The City of Calgary. Customer and Implementation Issues Arising from Business Tax Consolidation

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1 The City of Calgary Customer and Implementation Issues Arising from Business Tax Consolidation

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3 Table of Contents Introduction... 1 A. Implementation time frame... 3 B. Council s zero per cent business tax rate change policy... 5 C. Grants in lieu of property tax... 8 D. Vacancy...10 E. Vacant land...15 F. Partially developed property...18 G. Gross leases...20 H. Tenant defaults...23 I. Landlord property tax allocation administrative fee...25 J. Business tax exemptions...26 K. Machinery and equipment...29 L. Business revitalization zones...31 M. Assessment complaints...33 ISC: Unrestricted i

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5 Introduction In an effort to streamline Calgary s taxation system, reduce the administrative burden on business and to improve economic competitiveness, City Council directed Administration (via Notice of Motion NM ) to initiate an investigation as to whether business tax revenues could be consolidated with, and generated by, the non-residential property tax. At the 2011 October 05 Standing Policy Committee on Finance and Corporate Services meeting where the resultant report (FCS ) was presented, the main topics of discussion were the customer and implementation issues associated with consolidation. These issues are significant in that they will shape the environment in which a consolidated tax operates. Therefore, at its 2011 November 07 meeting, Council directed Administration to initiate a process to develop a framework for consolidation that: seeks stakeholder input makes recommendations on the customer and implementation issues arising from consolidation develops an implementation plan with a transition time frame and a communications plan The Notice of Motion, the report, and the associated minutes for each, are available online at calgary.ca/btc. As the next phase in this process, this paper is designed to inform stakeholders about the potential issues arising from the consolidation of business tax revenues with the non-residential property tax and the available options to address these issues. The facts and figures herein are based on data from 2011 unless otherwise referenced. All costs quoted are only Administration s best estimates to assist with policy considerations and are subject to change. A preliminary version of the paper was sent to industry organizations to ensure that the issues and options were fully described. Further, a survey, which complements this paper, has been designed to gather stakeholder views regarding the issues identified in this paper, it is available online at calgary.ca/btc. It must be emphasised that this paper, and the associated survey, do not presume that business and non-residential property tax consolidation will occur; rather, they are for the purpose of making recommendations to Council in March 2012 about significant parts of the framework for a potential consolidated tax environment. Stakeholder input on the issues in this paper, and the larger tax policy issue of whether there should be a consolidated business and non-residential property tax environment, will contribute to Council s decisions on the overall tax policy issue, as well as the analysis of individual issues in this paper. The options in this paper are presented for discussion and potential policy setting purposes, allowing for stakeholder consideration of the issues associated with consolidation. These options may not represent all possible options for any one issue, and, should consolidation occur, and a particular option is pursued for future policy purposes in a consolidated environment, the option presented in this paper may not fully represent the final and actual form that policy may take. ISC: Unrestricted 1

6 The current system The City of Calgary administers two real estate based taxes. They are the (1) non-residential property tax, and (2) business tax. In theory and practice, the non-residential property tax and the business tax have many similarities. Both taxes use real estate values to establish assessments and apply taxes. They are both levied predominantly on owners or occupants of non-residential real estate, and are often applied to the same physical space. Through its discretionary authority under Municipal Government Act (MGA) Section 371, Council is able to choose whether it will apply a business tax, by passing a business tax bylaw. Non-residential property taxes are generally levied on owners of non-residential properties, whereas occupants of business premises are subject to business taxes. The practical and simplified reality is that both taxes are generally funded by the same person; i.e., the person occupying and using the property and business premises, if applicable. In the case of an owneroccupied property that is used for business purposes, the property owner would pay both property and business tax. In the case of a business tenant occupied property, the business tenant(s) would receive business tax notices and pay business taxes. Additionally, the property owner would receive and be liable for property taxes, though would generally apportion the property taxes to any business tenant(s). A main distinction, therefore, lies in who is legally liable for tax payment. In the case of the property tax, taxes are more secure as municipalities have the ability to sell property to recover the outstanding taxes. In 2011, Calgary had approximately 14,000 taxable non-residential property tax accounts, and approximately 25,000 business tax accounts. The 25,000 business accounts are currently located on approximately 8,700 of the 14,000 taxable non-residential property accounts. In 2011, including growth and contingency provisions, The City will levy approximately $928 million in municipal and provincial non-residential property and business taxes. Of that $928 million, the non-residential property tax accounts for $721 million (78 per cent), and the business tax accounts for $207 million (22 per cent). The non-residential property tax is subject to budget related increases by City Council while there is a Council directed zero percent business tax rate increase policy. Over time the effect of this policy is that business taxes decline as a proportion of municipal and provincial property and business tax revenue. While the business tax is not applied uniformly among non-residential properties, it could be said that the typical non-residential property and business taxpayer s combined property and business tax payment is made up of 78 per cent in non-residential property taxes and 22 per cent in business taxes. This typical taxpayer example is provided for explanatory simplicity. Dependent on a number of factors, each taxpayer s circumstances will be different. Based on 2011 information the non-residential tax rate would rise 29 per cent when the business tax is fully consolidated. In cases where there is a taxable business operating on a property, this 29 per cent increase will be offset by the elimination of business taxes. Calgary is not the only jurisdiction to have considered this tax policy issue. Both Nova Scotia, which uses an annual cycle, and Edmonton, which is subject to the same enabling legislation, have recently considered the issue and decided to proceed with consolidation in 2003 and 2008 respectively. ISC: Unrestricted 2

7 A. Implementation time frame Issue As part of the implementation plan, it is important to use the appropriate time frame to ease the transition from a dual tax environment to a single tax environment, so that any tax changes due to consolidation are manageable for property owners. Background The initiating Notice of Motion (NM ) and subsequent direction from Council has been that Administration should prepare a time frame for consolidation of up to ten years for implementation. As a matter of implementation, the consolidation of the two taxes would only require that The City begin raising the revenues that were formerly raised by the business tax system using the non-residential property tax system and so it may be possible to consolidate with no phase-in period. Edmonton implemented their consolidation with no mitigation programs other than a four year transition time frame. Nova Scotia consolidated with limited mitigation programs over an eight year timeframe. A longer implementation time frame will ease the shift in taxes among non-residential properties due to consolidation. This benefit will come at the cost of a lower return on investment in the business assessment and taxation system. Such a time frame would mean that the same program that collected $207 million in taxes in 2011 will be used to collect the equivalent of 10 per cent of that $207 million in In addition, over a ten year time period, the transparency of administrative savings will be lessened as the Assessment business unit will continue to grow in order to accommodate an expanding property / business inventory. Option I. Implement the consolidation of business tax revenues with the non-residential property tax over a period of up to 0 to 4 years starting in 2013 Immediate phase-in is possible. Among the different timeframes, a shorter time frame will maximize the return on investment in the business assessment and tax program, any tax increase due to consolidation becomes less manageable for affected non-residential property owners and consequently demand for other mitigating programs will rise. The administrative cost savings achieved will be more obvious with a shortened implementation time frame. The cost of any mitigating programs, from a tax increase perspective, would be phasedin over the course of a shorter phase-in period. II. Implement the consolidation of business tax revenues with the non-residential property tax over a period of up to 5 to 7 years starting in 2013 ISC: Unrestricted 3

8 Return on investment in the business assessment and tax program starts to deteriorate as the time period for implementation is extended. As the time frame is lengthened, any tax increase due to consolidation becomes more manageable for affected non-residential property owners reducing demand for mitigating programs. The administrative cost savings achieved will be less obvious as the implementation time frame is extended. The cost of any mitigating programs, from a tax increase perspective, would also be phased in over the course of a longer time period. III. Implement the consolidation of business tax revenues with the non-residential property tax over a period of up to 8 to 10 years starting in 2013 Return on investment in the business assessment and tax program will deteriorate significantly as the time period for implementation is extended up to 10 years. As the time frame is lengthened, any tax increase due to consolidation becomes more manageable for affected non-residential property owners. The administrative cost savings achieved will be much less obvious as the implementation time frame is extended closer to 10 years. The cost of any mitigating programs, from a tax increase perspective, would also be phased in over the course of any phase-in period making them much less costly in the initial phases of consolidation. ISC: Unrestricted 4

9 B. Council s zero per cent business tax rate change policy Issue Council implemented a zero per cent tax increase (tax freeze) policy on business tax revenues which has been in effect for the past 19 years. The effect of this policy is that when Council s budget requires a municipal tax rate increase, it is generated from property tax rate increases, not from business tax rate increases. One of the primary concerns expressed by stakeholders about consolidating business tax revenues into the non-residential property tax is that the benefit of this policy to the business owner will disappear. This concern is based on an assumption that the Council approved tax increase to the non-residential property tax would also be applied to the former business tax revenues that have been consolidated. Background Since 1994, and included in the business plans and budgets, the total municipal revenue generated from the business tax only increases when there is growth in the tax base meaning when new businesses open or existing businesses expand. Year to year, the total revenue that The City gets from existing business tax accounts does not increase. Today, when Council approves a municipal property tax revenue increase, this increase is distributed by the same per cent change to both the residential property tax and non-residential property tax. A zero per cent increase is applied to the business tax rate, in accordance with Council s policy. This has the effect that the business taxpayer will not see an increase in their tax bill year over year, outside of fluctuations in the reassessment process (increases or decreases in the net annual rental value). In 2011 for example, the overall tax increase was 4.4 per cent for both residential and non-residential properties. The overall tax increase for businesses was zero. Council s July 04 Notice of Motion (NM ) directed that Council s zero per cent business tax rate change policy would continue in a consolidated environment. Administration has determined that the zero per cent business tax rate change policy could be replicated in a consolidated business and non-residential property tax environment. Options I. Apply Council s current practice of setting the non-residential property tax rate to any consolidated business tax revenues Applying the current practice would eliminate the effect of the zero per cent business tax increase policy. It would mean that the $207 million in business tax revenues that were collected in 2011 would be transferred to the non-residential property tax with no adjustment to how property tax increases are currently applied. If this option is pursued, revenues formerly from business tax would be subject to Council approved budget increases, where currently the business tax is not subject to budget related increases. Therefore, the $207 million in business tax revenues that have not been subject to a Council approved increase would, once consolidated, be subject to the same tax rate increase that Council approves for property tax. ISC: Unrestricted 5

10 No change to current tax practice relating to the application of increases to the nonresidential tax rate. Former business tax revenues become sensitive to Council approved increases in the property tax rate. Businesses would not continue to receive the zero per cent business tax rate change policy benefit. Does not align with the Notice of Motion (NM ) that initiated discussions on the consolidation of business tax. No additional program or administrative costs expected. II. Council s zero per cent business tax rate change policy would continue to apply to the business tax amount transferred to the non-residential property tax In choosing this option, the effect of the zero per cent business tax increase policy would continue to apply to the consolidated business tax revenues. The benefit, however, would be spread among all 14,000 non-residential property owners and not be confined to the business owners located on 8,700 properties. This would effectively mean that non-residential property taxes would increase at a lower rate than residential property taxes. This change could be incorporated into existing tax rate setting processes and methodologies, and is therefore anticipated to be able to be accomplished with no additional program or administrative costs. To continue the application of the zero per cent business tax rate a few additional steps will be required during the process of establishing tax rates. 1. The business tax amount would first be separated out of the revenue neutral nonresidential property tax base. This amount would be equal to the previous year s business tax amount plus a provision for physical growth based on growth in the nonresidential tax base. A zero per cent municipal tax inflation increase would be applied to this amount, resulting in the first part of the levy. 2. Next, the Council-approved tax rate increase would be applied to the base municipal non-residential property tax amount. That is, the remaining non-residential property tax base. The total municipal levy required from the non-residential property tax base is equal to the sum of these two values. 3. The municipal non-residential property tax rate would be calculated the same way that it is now: the levy required would be divided by the total non-residential property assessment base. Similarly, the municipal residential property tax rate would be calculated as it is now: the levy required by Council would be divided by the total residential property assessment base. 4. The non-residential tax rate that results would be lower than if the tax rate change was applied to the entire non-residential property tax base and it would be lower than the municipal residential property tax rate change. This is because the inflation increase is spread over a broader tax base for non-residential property than it would be otherwise. Consistent with Council s direction in NM A portion (12 per cent) of City tax revenue is not sensitive to inflation. ISC: Unrestricted 6

11 Would continue the beneficial effect of the policy to business owners, though it would be applied through the non-residential property tax rate, which is attributable to nonresidential property owners. The continued benefits will be shared across the entire non-residential property tax base as opposed to being targeted directly at businesses. The City of Calgary continues to be able to communicate and market a business-specific tax policy benefit. No additional program or administrative costs expected. ISC: Unrestricted 7

12 C. Grants in lieu of property tax Issue One of the questions raised about consolidation is whether the federal and provincial governments, along with a railway company, will increase their grant payments. An additional $3.2 million on top of their current $8.7 million level would be requested due to the projected increase in the non-residential property tax rate. Background Instead of taxes, the federal and provincial governments, and one railway company, pay grants in lieu of taxes. The grants are equivalent to the amount of property tax that would otherwise be paid on the property they hold. They are not subject to business assessment; nor do they pay business taxes. Consolidation, if fully implemented, could mean a 29 per cent increase in the grant amounts that they would pay to The City. Combined, this increase would be $3.2 million, based on 2011 assessment and tax information. The Notice of Motion (NM ) that initiated discussions on business tax consolidation directed that consolidation be revenue neutral to The City, meaning that no more or less revenues be generated by the change. Letters were sent to both governments and the railway company, requesting confirmation that they would pay increased grant amounts in a consolidated environment. The federal government responded that it would pay any increase that is mandated by the Payments in Lieu of Taxes Act, essentially confirming that it would pay increased grants due to consolidation. The provincial government responded that it did not yet have enough information and any increase in the grant amount would be subject to budgetary consideration. The City has provided additional information requested and is working with the province to make sure they have all the information needed to make a decision. The railway company has yet to respond to The City s request. The City of Edmonton was paid increased grant amounts by the two levels of government when it consolidated its business tax revenues with the non-residential property tax. Administration believes that, with a phase-in period, there is a high likelihood that the province would pay increased grants. To do otherwise would mean inconsistent practices among Alberta municipalities. If the province and the railway company do not increase their grants, The City will pursue appropriate options, if available, to encourage full payment of grants. If the two levels of government and the railway company do not increase their grants the related benefits ($3.2 million) will not be realized by the non-residential property taxpayers. Option I. Government and railway granting bodies provide additional grants to reflect an increased non-residential property tax rate after consolidation The amount of non-residential or business tax to be collected is a Council decision. Once set, those taxes must be distributed among taxpayers. If consolidation were to have occurred in ISC: Unrestricted 8

13 2011, grant payers would have been expected to pay $3.2 million in additional grants. This would mean that non-residential taxpayers would have paid $3.2 million less in taxes in Would result in $3.2 million in additional grants by the two other levels of government and the railway company. Would provide $3.2 million in tax relief to non-residential property owners / taxpayers except for the two other levels of government and the railway company. City revenues would not increase by the increased amount of grants received. No additional program costs are expected. ISC: Unrestricted 9

14 D. Vacancy Issue Property owners are concerned about potential increases to non-residential property taxes on vacant space in a consolidated tax environment. Currently, the business tax is not levied on unoccupied space. Property owners believe they may see increased taxes attributable to spaces from which no income is being generated; these increases would be paid for by the owners themselves or allocated among tenants who occupy the rest of their property. Background Business assessment and taxation is based on occupancy. Vacant space in a building is not subject to business assessment and, accordingly, business tax. Vacancy for the purposes of this paper is defined as space that is not leased, physically vacant and not committed. In a consolidated environment, former business tax revenues would be allocated in the same way as the current non-residential property tax revenue is allocated. This would result in the business tax revenue (1) being generated from a greater number of taxpayers because there are 14,000 properties versus 8,700 properties with businesses, and (2) based on property assessments which include a vacancy factor. This vacancy factor is either a typical vacancy factor when properties are assessed using the income approach to value or, where the sales approach is used, applied to the extent it is recognized in the real estate market through analysis of sales. As such, non-residential property assessments recognize vacancy, yet in more of a typical fashion than the direct method applied through the business assessment process. An example of the application of typical vacancy is provided in the following paragraph. Vacancy allowances are calculated on an annual basis as they are a key component in determining income based assessments. Vacancy allowances used in the income approach are prepared using information collected through the Assessment Request for Information process as well as market reports prepared by external real-estate companies. The typical vacancy for a specific property type is established (for example, class AA office buildings in the middle of downtown). Then, the property assessment is, in effect, reduced to arrive at a market value that accounts for the estimated vacancy. The taxes payable are correspondingly reduced. Atypical properties with characteristics that lead to a consistently higher vacancy rate over an extended period of time are adjusted accordingly. This policy works effectively for the current nonresidential property assessment and tax program which constitutes 78 per cent of the total municipal taxes. The other 22 per cent is the portion currently attributable to business tax. Concerns have also been expressed that if an unexpected and extreme economic downturn causes vacancy levels to increase to unmanageable levels mitigation may be required. At the meeting of the 2011 October 5 Standing Policy Committee on Finance and Corporate Services, stakeholders referenced Ontario s vacancy rebate program as a possible mitigation strategy for this issue. A program like this would fully rebate the additional property tax that an owner would have to pay, as a result of consolidation, if a non-residential space is vacant for more than 90 days. ISC: Unrestricted 10

15 The Ontario program has features that would not be possible to implement here without the intervention of the Alberta provincial government. These include the right of an applicant to file a complaint on a rebate decision and the right of the municipality to enter and ask for information with respect to an application for a rebate. Currently, in Alberta these rights exist with respect to assessments but do not extend further. In addition, the province of Ontario uses a 4 year assessment cycle which increases their need for such a program. In Calgary, where market value reassessment occurs each year, values reflect the year to year changes in typical vacancy across a range of property types and locations. Edmonton, which uses the same assessment cycle as Calgary, did not implement a mitigating program. Nova Scotia, which also operates on an annual cycle, did not pursue any mitigating strategies for vacant space either. Options I. Continue applying vacancy allowances in the preparation of property assessments to account for vacant space This option allows the non-residential property assessment and tax system to address the vacancy issue as it does currently. A vacancy allowance is applied to assessments for the majority (78 per cent) of the total tax applied to non-residential properties. This approach was adopted by Edmonton and Nova Scotia. By phasing consolidation in over a number of years, the impact of the shift of the vacancy allowance from the business tax to the non-residential property tax could make the transition much more manageable for affected property owners. The current vacancy allowance system, which is already applied effectively to the 78 per cent of assessment / tax on a property, compensates for the typical vacancy experienced by non-residential property owners and is capable of accommodating additional vacancy issues arising through consolidation. Through Calgary s annual, market value assessment system, vacancy allowances are built in through typical allowances, and are subject to inquiry to the Assessment business unit or complaints to the Assessment Review Board. Encourages property owners to seek occupants because the rate of tax will remain constant regardless of the tenancy. Some property owners with above typical vacancy may perceive this as a tax transfer to them, while property owners with typical occupancy levels may perceive this as appropriate as they would not need to fund, through a higher non-residential property tax rate, the costs of an additional vacancy program. Phase-in period would ease transition. No additional program costs expected. Property value (Billions) Proportion of base Ongoing program costs for all non-residential taxpayers ($ Millions) Capital costs for all non-residential taxpayers ($ Thousands) Option II. Implement a City-designed vacancy rebate program Alberta s legislation does not facilitate the implementation of a vacancy program similar to that currently in place in the province of Ontario. Administration has outlined a vacancy rebate program that may work within Alberta s legislative framework. ISC: Unrestricted 11

16 This option is to establish a vacancy rebate program for vacant space in circumstances where an individual property s vacancy is above the typical vacancy, and remains vacant for an extended period of time. Stakeholders consulted wanted to better understand how such a program might operate. To illustrate the potential effects of such a program, Administration has chosen a threshold of three per cent over typical vacancy and a period of over 90 days. These figures are hypothetical but necessary in order to understand the operation of such a program. It is estimated that, using the above parameters, approximately 1,600 properties would have qualified in The vacancy rebate would be applied to the municipal property tax, one of The City s key revenue sources. Assessment values, by provincial law, are based on the value of real estate on July 01 of the year prior to taxation. The tax rate is set in the following spring, based on these assessed values. If an economic downturn occurs after the tax rate has been set, the resulting increase in vacancy and vacancy rebates could have a significant impact on municipal revenues. From a taxpayer perspective, this is how the program would work: 1. The vacancy of the property is higher than the typical vacancy used in the assessment for that property type and area. 2. The property owner fills out an application detailing each of the vacant spaces. 3. An Assessment employee processes the initial application and performs follow up including phone calls and inspections, if necessary. 4. Each three month period thereafter, the property owner supplements their initial application with an update of the current vacant space on their property. 5. In December, the rebate amount is determined based on the information provided by the property owner over the course of the year (from December of the previous year to November of the current year). To implement the above rebate program, The City will need to process applications, carry out due diligence by follow-up phone calls and site inspections when permission is granted by the property owner. The City will also need to finance and pay out the rebates for each of the 1,600 properties estimated to qualify. The increased staff needed to administer the program, the increased funds needed to pay out the vacancy rebates, and the funds needed to establish a contingency fund for the purposes of paying unexpected vacancy rebates (in case of an economic downturn) would require The City to raise the non-residential property tax rate accordingly. Moreover, property types for which the assessments are not based on the income approach will require further study and analysis to develop typical vacancy rates. On the assumption that 2011 estimates of vacant space (1,600 qualifying properties) are correct, 2 the best estimates of overall program costs are expected to be just over $4.9 to $8.0 million dollars annually comprising $4.6 to $7.7 million dollars in rebates and $290,000 on operational cost for four FTEs in addition to those currently administering the business tax system. It is estimated that there would be no system upgrades at this time to implement this 1 This projection is based on a random sampling of 435 properties representing just over 5 per cent of the total population of properties where a business was assessed in The random sample was checked against the entire population to ensure that it was representative. 2 Again, knowing the actual incidence of vacant space that would qualify for the rebate is extremely difficult and so these estimates are, at this point, for illustration purposes only. ISC: Unrestricted 12

17 rebate program as Assessment would continue to use the software for the business assessment system to implement a vacancy rebate program. Based on 2011 information, once consolidation occurs it is estimated that affected nonresidential taxpayers will have to pay 29 per cent more in total property tax due to consolidation. The extra $29 on every $100 represents the business tax amount in the property tax. Currently this portion is paid through the actual business tax and is normally paid by either the tenant or the property owner, if they also operate a business on the property. The City would need to rebate 22 per cent of the consolidated tax to make the non-residential property tax equal to the $100 that is the current property tax amount. While all non-residential property owners would have to pay an elevated property tax rate to pay for the increase in administrative costs, the rebates themselves and the contingency fund, only owners with higher than typical vacant space on their property would benefit from the program. Owners of low vacancy buildings would receive fewer rebates while owners of higher vacancy buildings would see more rebates. In effect, owners of low vacancy buildings would be paying a subsidy to owners of high vacancy buildings. The rebate would be calculated in the following way after a completed application form is received by The City: 1. Finance would calculate the value of the property tax for the property, on an assessment of 5,000,000. $ 2. Assessment would deduct the typical vacancy (four per cent) plus the three per cent threshold from the actual vacancy rate (10 per cent) to get the percentage of space that qualifies for the rebate. 3. Multiply the result of #2 by the property tax and by the 22 per cent maximum rebate in order to calculate the rebate amount. 4. To get the final rebate, the full-year rebate amount ($681.31) would be prorated based on the percentage of the year, determined in days, that the space is not occupied. In this example, it is 120 days. 5. Finance would be responsible for paying out the rebate dependent upon both the time frame for consolidation and the proportion of the non-residential property tax made up by the business tax amount. Mitigates any potential increased tax on vacant space. Is an additional vacancy program, over and above an existing vacancy allowance program that is capable of accommodating vacancy issues arising through consolidation. ISC: Unrestricted 13

18 Could be perceived as a tax subsidy from property owners with typical or lower vacancy levels to property owners with higher vacancy levels. There will be administrative costs to property owners in the preparations of applications for assistance from the program. Compounds the revenue impacts of economic downturns. The City would have to build a contingency fund for unexpected levels of vacancy in the case of an economic downturn. Increased complexity for The City to administer the program. Could effectively reward for poor management of a property and sub-optimum space utilization. Administrative savings from consolidation are affected by program costs, the best estimates of which are: $4.9 to $8.0 million dollars comprising $4.6 to $7.7 million dollars annually in rebates and $290,000 in operational costs for four FTEs. Property value (Billions) Proportion of base Ongoing program costs for all non-residential taxpayers ($ Millions) Capital costs for all non-residential taxpayers ($ Thousands) Option 2 1, ISC: Unrestricted 14

19 E. Vacant land Issue Currently, non-residential vacant land attracts a lower rate of tax than other non-residential property owners because: (1) the property has a lower value and (2) generally, vacant land attracts only non-residential property tax and does not attract business tax. Consolidating business tax revenues with the non-residential property tax will mean that non-residential vacant land could attract more taxes than in the current environment. Background In 2011, 2,000 of the 14,000 properties subject to the non-residential property tax were vacant land properties and therefore not typically subject to business taxes. Owners of vacant land properties may be concerned that consolidation, and the effects associated with a higher nonresidential property tax rate, would be unfair to them. If these 2,000 properties were subject to the 29 per cent non-residential property tax rate increase required to recover business tax revenues, it would amount to an estimated tax increase of $12.5 million. The median tax change to these vacant land properties would be $1,650. The current non-residential property and business tax system, where owners of non-residential vacant land typically pay lower municipal taxes than owners of other types of property, may distort the economics of, and investment decisions in, the real estate market and provide an incentive to hold property longer before development. The market based assessment system for non-residential property tax is a neutral tax system. The amount of taxes paid is directly proportionate to the value of the property. Because nonresidential taxes increase as assessed value increases, the non-residential property tax system accounts for the incremental value that business operators bring to the property, as well as their corresponding impact and demands on municipal services. Adding an additional business tax on business operators creates a tax inequity that effectively penalizes business operators and benefits vacant property owners. By increasing the holding costs of land, consolidation may remove tax inequities and encourage faster development of both greenfield and brownfield parcels of vacant land. By phasing in consolidation over a number of years, the impact of the increase in the non-residential tax rate and the associated increased property tax liability for vacant land would be spread out, making the transition much more manageable for affected property owners. Options I. Non-residential vacant land is taxed at the same rate as improved non-residential property after tax consolidation In the absence of any business tenants, vacant land would not have been assessed for business tax. The continuation of current property tax policy would mean that owners of nonresidential vacant land would see a potential 29 per cent increase in their non-residential property tax bill once fully implemented. ISC: Unrestricted 15

20 This increase, whether it is immediate or phased-in, would be revenue neutral so the total amount of taxes collected by The City would be the same as before the business tax was consolidated with the non-residential property tax. While owners of vacant land would see an increase in the total taxes on their property, owners of improved and occupied properties would see a decrease in their total taxes. May encourage development of vacant land. Tax increases for those who invested in land under the separate non-residential property and business taxation system, with expectations that holding costs for non-residential land would not include the effect of business tax consolidation. Phase-in period, if implemented, would ease transition. No additional program costs are expected. Removes disincentives to develop a property and operate a business. Property value (Billions) Proportion of base Ongoing program costs for all other nonresidential taxpayers ($ Millions) Capital costs for all non-residential taxpayers ($ Thousands) Option II. Implement a differential (lower) tax rate for non-residential vacant land Under the Municipal Government Act, Council is able, by bylaw, to divide the non-residential assessment class into two sub-classes vacant non-residential land and improved nonresidential land. These sub-classes can be taxed at separate rates. If Council chose to set separate tax rates, it could lower the tax rate for vacant non-residential land. For example, Council could tax the approximately 2,000 vacant land properties that would be affected by consolidation at the current tax rate instead of the consolidated tax rate. To do so, the annual Property Tax Bylaw would need to include an additional set of calculations showing the vacant non-residential land assessment base, a corresponding tax levy and rate. As a result of a lower tax rate for vacant non-residential land, there would have to be a higher tax rate for improved non-residential land to ensure revenue neutrality as per Council s direction. In addition to the lower tax rate, The City would require an estimated $750,000 to make the necessary changes to the assessment and taxation related software. Change in the current policy of not having different tax rates within a property class. In Administration s estimates, this program would require an increase in the improved non-residential property tax rate in order to recoup the $12.5 million in reduced taxes for vacant land owners. Some property owners with developed property may perceive this program as a tax subsidy to fund the lower tax rate for vacant land. The best estimate for capital costs to implement a new tax rate is $750,000 for software upgrading. Ongoing administration costs are marginal and anticipated to be able to be absorbed into existing processes. ISC: Unrestricted 16

21 Property value (Billions) Proportion of base Ongoing program costs for all non-residential taxpayers ($ Millions) Capital costs for all non-residential taxpayers ($ Thousands) Option 2 2, ISC: Unrestricted 17

22 F. Partially developed property Issue Currently, non-residential partially developed property attracts a lower overall rate of tax than other non-residential property owners because: (1) the property has a lower value and (2) generally, partially developed property attracts only non-residential property tax and does not attract business tax until occupied. Consolidating business tax revenues with the non-residential property tax will mean that partially developed property could attract more taxes than in the current environment increasing the cost of development of the property. Background Today, owners of partially developed non-residential property do not pay business tax. Generally, once a property is occupied, it is subject to business tax. This raises the overall rate of tax applied to the property. Before and during development, a property is subject to only one tax; after development and occupation, the property is typically subject to two taxes. As with vacant land, this is an issue only if the preferred option is taxing partially developed property at a lower rate than developed. However, if the preferred option is that vacant and improved land should be taxed at the same rate, then this is a transitional issue that will be largely mitigated by a phase-in period, if implemented. The increase in taxes due to development, whether immediate or phased-in, would be revenue neutral so the total amount of taxes collected by The City would be the same as before consolidation. Owners of partially developed property would see an increase in the total taxes applicable to their property; many owners of improved and occupied properties would see a decrease in total taxes applied to their properties. Options I. Non-residential partially developed land is taxed at the same rate as developed nonresidential property after tax consolidation Continue the current practice of taxing partially developed property at the same rate as all nonresidential property. Partially developed property would absorb the tax increase due to consolidation and any phase-in period would be used to mitigate the effects of the increased taxes. Once consolidation occurs, the property would be taxed at the same rate before, during and after development. This is similar to the current residential property tax system. Tax increases for those who invested in land under the two-tax system, resulting in higher than expected holding costs for non-residential land under development. Removes tax inequity between partially developed property and other non-residential property. As properties are being developed, the effect of the increase will be mitigated through a possible phase-in period, and the development of the properties should be completed within the phase-in period. This is a transitional issue that will resolve itself within a few years (i.e., the time it takes to fully develop properties that are currently under development). ISC: Unrestricted 18

23 Property value (Billions) Proportion of base Ongoing program costs for all non-residential taxpayers ($ Millions) Capital costs for all non-residential taxpayers ($ Thousands) Option II. Implement a tax rebate program for partially developed property The second option would be to implement a tax rebate program for affected property owners. This option allows The City to implement a temporary tax relief program for property owners who develop non-residential property. Under such a program, eligible property owners could receive a tax rebate to cover the increase to their non-residential property taxes due to consolidation. As part of the assessment process, Assessment already determines whether a property is partially developed or completed/occupied. Applications will have to be processed and the funding will have to be requested through the budget process. Funding for this program would come from an increase in the non-residential property tax rate. In 2011, the best estimate for sustaining this program was $7.2 million in rebates: $35,000 / $70,000 for.5 / 1 FTE. However, 2011 was not a typical year. There were several very large buildings that were partially developed as of the date used to determine the condition of a property for assessment purposes. This led to an unusually large amount of assessed value in partially developed non-residential land. Administration s best estimates are that this program would require an increase in the non-residential property tax rate to fund the $7.2 million rebate program and the additional administrative costs. Some property owners with developed property may perceive this as a subsidization to fund the costs of a rebate program for partially developed property. Approximately 31 properties would qualify based on 2011 numbers. Property value (Billions) Proportion of base Ongoing program costs for all non-residential taxpayers ($ Millions) Capital costs for all non-residential taxpayers ($ Thousands) Option ISC: Unrestricted 19

24 G. Gross leases Issue Consolidation of the business tax revenues with the non-residential property tax will result in an increased tax liability to the landlord and / or property owner while tenants see the elimination of business taxes. Typically, the increased tax burden would be distributed to the tenants of the property. If the landlord / tenant relationship is governed by a gross / fixed cost lease without the option to change the terms of the leases due to the changed tax environment, the landlord might have to absorb the increased portion of the non-residential taxes until the expiry of the lease. Background It is the property owner or landlord s responsibility to pay the non-residential property taxes attributed to their property. In a typical landlord / tenant situation, the property taxes are apportioned to the tenants of the particular property for their payment according to their lease agreements. The majority of property owners negotiate commercial net leases with their tenants that allow the property owner or landlord to pass on any changes in property taxes or other operating costs to their tenants. In certain circumstances a landlord and tenant would negotiate a commercial gross or fixed cost lease, whereby the total rent paid by the tenant includes all operating costs and property taxes or is capped at a certain rate (e.g. the Consumer Price Index). In these cases, the payments are fixed, which makes it difficult for the landlord to pass increased costs that might arise from consolidation on to the tenant beyond what was initially agreed to in the lease. In such circumstances, the tenants will benefit by not having to pay business tax and will see no increase for consolidated property taxes. Some landlords / property owners have already negotiated a clause into their commercial gross leases that allows them to seek increased payment from tenants due to a change to the property taxes. Consolidation will affect property owners that do not have such a clause and who would be unable to request and receive payments to recoup the increased non-residential property tax payments from their tenants. It is assumed that leases negotiated after the conclusion of the tax consolidation decisionmaking process would factor in the outcome of this process. Since all leases have end dates, this is a transitional issue that will phase out over time. Options I. Apply the property tax equitably among all properties regardless of lease type Under this option, landlords / property owners would have to either absorb the increase to the non-residential property tax or work with their tenants to renegotiate existing leases to accommodate the increased property taxes due to consolidation. This option would require no additional funding. ISC: Unrestricted 20

25 Landlords / property owners will have to pay the increase in taxes unless they are able to renegotiate the terms of existing leases. A transitional problem that should resolve itself over time as gross leases expire. No additional program costs expected. Property value (Billions) Proportion of base Ongoing program costs for all non-residential taxpayers ($ Millions) Capital costs for all non-residential taxpayers ($ Thousands) Option II. Advocate for change in provincial legislation to allow affected landlords / property owners to increase rents to cover the increased property tax This option is to advocate for change in provincial legislation to allow affected landlords / property owners to recoup increases in property tax due to consolidation in order to cover the increased property tax. The provincial governments in Nova Scotia and Ontario passed similar legislation when phasing out their business tax. The City of Edmonton did not implement a mitigating program for this issue. If advocacy efforts are successful, landlords / property owners would be able to renegotiate their leases in order to receive compensation for the increase in property taxes caused by consolidation. This would not be an extra burden on tenants, as the increased payment to the landlord / property owner would be equivalent to, or more likely less than, the payment they would otherwise have made to The City for business taxes. Advocacy on this issue could fit into Assessment s existing work plans and so would require no new funding. Allows the landlords / property owners to recoup the increase to their property taxes from their tenants. Risk regarding timing and outcome of provincial government s review of this issue No additional program costs expected. Property value (Billions) Proportion of base Ongoing program costs for all non-residential taxpayers ($ Millions) Capital costs for all non-residential taxpayers ($ Thousands) Option III. Implement a tax rebate program for affected landlords / property owners The third option would be to implement a tax rebate program for affected landlords / property owners. This option would allow The City to implement a temporary tax relief or assistance program for landlords / property owners who are unable to renegotiate gross leases with their tenants. Under such a program, eligible landlords / property owners could receive a rebate on the portion of their non-residential property taxes that has increased due to consolidation for a period of up to 15 years. This program would apply only to leases negotiated before the decision to consolidate was made and then, only for the original term of the lease (i.e., the program would not apply to an extension of an existing lease). Property owners would be required to submit an application ISC: Unrestricted 21