Tax Increment Financing takes a step forward in England 

September, 2011 - Euan Murray

The government has recently published a consultation document seeking views in relation to its proposals for business rate retention ("BRR") in England and options for enabling local authorities to carry out Tax Increment Financing ("TIF") within the business rates retention system.  The business rates consultation may interest developers, the public sector and those involved in renewables or regeneration, particularly those considering Tax Increment Financed projects.

The BRR Model

The consultation sets out the government's proposals for the implementation of a new BRR model.  Currently Business Rates are not retained in the area in which they are paid, rather they are aggregated centrally by Treasury and then redistributed to each authority by way of a formula grant.  It is therefore possible under the current system for a local authority to receive less income under the formula grant than it actually collects.  The converse can also be the case, where some local authorities receive a larger amount of funding than the rates they collect within their area. 

The government consultation proposes amending the current system so that local authorities will instead be able to directly retain a proportion of the business rates generated within their areas and envisages that the ability to retain business rates at a local level should act as strong incentivisation for local economic growth.  The consultation does not specify what that proportion would be.    

As some authorities collect business rates in excess of their current formula grant, the government proposes setting a baseline for each authority at the outset of the new scheme so that authorities do not see a significant reduction in their revenue, which would in turn have a detrimental impact on service delivery in that area. 

In order to achieve the right balance, the government proposes introducing a tariff/top-up scheme.  Where an authority collects business rates above its baseline, it would pay the difference to the government in the form of a tariff.  Where an authority collects a level below the baseline, the government would pay a top-up grant to that authority.  In the short term, the rates retained under the new model proposed by the government are therefore unlikely to be radically different to the sums most authorities currently receive. The consultation does, however, offer the opportunity for authorities to comment on the factors that should be taken into account in setting the baseline, as well as the tariff and top-up mechanism, and authorities may wish to consider this carefully and use their response to seek to maximise the sums retained locally.

Currently the rateable value of each property is re-valued, based on rental value, every five years and this determines the level of Business Rates payable.  This could, of course, have a significant impact on the level of collectable rates.  As such, the consultation proposes that the tariff/top-up mechanism is adjusted every five years at the same time as the revaluation in order to mitigate this risk and ensure that the sum of the rates retained by the local authority and the tariff or top-up remain the same in real terms as they were before the re-valuation was carried out.

The new model also includes the concept of a levy to recoup a share of any disproportionate growth achieved by authorities as a result of the new scheme.  Where an authority with a high business rate taxbase receives disproportionate financial gains through the retention of business rates, the government plans to recoup part of that by imposing a levy on that authority.  The consultation suggests that the proceeds of the levy would be used by government to manage negative volatility in individual authorities' business rates and therefore ensure stability in the new model.  Central government also indicates it will retain an option to 'reset' the system, intended to allow it to address irregularities in the system, such as substantial shifts in population.  Both a partial reset against the baseline position and a full reset of the entire system are outlined as potential options in the consultation and it also raises the question of whether the government should set a fixed period for resets or not.

The new model is intended to incentivise growth through the retention and reinvestment of increases in Business Rates within an authority's area, however, this incentive is somewhat off-set by the levy and reset functions the government is retaining which could penalise those authorities that achieve very high local economic growth.  Authorities may therefore perceive these tools as a barrier or disincentive.  The consultation offers the chance to comment on both of these mechanisms and authorities should consider their impact carefully when responding. Authorities should use the consultation as a means to try and influence the outcome to enable retention of the greatest share of Business Rates possible within their area and therefore maximise the potential for local growth.

Pooling within the BRR Model

One of the more interesting concepts highlighted in the consultation document is the opportunity for groups of authorities to 'pool together'.  This provides an interesting mechanism for authorities to consider as it may smooth out some of the volatility in Business Rates across the relevant areas and the government envisages that it may result in some authorities achieving an increased level of income through collaborative effort and making use of efficiencies across the pool's collective area.  There would be a single top-up or tariff applicable to the pool (which would be the sum of each individual authority's top-up/tariffs) and a single disproportionate benefit levy.  It states that the government is keen to promote the use of pools and is considering whether additional incentives should be available in pool scenarios, such as allowing the pool to retain a higher level of Business Rates than the authorities would be entitled to individually. 

Although an interesting concept, which provides substantial potential for authorities to collectively generate economic growth across their areas, pooling is likely to give rise to difficult issues.  The consultation itself highlights that authorities within such a system would need to agree how the rates retained would be allocated, what contribution to the tariff is to be paid (or what proportion of any top-up is to be received) by each member and what proportion of the levy is to be attributed to each member.

Pooling offers the potential to introduce a real regional dimension to the retention of Business Rates.  It would allow Councils to group together within a regional area and circulate the revenues received around that wider area to achieve the best outcomes.  This has the potential of allowing the utilisation of greater funds in areas that need more investment, for the benefit of the entire region.  Any authorities interesting in pooling together should commence discussions with their regional partners now, in order to use the consultation to the greatest effect, identifying collective issues and concerns so that they can be addressed now and seeking to secure the best possible incentives.

Enterprise Zones ("EZ") and Government's Renewable Energy Commitment

Areas that are allocated EZ status will benefit from:

  1. A business rate discount of up to £275,000 per business over a 5 year period; and
  2. Additional rates generated in the EZ being retained by the Local Enterprise Partnership for at least 25 years for local reinvestment purposes.

Subject to government proposals being introduced, TIF may be linked to EZ status in order to fund key infrastructure in an EZ, but it is ultimately a separate scheme. Critically, under the proposals outlined in the government consultation, TIF would also be available outwith the EZ.

Under the government's renewable energy commitment, any communities that host "renewable energy" projects will be allowed to retain the additional business rates generated. The government therefore proposes allowing local authorities to retain all of the business rates generated from new renewables projects in their area, and that those sums would be discounted in the calculation of the levy to be applied against Business Rate growth.  This commitment will operate separately from EZs and TIF.

The operation of TIF within the wider BRR model

TIF is effectively a mechanism that allows a local authority to utilise future increases in tax revenues (such as increases in Business Rates) to finance improvements in enabling infrastructure now, which should stimulate planned regeneration development within a defined boundary.  The mechanism enables a local authority to raise finance for a development against the incremental increase in taxes that commercial development will produce.

In Scotland, TIF is moving forward quickly. In March this year, the Scottish Government issued a news release confirming that John Swinney, the Scottish Government's Cabinet Secretary for Finance, had granted provisional approval to North Lanarkshire Council to utilise TIF for phase two of the Ravenscraig regeneration project.  The investment was stated to be £73 million with the potential to unlock £425 million of private investment in the area.  The same news release also confirmed that the City of Edinburgh Council's pathfinder TIF project, was also formally agreed between the Scottish Ministers and the Council. 

In 2010 central government also confirmed that it was committed to introducing TIF in England and the consultation proposes two options for the operation of TIF within the government's proposed new business rates retention system.  The two options pivot around the concept of the disproportionate benefit levy:

  1. The first option would allow local authorities to decide for themselves whether to enter into a TIF scheme or not. The additional business rates generated would be retained by the respective local authority but would be subject to the disproportionate benefit levy applicable to the business rates retention system as a whole. The rates retained would also be subject to the tariff/top-up system, and would be vulnerable to adjustment for revaluation or reset in order to maintain sufficient stability within the wider rating system. Access to a TIF scheme under this option would be unrestricted but the potential loss of a portion of the additional rates to the levy/reset is a risk that may limit the number of participants.
  2. The second option is a variation of the first option, which  limits access to TIF, so that local authorities that wished to invest in a TIF scheme would require central government approval. Once a local authority had been approved for a TIF scheme, they would retain any additional business rates generated from the TIF project for a defined period of time. Unlike the first option, the retained rates would not be subject to the disproportionate benefit levy, and would not be considered in assessing tariffs/top-ups.

Certainty would benefit both the private and public sector and the second option might better deliver this. The public sector needs to be clear on the costs involved in order to develop a TIF project and their 'Plan B' if additional rates do not flow as expected to.

Some key points on TIF for developers:

  • Although local planning decisions are made independently from business rates factors, the financial incentives and potential benefits of TIF schemes to local authorities may be a major factor in influencing planning decisions. This may be of particular advantage to developers of commercial space or renewable energy projects, which can struggle to gain planning consents and should allow developers to engage in more detailed forward planning, for example, seeking to influence the boundary of a TIF scheme or including non-contiguous areas.
  • Early engagement with local authorities that are considering TIF schemes may prove fruitful to developers. Developers who are prepared to structure affordable and deliverable commitments relating to proposed TIF infrastructure projects could be influential in local authorities' decision making process regarding demarcation of TIF areas and whether the local authority should progress its TIF project.
  • Developers who engage with local authorities in relation to TIF schemes should be aware of the national and EU procurement rules that a public body is bound by, and the risks to the developer if these are not adhered to. Confidence that the local authority can manage the state aid and procurement rules will be important to provide confidence for the private sector incurring costs at all.
  • Given the recession and ensuing number of repossessions of property by lenders, TIF projects may also give banks the opportunity to improve the position of "their" less attractive assets that are currently not viable for development.

Some key points on TIF for Local Authorities:

  • The local authority must be careful to ensure that the TIF plans do not advantage any local companies in such a way that would constitute unlawful state aid, i.e. the TIF project must not favour a particular undertaking in a way that distorts trade or competition.
  • Local authorities will need to be comfortable that there will be a genuine sustainable increase in business rates within the boundary of the TIF rather than simply displacement of business from (nearby) areas into TIF zones.  Where the second option proposed in the consultation is adopted, displacement is likely to be a key consideration for central government in approving a proposed TIF scheme.  Where authorities proceed with option 1, and elect to proceed with a proposed scheme, displacement will still be a key consideration.  Under the new BRR model the authority retains a proportion of the Business Rates across its entire area, and measures to combat displacement must be considered in detail. Without them, it is possible that although the income from Business Rates increases within the TIF zone, the authority's income from Business Rates outwith the TIF scheme falls by the same amount (or worse still by more), thereby destroying the overall benefit to the authority.
  • In order to prevent unnecessary problems or unexpected costs arising from TIF projects, local authorities should ensure that they follow national and EU procurement rules in respect of advertising and tendering so that any contracts entered into are effective under national and EU law. The private sector property developer is also more aware of the risks it faces if the public sector is (successfully) challenged.
  • TIF projects by nature, require public assistance to enable viable private sector development.  The public sector may wish to consider ensuring a level of binding commitment and anchor development agreements before proceeding with a TIF, together with tangible contractual remedies where the private sector fails to develop quickly enough, or worse, fails to develop at all.

Although TIF is by no means a silver bullet, when viewed alongside the wider BRR Model, it will give local authorities a new tool to consider in plugging the funding gap that many are now facing following the  government's public sector spending review.

For further information please email [email protected].



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