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Section 17: Non-Domestic Taxation

Background

1. Non-domestic rates are taxes on property payable by businesses in Scotland. Rate bills are calculated by multiplying an assessed rateable value for a business property by a non-domestic poundage rate. The rateable value of every property is determined by a local Assessor, who is independent of both local government and the Scottish Executive. The rateable value is the Assessor's estimate of the annual rent which that property would attract on the open market. A single national poundage rate applies across Scotland.

2. Non-domestic rates are normally paid by the occupier of a non-domestic property - usually this is the owner-occupier or tenant. If a property is empty, the owner or tenant may have to pay a reduced rate.

3. Non-domestic properties are properties such as shops, offices, warehouses and factories, and any others that are not classed as domestic properties. In some cases, properties may be used for both domestic and non-domestic use (for example, a Guest House or Hotel) in which case both council tax and non-domestic rates will be charged. It is the Assessor who determines the classification of properties ( i.e. domestic or non-domestic).

4. Some types of property are exempt from entry in the Valuation Roll. This means that these properties are not liable to pay non-domestic rates. Some examples of exempt properties include:

• agricultural land and buildings;
• fish farms, fishing, and sporting rights;
• public parks;
• the sites of Automatic Telling Machines ( ATMs) in designated rural areas; and
• churches and other places of worship (these are entered in the Valuation Roll but are fully exempt from rates).

5. In addition, business rate reliefs are available in a number of circumstances:

• Small Business Rates Relief is available for non-domestic properties with a rateable value of £11,500 or less. This relief provides a discount of between 5% and 50% on the rate poundage.
• Empty and unused properties are usually eligible for 50% rates relief, with no rates at all being payable for the first three months that the property is empty. For some properties ( e.g. industrial and listed buildings, and properties with rateable values of less than £1700), no rates are payable at all. Local authorities also have discretion to apply rates relief where part of a property is completely unoccupied for a short time.
• Properties used wholly or mainly for charitable purposes attract rates relief of between 80-100%, where the occupier is a registered charity. Relief can also be provided at the discretion of the local authority to properties occupied by certain other types of non-profit-making organisation.
• Certain businesses in rural settlements qualify for rate relief of 50-100%, as do certain previously agricultural lands and buildings which are used for non-agricultural purposes. Discretionary rate relief is also available for stud farms.

6. Local authorities also have discretion to give up to 100% relief to businesses facing severe hardship in appropriate cases (for instance to businesses which are particularly important to the local community and where a one off assistance will resolve the difficulties).

7. Particular issues apply to certain types of business activity:

• Home workers: A person who works from home may be liable for non-domestic rates on the part of the property used for work, and will be liable for council tax for the rest of the property (the property's valuation band may change as a result).
• Holiday homes: These are liable for non-domestic rates if they are available for let for more than 140 days a year. Council tax is payable on any part of the property used as the occupier's home. Where a holiday home is available for let for fewer than 140 days per year, then council tax is payable instead.
• Bed and Breakfast homes: These are liable for non-domestic rates if B&B accommodation is provided for more than six people at any one time. In such cases, council tax also is payable on that part of the property used as the occupier's home. Where B&B accommodation is offered in the occupier's own home to six people (or fewer) and the occupier lives in the property, then non-domestic rates are not charged but. council tax is payable

The Overall Contribution of Non-Domestic Rates

8. Total non-domestic rate income in Scotland in 2004-05 was £1.812 billion. This compares with £1.960 billion gross council tax income. Non-domestic rate income increased by 36% between 1996-97 and 2004-05. In the same period, council tax income (including Council Tax Benefit) rose by 64%. ²⁵⁶

9. Between 1996-97 and 2004-05, rateable values rose by 18%. The non-domestic rate poundage rate increased by 9%, from 44.9p to 48.8p. Following revaluation in 2005, the poundage rate in 2005-06 was 46.1p (up 3% on the 1996-97 rate but down 5% on the 2004-05 rate). ²⁵⁷

10. The non-domestic rate poundage rate has been reduced again in 2006-07, to 44.9p. Occupiers of property with a rateable value in excess of £29,000 are required to pay a supplement on this rate of 0.4p in 2006-07 to cover the additional costs of the small business rate relief scheme. ²⁵⁸

11. The in-year collection rate for non-domestic rates ranged in 2004-05 from 92.9% (West Dunbartonshire) to 98.8% (Orkney Islands). The Scotland average was 96.2%. ²⁵⁹

12. Non-domestic rates account for a significant proportion of the overall tax revenue paid by businesses in Scotland. In 2003-04, estimated non-domestic rate income was £1.7 billion, and corporation tax revenue was £2.38 billion (excluding North Sea revenue). ²⁶⁰ In contrast, local taxes account for only around 8% of taxes paid by households. ²⁶¹

13. Businesses pay a greater proportion of their overall tax burden to local government than do private households. It is not obvious that the relative importance of local services is greater for businesses than it is for the public. For instance, responsibility for providing and maintaining the national infrastructure and business support on which businesses in Scotland depend tends to rest either with the Scottish Executive, the UK Government or even the European Union ( e.g. in the case of support for agriculture and rural business). We have not attempted to quantify the extent to which different stakeholders benefit from services provided at either UK, Scottish or local level.

14. Any marginal change in the uniform business rate will make a significant difference to the overall tax burden that businesses pay. Any consideration of change to local business tax rates needs to take account of broader macro-economic effects as well as local issues.

Alternative Types of Business Taxation

15. Responses to the public consultation suggested that there was little evidence of awareness of how non-domestic rates operate. Where views were offered, we have been struck by the limited nature of support for fundamental change in how businesses should be taxed. While there has been discontent about how much businesses in Scotland are expected to pay in tax, the non-domestic rates system itself is familiar and broadly trusted.

Tax on employment/payroll

16. Virtually no support for an employment tax or a tax on corporate profits was expressed by business representatives, local authorities or members of the public who responded to our consultation. It was considered that such a tax might discourage employment and could unfairly penalise labour-intensive businesses over their capital-intensive counterparts. To us, there appears to be little rational basis for considering this option further.

Tax on profits

17. We were surprised at how little support was expressed for a tax on business profits from the business community. We consider it arguable that many businesses, especially small or young enterprises, could welcome the removal of non-domestic rates as a fixed cost on their business that hampered their ability to become profitable. However, representative bodies argued that businesses work hard to make a profit and the last thing they then want is to find that profit being taxed. As Mervyn Rolfe of the Scottish Chambers of Commerce said in oral evidence to us about a tax on profits:

"All of us in business want to make a profit. Even where someone has had a bad year this year, they still believe they are going to make a profit next year. You've got to, that's the only way you stay in business. So 'I'm going to be penalised as soon as I do make a profit' would be the attitude that they would come out with. I don't think you would find much favour at all."

18. Even the Federation of Small Businesses in Scotland, whose members might be most likely to benefit from the switch to a tax on corporate profits, preferred the status quo. To quote Susan Love in oral evidence to us:

"The benefits of a tax on property are that it is a tangible asset, it's predictable you roughly know what the value is going to be, you roughly know what you are going to be paying and that's something that the members like, you know, they like the predictability of knowing roughly what they are going to be paying."

19. Similar comments about the importance of local taxation being predictable were made in a submission to us by the Scottish Retail Consortium.

20. Business representatives also referred to the potential administrative difficulties that might apply in operating a tax on profits. In particular, the question of transfer pricing bedevils tax calculations at all levels.

21. The potential difficulties and costs in collecting the tax were also referred to by some local authorities. Another concern was the fact that the yield from a tax on profits would be less predictable than the present non-domestic rates system. A tax on profits in principle should have an element of buoyancy.

Land value taxation

22. In our discussion about property tax options (see section11), we considered the land value tax model. One of its potentially beneficial effects is in relation to vacant and derelict land.

23. In that respect, insofar as it aims to encourage appropriate development of medium- and large-scale parcels of under-utilised land, a land value tax is perhaps more obviously appropriate as a tax on business than on domestic households. The proposal for a business tax that was based on land value taxation was supported by the Scottish Green Party and by the Scottish Liberal Democrats, who suggested that it might be tested through a pilot. There is no reason why any property tax cannot be applied to vacant or derelict land to incentivise its optimal use.

24.RICS Scotland said that, while they agreed that tax models should be reassessed from time to time, changes to the existing system should only be taken where there are overwhelming reasons in terms of such factors as clarity, fairness and ease of collection.

25. We agree with the Scottish Liberal Democrats that the effects of a land value tax might be tested through pilot work before general implementation was considered.

26. We note the recent recommendation in the review of housing supply by Kate Barker for HM Treasury, ²⁶² that a planning gain supplement should apply to landowners on the granting of planning permission, to capture for the community some of the gains that accrue.

27.HM Treasury has consulted on this recommendation and expects to report by the end of 2006. ²⁶³ We look forward to seeing the outcome of this consultation.

28. In relation to business taxation, non-domestic rates is a system which is clearly understood and broadly accepted by most non-domestic taxpayers. In the face of limited demand for change in a system which appears to work well, we do not recommend the replacement of the existing non-domestic rates system, although we would recommend giving authorities the power to tax vacant or derelict land and property.

Level of Tax

29. A number of submissions from business interests referred to the higher rate poundage that applies in Scotland, compared with that in England. In the report about the deliberative focus groups, GfKNOP also reported strong criticism by those paying business rates about the level of non-domestic rates.

30. However, this debate has since been overtaken by events following the First Minister's statement in September 2005 that the Scottish Executive proposes to bring the Scottish poundage in line with the English one as quickly as possible. ²⁶⁴ As indicated in section7, COSLA did not press for re-localisation, taking the view that "having a uniform business rate is a sensible approach [to provide] a level playing field throughout Scotland".

31. We have not considered the future of the Small Business Rate Relief Scheme which was the subject of a recent separate evaluation undertaken by DTZ Pieda Consulting on behalf of the Scottish Executive ²⁶⁵). Evidence there suggests that a negative relationship might apply between non-domestic rates and property rents. ²⁶⁶ Any decrease in no-domestic rates could be offset in whole or in part by an increase in commercial rent.

Other Proposals

32. A number of respondents have commented on the possible role of BIDs (Business Improvement Districts) and on the scope for encouraging local authorities to retain money flowing from rates buoyancy. In England, LABGI (Local Authority Business Growth Incentive) schemes have been introduced with that in mind. We have considered a proposal for a tax directed specifically at some or all of the tourism industry, with a view to raising revenue specifically for the tourism industry.

BIDs

33. A Business Improvement District ( BID) is a precisely defined geographical area of a town, city, or commercial district, where businesses vote to invest collectively in local improvements resulting in improved economic performance. BIDs are developed, managed and paid for by the business sector by means of a compulsory BID levy on each business's non-domestic rates bill.

34. Before agreeing to fund the additional investment, the businesses themselves will decide how their money will be spent and how much they are prepared to pay. Each business liable to contribute to the BID will be able to vote on whether or not that BID goes ahead.

35. A BID can be established wherever additional services to those which the Local Authority provides are desired by the local business community. It could be located in a town centre, in one or two particular streets or an entire city centre area. Equally it could be located in an industrial estate, business park or even, if there is sufficient business support, in a sparsely populated area.

36.BIDs have operated with apparent success in England and abroad (notably the USA). For example, a BID in Union Square, New York City provides supplemental sanitation, graffiti removal, public safety and promotional services for the district. Another BID in Philadelphia has introduced successful maintenance, crime prevention and marketing projects.

37. In Scotland, we understand there is some support in principle for the concept in Scotland, based on responses to a 2003 consultation by the Scottish Executive, ²⁶⁷ provided there was a clear need for additional services and the benefits for businesses paying the BID levy were clearly identifiable. However, the Federation of Small Businesses in Scotland expressed concern that the scheme could turn into an expensive exercise that did not produce positive results for business. In oral evidence to us, they explained that, while BIDs should not duplicate baseline services, there exists nothing formal that explains exactly what benefits businesses should be entitled to receive as part of these baseline services.

38. The Executive is planning to implement BIDs nationally in April 2007. It is sponsoring a series of 6 pilot projects across Scotland in 2006-07. ²⁶⁸

39. The introduction of these schemes, if properly implemented, should provide an opportunity to bring specific benefits for local businesses and the broader community alike. BID schemes also might help to develop an ever more constructive and proactive relationship between councils and the business community.

Rates buoyancy and LABGIs

40. At present, the 3 year funding settlements for local authorities include in the annual totals estimates of income that each council will be expected to receive from non-domestic rates. In practice, the actual income that councils collect will vary year-on-year, not least as a result of changes in business conditions. Where actual non-domestic rate receipts fall short of the estimated income, the Executive meets the shortfall, supplementing local government income from the funding available to it. The corollary is that, where actual income exceeds estimated income, the Executive retains the surplus.

41.COSLA have argued that monies flowing from non-domestic rates buoyancy should be made available to councils - in other words, that local authorities should be able to retain non-domestic rates receipts where they exceed the estimated total. On a related issue, both Glasgow City and City of Edinburgh Councils have expressed criticism that they collect more non-domestic rate income than they receive from the non-domestic rate income pool. They suggested that local authorities should be able to retain a proportion of the growth in rates income.

42. The Government in England has recently introduced LABGI (Local Authority Business Growth Incentive) schemes, which enables local authorities to retain a share of additional non-domestic rate revenues they collect, as an incentive to stimulate local business growth. CBI Scotland and the Scottish Chambers of Commerce have expressed support in principle for a similar scheme in Scotland, while noting that there are complex issues.

43. We recognise the appeal of a LABGI scheme and that such a scheme could provide an incentive for councils to promote business and to improve non-domestic rate collection rates further. However, care would have to be taken to ensure that the benefits for local authorities arose from stimulating new business activity, and not from displacing existing business activity from other areas in Scotland.

44. We equally recognise the arguments that exist that cities in Scotland and overseas are the principal engines of economic growth and that a nation as a whole benefits when the economies of its major cities are healthy. The Scottish Executive already operates the Cities Growth Fund for the City-Regions in Scotland, currently worth around £40m per year, to support capital investment, to improve the urban infrastructure and to contribute to the regeneration of each city and City-Region. Although it takes the form of ring-fenced Executive funding, it appears to fulfil similar goals to those of LABGIs. We note that City-Regions are required to produce investment plans and to consult with neighbouring local authorities and other public and private sector stakeholders across each City-Region.

A tourism tax

45. City of Edinburgh Council put forward a strong argument in favour of an enabling power for local authorities to impose a levy on tourism-related businesses. They argued that council investment in their festivals held in August and December/January have helped to boost hotel occupancy rates. However, present non-domestic rates arrangements prevent local authorities which invest in tourist-related activities from benefiting from that investment, as the returns of any increases in the rateable values of visitor-orientated facilities that arise from increased tourism activity are channelled into the national non-domestic rate pool and redistributed across Scotland. City of Edinburgh Council proposed a discretionary power for local authorities, intended for use at times when visitor numbers - and council investment in tourism - are at their strongest.

46. A sample survey of enquiries we made to a number of hotels and guest houses in Edinburgh confirmed that prices quoted for August are often substantially higher than at other times of the year (in our sample, we compared prices for October). Many of the hotels belong to multi-national chains and it is questionable whether much of the proceeds from these mark-ups is retained within the local economy, or even within Scotland.

47. There is a question as to whether a local authority should be given a discretionary power to apply a tourism tax on accommodation or other tourist-orientated facilities in its area. We recognise the merits of the City of Edinburgh Council's argument and are minded to support the suggestion.

Conclusions

48. There are sound reasons for retaining non-domestic rates as the basis for local business taxation. Taxes on property are relatively inelastic, so the yield from non-domestic rates should be reasonably stable and predictable in the face of changing levels of business profitability or adjustments to tax rates. For businesses this has the disadvantage that their tax payment does not vary according to their ability to pay ( i.e. their profitability). However, we were struck by the fact that business representative groups to whom we spoke considered that their members would prefer this situation to one where profits were subject to local taxation.

49. A uniform or similar rate of tax applying across the country can amplify differences in occupancy costs between high-cost and low-cost areas, providing a heightened incentive for firms to locate in low-cost areas. ²⁶⁹ This can be a valuable economic device for those parts of Scotland that face urban deprivation or rural isolation.

Recommendation 12: We recommend that non-domestic rates should be retained as the basis for local business taxation.

Recommendation 13: We recommend that the non-domestic rate should continue to be set by the Scottish Executive.

Recommendation 14: We recommend that non-domestic rates should be extended to vacant or derelict land, as an incentive for re-development.

Recommendation 15: We recommend that consideration should be given to introducing a discretionary power for local authorities to apply a tourism tax.

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