionals’ Forum, and former Head of Business Tax Policy at HM Treasury.

The Business Rates system has long been considered by businesses as outdated and in need of reform. It imposes its tax burden whether the business is “in the red or the black”, i.e. profitable or not.  Also, whilst purported to be a tax on business collected by means of property, it has a distinct bias to taxing retail and manufacturing since they use more and more expensive property, relative to their size in the economy.  And finally, the absolute burden of business rates has increased significantly over the last decade as the tax rate increases outstripped the growth in capital values of property.

The previous Conservative governments held a number of consultations on business rates, culminating in changes in the administration, some reliefs for smaller businesses and properties, and a shift in the basis for addressing future inflation.  But none of these addresses the core concerns listed above.  Now the new Conservative government has committed to a fundamental review of the system in both its general election manifesto and the recent response to last year’s Treasury Select Committee inquiry into the impact of Business Rates on business.

Read more: Retail bosses call for business rates reform in 2020 budget

More details on this review are expected to be announced in the Budget, with one option under consideration being a replacement with a system that could address the fundamental weaknesses of today. One of the alternatives put forward by both Labour and the Liberal Democrats at the last election is a Land Value Tax, something that the current government is rumoured to be considering.

So what is an LVT?

In contrast to business rates, an LVT is a tax charged on the value of the land itself rather than what is built on the land. So, any buildings or improvements on the land are excluded from the calculation, in theory removing a tax penalty for improving the value of what is on the land and hence providing more encouragement to development.

A move away from a business rates system that, whilst introduced in its current iteration at the time of the poll tax, has its origins in taxes that have been in place for hundreds of years to a new tax on land would certainly represent a ‘fundamental’ change. As a result, significant policy work and consultation would be required in order to develop such a system and how it would be administered.

A move to an LVT would initially give relief to many occupiers being impacted by the current level of business rates, where the “multiplier” (effectively the tax rate imposed on the value of the property at the last valuation date, currently being 2015) now sits comfortably above 50p in the £ for many properties. However, at this stage its not clear what would be the actual benefits of such a move in practice and who would gain any benefits arising from redistribution or changes in rate.

A tax payable by landlords

Under an LVT system, the tax would move from being predominately one levied on occupiers to one payable by landlords. Such a shift would raise questions regarding on whom the final incidence of the tax would likely fall, testing the argument made by many economists that today’s business rates burden is ultimately borne by landlords as it is reflected in reduced levels of rent. With business rates currently linked to rental values of property, they are consolidated by many businesses in occupancy cost. Landlords could be expected to argue that their reduction leaves more funds available to pay rent and those could then be used to cover the additional burden being placed on landlords.  Hence, under this argument, all that is achieved is a merry-go-round of contract changes, with the tenant ultimately still facing much the same burden as before.

However, the changes in commercial rents may not change overnight and hence the shift to LVT may well have a significant impact on the investment value of the current stock of property which could have wider implications to UK real estate, leading to a significant shift in value away from landlords to tenants in the short term.  That’s a lot of disruption and hence imposes an obligation on the government to ensure that the benefit is worth it.

The beneficiary of business rates

And beyond the complexities of the move exists another complexity.  The benefit of business rates today does not lie directly with the Exchequer, but instead with local authorities.  For Treasury to gain any financial benefits for the wider Exchequer, or indeed to fund any reduction, changes will need to be made to the funding mechanism for local governments.  The net tax revenue collected from business rates last year was in the region of £26.5bn and this is a significant part of local authority funding.  An LVT might be set by the Treasury at such a level as to deliver a given revenue target across England and Wales, but the change in the underlying basis is likely to affect different local authorities differently.  That is not a recipe for an easy move and will most likely require some element of smoothing in the near term. This would also raise the question on the application of an LVT on agricultural land (currently exempt from business rates) and residential property (Council Tax).

Calls for reform

All of these challenges have perhaps been the reasons why the previous consultations have led to small, iterative changes rather than reform.  However, even with those changes, the current system is one that businesses believe needs reform and it appears that the government agrees. The retail sector has been at the forefront of the call for change, as it bears a disproportionate amount of the tax. However, if rents were to adjust to account for the tax being moved to landlords, it’s not clear that this alone would significantly affect that distortion or, for example, level of the playing field between bricks and mortar and digital retail from a property tax perspective.

The review will be welcomed by many, but a lot of businesses will certainly hope the Budget provides some more immediate short-term relief in the interim.  Other options for reforming business rates do exist and could be implemented more quickly, with more impact and less disruption.  If the consultation focuses on these, there may yet be a chance that this consultation will not follow the route of the others and produce worthy changes instead of ones that do not address the fundamental flaws of the current system.

Read more: EY adds two key appointments to its Business Rates team