INVESTIGATION INTO A SMALL BUSINESS RATE RELIEF (SBRR) SCHEME IN NORTHERN IRELAND

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1 INVESTIGATION INTO A SMALL BUSINESS RATE RELIEF (SBRR) SCHEME IN NORTHERN IRELAND March 2008

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3 CONTENTS EXECUTIVE SUMMARY: INVESTIGATION INTO A SMALL BUSINESS RATE RELIEF (SBRR) SCHEME IN NORTHERN IRELAND... (i) 1. INTRODUCTION POLICY RATIONALE AND REVIEW OF EXISTING EVIDENCE SMALL BUSINESS RATE RELIEF SCHEMES IN THE REST OF THE UK THE SMALL BUSINESS SECTOR IN NORTHERN IRELAND REVENUE IMPLICATIONS OF A SMALL BUSINESS RATE RELIEF SCHEME IN NORTHERN IRELAND CONSULTATION AND SMALL BUSINESS SURVEY: RESULTS AND ISSUES ASSESSMENT OF THE POSSIBLE EFFECTS OF SUBSIDISING SMALL BUSINESS CONCLUSIONS AND RECOMMENDATIONS...68 ANNEX A: STATE AID...72 ANNEX B: EQUALITY AND NEW TSN ASSESSMENT...75 ANNEX C: LIST OF CONSULTEES...82 ANNEX D: ERINI QUESTIONNAIRE ON SMALL BUSINESSES AND NON-DOMESTIC RATES...83 ANNEX E: ERINI RESPONSE TO REVIEW OF RATING POLICY, RATE RELIEFS FOR BUSINESS IN NORTHERN IRELAND, JULY ANNEX F: BIBLIOGRAPHY...97

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5 EXECUTIVE SUMMARY: INVESTIGATION INTO A SMALL BUSINESS RATE RELIEF (SBRR) SCHEME IN NORTHERN IRELAND 1. INTRODUCTION The Economic Research Institute of Northern Ireland (ERINI) has been commissioned by the Department of Finance and Personnel, to investigate the case for a small business rate relief scheme in Northern Ireland. Small business rate relief schemes already exist in England, Scotland and Wales though these differ markedly between countries in the valuation thresholds for eligibility and funding arrangements. The aim of the investigation is to establish if there are sufficient grounds for introducing a small business rate relief (SBRR) scheme in Northern Ireland taking into account evidence on potential impact, cost and incidence of such a relief, and drawing upon the experience in the rest of the UK and consultation with key stakeholders. 2. POLICY RATIONALE AND REVIEW OF EXISTING EVIDENCE The rationales market failure and social or equity arguments - for adopting a policy of providing rate relief for the small business sector are discussed. In addition there is a short review of the academic literature on small business relief schemes and their impact, particularly on the incidence of rate relief where the evidence suggests that much of a reduction in business rates would accrue to the owners of commercial property, rather than the businesses operating in those premises. 3. SMALL BUSINESS RATE RELIEF SCHEMES IN THE REST OF THE UK The range of small business relief schemes operating within the United Kingdom are described, including the latest Scottish scheme which is due to come into effect in April With devolution to Scotland and Wales there are now a number of different schemes working in Great Britain, each with its own valuation thresholds and funding arrangements. The English scheme is self-funding with larger firms Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008 (i)

6 paying for the relief given to smaller businesses; the new Scottish scheme is only partially self-funding; the Welsh scheme is entirely funded by the Welsh Assembly Government and is regarded as a social policy rather than a driver for economic investment. There is also some evidence about the effectiveness of the older Scottish scheme that suggested the impact would be slight and that, for most firms, rates relief is just a windfall addition to profits. 4. THE SMALL BUSINESS SECTOR IN NORTHERN IRELAND Small businesses are a vital and a growing element of the Northern Ireland economy. The small business community employs a growing proportion of private sector employees, and enjoyed 10.5 per cent growth in employment between 2003 and Its contribution to the local economy in terms of GVA is 7.35billion per annum (54% of total GVA) and for this reason small business is often high on the agenda for policy-maker. The small business sector accounts for a greater proportion of turnover and employment compared to the UK as a whole. This in turn highlights the relatively smaller contribution which large firms make to the economy. The sector is largely local market focused so there is a considerable amount of internal competition for goods and services. This is reflected in the significantly larger proportion of small businesses in Northern Ireland who cite competition as a major obstacle to success compared to the other UK regions. Growth aspirations, however, are strong. 5. REVENUE IMPLICATIONS OF A SBRR IN NORTHERN IRELAND Simulation of the revenue effects in Northern Ireland of adopting any of the existing schemes in Great Britain show that the cost of a small business rate relief scheme in Northern Ireland would range from approximately 48m. under the new Scottish scheme, implying an extra 7p in the pound being levied on larger firms in Northern Ireland to cover all of this amount; 17m. under the English scheme, with an extra 2p being levied on larger firms to pay for the scheme; and 6m. under the Welsh scheme with the cost being funded by the Executive. Complications in operating a (ii) Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

7 scheme arise from the fact that Northern Ireland has both a Regional Rate which is set centrally and a District rate which is set independently by each District Council. 6. CONSULTATION AND SMALL BUSINESS SURVEY: RESULTS AND ISSUES ERINI consulted with a range of organizations for this report and, of those who responded, the main points made in favour of a scheme are: Northern Ireland is the only region of the UK which does not have a small business rate relief scheme; The rates burden falls heavier on small firms compared to large firms in relation to costs; The viability of many businesses is under threat in light of increasing costs; Small businesses are integral to the local economy and deserve greater support; The introduction of the relief is important in maintaining rural services. Arguments against the scheme include: The scheme does not distinguish between high and low value added small business - as such any impact will be diluted to the extent that impact will be at best minimal; It could act as a disincentive to growth among small businesses by encouraging businesses to stay small. ERINI also undertook an extensive survey among the small business community in Northern Ireland but there was a such a low response rate that no definite conclusions can be drawn from the survey. Rather the results should be interpreted as a pilot, indicating areas of importance or concern. The survey highlighted that: Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008 (iii)

8 There is an extremely diverse range of businesses operating across the small firm sector in terms of sector, size, cost structures and business performance. Allied to this, the survey would suggest that the impact of rates on costs and profits is also exceptionally diverse. The distinction between those who own and those who rent their premises in terms of the issues impacting on their businesses along with any associated impact of rates relief is worth further consideration. Unsurprisingly, the larger the relief the more significant the impact. However, the survey has highlighted that the relief is most likely to impact on capital expenditure and recruitment. Deadweight is quite significant in that 1 in every 10 businesses highlighted that even a 50% relief would have no impact on investment decisions. In addition ERINI attempted to match a small sample of Valuation and Annual Business Survey data. This very limited analysis would suggest that the overall impact of rates on the profits of businesses is small but that it is the smallest businesses where the impact is greatest. Much more detailed analysis is required to confirm these findings. 7. ASSESSMENT OF THE POSSIBLE EFFECTS OF SUBSIDISING SMALL BUSINESS The evidence on the performance and obstacles facing small businesses in NI suggests that there is no significant market failure that a policy instrument such as a rate relief scheme could appropriately address. The rationales for the GB schemes centre on equity issues, either because there is evidence that rates form a larger proportion of small business profits or turnover compared with larger businesses, as indeed the evidence for NI also suggests, or to achieve particular social objectives. The evidence on where the relief might fall (its incidence) points to the majority of any rate relief being captured by the landlords of those businesses that rent their property (iv) Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

9 (capitalisation). This could mean that up to 50% of small businesses in NI may see no benefit from a rate relief scheme. The administrative costs on government and compliance costs on businesses of a potential small business rate relief scheme would also have to be taken into account. 8. CONCLUSIONS AND RECOMMENDATIONS Taking account of all of the evidence collected ERINI has concluded that there is no compelling economic justification for the introduction of a small business relief scheme in Northern Ireland. The local rate base has already been weakened by a series of reliefs and exemptions and a further relief to small firms would mean that either public services would have to be curtailed or those firms not benefiting from the relief would face even higher rate bills. The benefits that would be generated by such a scheme would be inadequate to justify its cost. However, if the Executive and the Assembly decide to proceed with a small business rate relief scheme on wider political or social grounds the recommendation is that they adopt the Welsh scheme as the appropriate model for Northern Ireland including its provision for supporting Post Offices. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008 (v)

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11 1. INTRODUCTION 1.1 The Economic Research Institute of Northern Ireland (ERINI) has been commissioned by the Department of Finance and Personnel, to investigate the case for a small business rate relief scheme in Northern Ireland. The policy background and terms of reference for the study are given below. Policy Background 1.2 Small Business Rate Relief (SBRR) is one of a number of policy instruments aimed at assisting the start up and development of small businesses as the bedrock of enterprise policy. Small businesses pay a higher proportion of turnover in rates than larger business and reflecting this the Government introduced a scheme in England in 2005, under which the occupier of a business below a rateable value threshold pays a lower rate in the pound. This followed a broadly similar scheme which was introduced in Scotland in More recently Wales has followed suit though the scheme introduced there in 2007 is significantly different from both the Scottish and English schemes, in terms of both funding and scope. There is an element of the Welsh scheme that also addresses the issue of maintaining Post Office services. 1.3 The Direct Rule Government in Northern Ireland consulted on a small business relief scheme in a policy paper in March It decided not to proceed with a scheme at that time because it had reservations about the effectiveness of introducing an SBRR scheme. In particular, Northern Ireland did not have the same scale of big business found in England and Scotland which is necessary as larger businesses pay a supplement to fund the schemes there. Furthermore, initial evidence from the Scottish scheme introduced in 2003 had concluded that SBRR was not effective as the relief was too thinly spread; it added a major complication to the rating system and take up was low. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

12 1.4 It was decided, however, that a review of the case for introducing small business rate relief in Northern Ireland should be carried out during 2007, which could draw from the experience of the other schemes, though not be fettered by them 1.5 The broad aim of a small business rate relief scheme would be to support the growth and sustainability of small business in Northern Ireland and if feasible, help maintain services in disadvantaged areas. Although these aims may be worthy, any decision by the Executive and the Assembly to proceed with such a scheme will be have to be made in the light of alternative ways of providing support for small businesses and, most importantly, other Departmental spending priorities. 1.6 The Terms of Reference for the review are to: Establish if there is sufficient rationale for introducing a small business rate relief scheme. Consider if such a scheme should be independently funded or paid for by charging larger business a supplement Consult with stakeholders, considering arguments given for and against such a scheme. Consider in the wider context of the removal of industrial derating. Consider the success of similar schemes in Scotland and England (which started in 2003 and 2005 respectively). Examine the SBRR scheme in Wales, which commenced in April Examine the options for a SBRR scheme in the Northern Ireland context, providing an estimate of cost for each option. Consideration should be given to the thresholds for relief than should be applied, as well as any other eligibility criteria. There is strong independent evidence that the benefit of a business rate exemption will pass to the landlord in the medium to longer term, as the landlord is able to charge higher rents and most small businesses (particularly retail) 2 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

13 rent. This matter needs to be considered in gauging the effectiveness of any small business rate relief scheme Provide associated impact analysis: Equality Impact Assessment and New Targeting Social Needs Analysis. Assess the State Aid implications of introducing a SBRR. Make recommendations based on consultation with stakeholder groups, evidence obtained and analysis carried out. Methodology 1.7 The Terms of reference are obviously wide ranging and require the use of a number of analytical approaches. These are set out below. 1.8 The three key issues surrounding a subsidy such as rate relief are need, impact and incidence. Need 1.9 The issue of need or a rationale for a subsidy depends on the existence of market failure(s) and/or the achievement of a social or equity objective. The fact that some costs for small businesses are proportionately greater than for larger ones is not in itself evidence that the market is failing. Overheads, for example, do not normally rise in line with turnover. A market failure rationale for government intervention in support of small businesses therefore requires close scrutiny. Impact 1.10 The question is whether a subsidy on premises occupied by small firms would generate sufficient net additional benefits in terms of investment and jobs to justify the loss in revenue to the Exchequer, or the imposition of an additional burden on other rate payers. This would depend upon the extent to which rents would respond to a change in business rates, i.e. whether the owners of commercial properties Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

14 respond to rates relief by increasing rents, as economic theory suggests, and so reduce additional resources for investment. Incidence 1.11 A key issue is the relationship between local taxes and property capital values. The value of a property represents the discounted value of the stream of future rents arising from that property. The level of rents will be influenced by the level of taxes. That is, a reduction in business rates will increase the return on property and should be reflected in a rise in property values and hence rents. The main point is, therefore, that much of a reduction in business rates would accrue to the owners of commercial property, rather than the businesses operating in those properties. An unintended consequence of a rate relief scheme may therefore be that the final beneficiaries of the subsidy are quite different from the small businesses it was supposed to benefit. Consultation, Survey, Data Analysis and Empirical Evidence 1.12 In the consultation process 5 key stakeholder organisations made written submissions to the review team. A postal survey of over 1000 commercial businesses was undertaken but the response rate was very low (this is discussed in a later section). Analyses were performed on the industrial valuation database and links for a sample of businesses were established with the Northern Ireland Annual Business Inquiry to match up rates with turnover, profitability and other measures. Also included were results from the Small Business Survey (BERR, 2005) and existing empirical research. Together this evidence was used to indicate the need for a small business rate subsidy and its possible impact and incidence. Structure of the Report 1.13 The report is structured as follows: Section 2 examines the rationale for adopting a policy of providing rate relief for the small business sector. In addition this section provides a short review of the academic literature on small business relief schemes and their impact. 4 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

15 Section 3 looks at the range of small business relief schemes operating within the United Kingdom. With devolution to Scotland and Wales there are now a number of different schemes working in Great Britain, each with its own characteristics. There is also some evidence emerging about the effectiveness of specific schemes that is of interest in the context of this report. Section 4 provides an overview of the small business sector in Northern Ireland and makes comparisons with other regions. The key issues are both the diversity of activities covered by the small business sector and the degree to which the sector is characterized by businesses of different sizes even within the standard definitions of small business. Section 5 is concerned with the analytical simulation of the revenue effects in Northern Ireland of adopting any of the existing schemes in Great Britain. The complications arising from the fact that Northern Ireland has both a Regional Rate which is set centrally and a District rate which is set independently by each District Council are also examined. Section 6 reports the results of the consultation exercise carried out by ERINI as part of this study. In addition to consultation with specific bodies the Institute undertook an extensive survey among the small business community in Northern Ireland and this is also discussed in this section. Section 7 pulls together the preceding work in order to give an overview of the implications of introducing a small business rate relief scheme in Northern Ireland and spells out the options available. Section 8 is devoted to the conclusions from this study. The study is supported by six annexes which deal with a range of technical issues such as State aid. The annexes also provide an Equality and Targeting Social Need assessment for a policy of providing rate relief for small businesses. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

16 2. POLICY RATIONALE AND REVIEW OF EXISTING EVIDENCE Policy Rationale 2.1 Non-domestic rates are a tax on commercial and industrial property and are classified in the National Accounts as a tax on production, that is, a tax that enterprises incur as a result of engaging in production, independently of the quantity or value of the goods and services produced or sold. It would generally be treated by companies as part of their overheads so any relief from the tax would constitute an operating subsidy. According to Treasury Guidelines 1 any policy intervention must have a firm rationale supporting it. Intervention must also be cost-effective the benefits of intervention must exceed the cost. The rationale is usually to address a market failure or to assist in meeting clear government distributional objectives that would not otherwise be met. Market Failures 2.2 The following are some of the most common factors that can give rise to market failure: public goods 2 giving rise to the free rider problem; externalities 3 such as training and technology spillovers; imperfect information; and barriers to entry or exit leading to insufficient competition. Section 4 examines the performance of small businesses in Northern Ireland to see if there is any evidence of market failure. If a blanket subsidy is granted without a clear need for it, then there is a high risk of unacceptable levels of deadweight and market distortion. Indeed applying a subsidy to property sends a signal to the market that understates its true value and hence leads companies to make decisions about the use of property based on false information. 1 'Green Book, Appraisal and Evaluation in Central Government' HMT Treasury. 2 Public goods are characterised by the fact that once provided for anyone they can be consumed by everyone. 3 Externalities or external effects are by-products of market transactions for which no payment or compensation is paid. They may be positive or negative depending on circumstances. 6 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

17 2.3 A key question is how a small business rate relief would sit within the Regional Economic Strategy (RES) 4. Although the current RES remains in draft form and is subject to review by the Executive it does set out further principles to assess the robustness of policy intervention. The existence of market failure is a paramount requirement: The primary principle should be that Government intervention will be on the basis of demonstrable market failure. 2.4 Within the context of Northern Ireland, four drivers have been identified as the focus of government policy on economic development: (1) Increase investment in Research and Development (R&D) and the promotion of innovation and creativity; (2) The promotion and encouragement of enterprise; (3) Ensuring that the workforce has the right skills for future employment opportunities; and (4) Ensuring that a modern infrastructure is in place to support business and consumers. 2.5 Furthermore, any policies must exhibit durability and/or spillovers into the rest of the economy: there is a further requirement to ensure that at least one of the following conditions apply: (1) Durability that projects supported should be envisaged to be sustainable within Northern Ireland without periodic public assistance. There should be a presumption against re-securing previously assisted investments; and (2) Spillovers where sufficient (in comparison to the assistance) spillovers or wider benefits would be envisaged to endure. If a policy cannot demonstrate compatibility with either of these two conditions then it should be considered outside the boundaries of any economic strategy'. Such a robust application of principles is necessary to ensure that limited public expenditure resources, financed from taxation, are used most effectively and efficiently in the promotion of our four economic priorities. 2.6 A general subsidy to the highly diverse small business sector sits uneasily with the Regional Economic Strategy in its present form in that it clearly contains substantial deadweight since its application is indiscriminate. In addition it would appear to fall foul of the requirement for durability as this would be an ongoing or indefinite subsidy. 4 Source: dfpni.gov.uk Northern Ireland Draft Regional Economic Strategy, Final Draft, January Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

18 2.7 The other policy rationale for a SBRR is based on a social or equity argument. This can take various forms. One example is the argument that small firms provide jobs across the economy and in areas that find it difficult to attract larger enterprises. A modest subsidy might therefore be justified provided that the gain in employment justifies the implied cost in revenue or expenditure foregone. Other equity arguments might be that a tax based on property bears more heavily on small firms, or that local communities, particularly in rural areas, rely on small businesses for services and cohesion. However, the equity argument also works both ways in that larger businesses may have to bear higher non-domestic rates to cover the cost of a small business subsidy with an implicit threat to employment. Alternatively if the scheme is funded from public expenditure other services and benefits will have to be foregone which could bear particularly heavily on the less well off. 2.8 An aspect of the equity issue that is also encountered when considering an SBRR scheme is parity. Since England, Wales and Scotland all have such schemes then, it is argued, so should Northern Ireland if our small business community is not to be put at a competitive disadvantage relative to their counterparts elsewhere in the United Kingdom. This is a point that we consider in more detail later in the report. Review of Existing Evidence on the Rationale, Impact and Incidence of Business Rates 2.9 The following is a brief survey of some of the recent literature on the rationale, impact and incidence of business taxes. Review of Tax Policy in Northern Ireland Sir David Varney, December In addition to their assessment of the case for a differential rate of corporation tax in Northern Ireland the Varney Review team considered other areas of business tax policy including relief against business rates They focused their assessment on a proposal by the Federation of Small Businesses (FSB) which called for the introduction of a Small Business Rates Relief Scheme in Northern Ireland. This, it was proposed, should be available for a ten- 8 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

19 year period and would offer small businesses 50 per cent rates relief conditional on any savings being reinvested into businesses. The FSB estimated that the policy would cost nearly 4.5 billion over ten years This estimate of 4.5 billion requires some comment as it would roughly equate to the total amount of rate revenue raised by the non-domestic sector in Northern Ireland over 10 years. It is ERINI s understanding that the figure covers all nondomestic properties both large and small in all sectors and so is an all business rate relief proposal rather than one aimed specifically at small business Whatever the scope of the FSB proposal, Varney saw it as raising three key issues. Firstly, the issue of the economic impact: how effective would this scheme be in increasing resources available to business for investment? This would depend upon the extent to which rents would respond to a change in business rates, i.e. whether the owners of commercial properties respond to rates relief by increasing rents, as economic theory suggests, and so reduce additional resources for investment A second key issue is the relationship between local taxes and property capital values. The value of a property represents the discounted value of the stream of future rents arising from that property. The level of rents will be influenced by the level of taxes. That is, a reduction in business rates will increase the return on property and should be reflected in a rise in property values and hence rents. A comprehensive survey of the literature on property tax capitalisation finds a statistically significant degree of capitalisation, with the estimate lying somewhere between 50 and 100 per cent. The key observation is, therefore, that much of a reduction in business rates would accrue to the owners of commercial property, rather than the businesses operating in those properties A third issue concerns financing business rates policy is a devolved matter for the Northern Ireland Assembly. Small business rates reliefs are self-financed in other parts of the UK, i.e. the reliefs are funded from within the rates paying population for that region. This has been done through a supplement to the rates bill of those businesses not eligible for the relief. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

20 2.16 Of the other tax policies briefly considered by the Varney review relief against business rates, reduced VAT on tourism and enhanced family tax credits it did not consider that there was an overwhelming case for differential tax policies in these areas for Northern Ireland. Cambridge Econometrics, In a study commissioned by HM Treasury and HM Revenue and Customs, Cambridge Econometrics examined whether rents moved in response to a change in National Non Domestic Rates (NNDR) 5. This was done using Enterprise Zones (EZs) as a control group against which to assess properties with similar characteristics receiving no relief from rates. The nature of the relationship between rents and NNDR was investigated using the change in EZ-related NNDR status as the trigger point for altering the negotiation stance between landlord and tenant The results from the regression analyses suggested that there is evidence that rents move in response to a change in the NNDR. The average capitalisation effect obtained across the sectors was around 69%, implying that most of the NNDR exemption benefits accrue to the owners of the property. In addition it was estimated that, on average, rents were 13% higher in the EZ. Manchester Business School, The Manchester Business School was commissioned by the Small Business Service (SBS) to review the academic literature relating to taxation and small businesses. 6 The literature search was carried out mainly using the leading, internationally recognised, economics journals. Other sources, such as government sponsored studies, were used where appropriate to cover all the areas of interest specified by the SBS. 5 The Relationship between National Non-Domestic Rates and Rents on Commercial Property: Empirical Evidence from Enterprise Zones A Final Report for HM Treasury and HM Revenue and Customs. Cambridge Econometrics, (Taxation and Small Businesses: a Review of the Literature, Francis Chittenden and Brian Sloan, Manchester Business School, November 2006). 10 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

21 2.20 The reviewers came to the following conclusions: (1) There would appear to be justification for tax policies that favour small firms, provided these do not distort the workings of the whole economy e.g. by causing a transfer of activities from large efficient firms to smaller businesses that lack economies of scale; or from employment to self-employment. (2) Small firms are constrained in terms of financial resources, but this is not as a result of imperfections in the functioning of the financial markets. Rather the causes are inherent to the nature of small businesses and their owners (e.g. information asymmetries and owner s enthusiasm for retaining their independence). (3) Small firms with untraceable incomes are very likely to evade tax, at least to some extent. (4) Detection is poor and audits may not increase future compliance. However, the threat of audits does promote compliant behaviour The reviewers also concluded that many of the countries reviewed have incomplete integration between personal and corporate tax systems. Consequently, especially where special tax provisions for the self-employed and SMEs exist, tax systems are not neutral and affect decisions regarding organisational form, corporate capital structure and dividend distributions. The resulting non-neutral tax systems are often inefficient, distorting the allocation of resources. The favourable tax treatment of the self-employed and SMEs can be justified on efficiency grounds if there are spillover (external) effects to the rest of the economy. Consequently, governments need to review tax bias against entrepreneurs and to design tax policies for entrepreneurship to remedy market failures, while avoiding adverse side-effects. As a consequence of the above they suggest that an optimal small business tax system might have the features shown in Table 2.1 below. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

22 Table 2.1: Characteristics of an Optimal Small Business Tax System 7 Political context Appropriate to the public aspirations of the day Supported by policies respected by the business community Stable, little or no annual change Tax structure Low tax rates, consistent with revenue needs Broad tax base, with a mix of direct / indirect taxes Tax production as little as possible, mainly tax consumption Neutral to the choice of legal form which should be adopted for commercial reasons Neutral to the decision between employment and self-employment, taking account of employment law and other regulations impacting employers (i.e. should not encourage quasi-employment ) Encourage the retention of profits, the most efficient source of small business finance because it avoids information asymmetries and the costs of investigation and monitoring associated with external sources of finance Taxes management Supportive of tax payers who want to pay the minimum correct amount of tax on time Administratively efficient within government Simple tax rules offering clarity and certainty Business people treated with respect Tax compliance Minimise tax planning activity by reducing opportunities and incentives to: Switch incomes from high to low taxable sources; Alter the timing at which incomes are recognised or tax is payable; Move incomes from high to low tax bands (e.g. by avoiding thresholds) Minimum requirement on business to conduct administration on behalf of government or other taxpayers Lowest possible compliance costs Single point of contact and payments for businesses Minimise the amount of time taken up in interaction with the authorities Minimises evasion Strong incentives to declare income, including making transactions as visible as possible and where appropriate taxing incomes at source 7 Source: Table 3, Report for the Small Business Service TAXATION AND SMALL BUSINESSES: A REVIEW OF THE LITERATURE,Francis Chittenden and Brian Sloan, Manchester Business School, November Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

23 London School of Economics, Research (unpublished) by the London School of Economics (LSE) 8 found that local taxation (namely business rates in England , before introduction of Uniform Business Rate) had a negative impact on employment growth. This was due to distortions in the taxation system, such as the fact that rent negotiations tend to be very long-term (every five years or so), which would mean that any tax increases would not be capitalised very fast. However, they also found that local taxation had no effect on the location decisions of firms, or their entry into a location. New entrants are mobile and negotiate their rent upon entry so that the capitalisation of local tax is immediate. ERINI, ERINI has already commented on the case for rate relief for small firms in its response to the public consultation on the Review of Rating Policy 9. The full response is appended at Annex E. ERINI considered that while the principle of supporting small businesses may be sound it was by no means clear that the most effective and economic way was through a blanket rate relief because of the likelihood of large deadweight. It also cautioned that the final incidence of the subsidy may end up elsewhere. A comparison of average property costs showed that Northern Ireland was not out of line with the UK as a whole but figures from the GB Green Paper on Local Government Finance (2000) did confirm that rates represent a higher proportion of turnover and costs for smaller firms than for larger ones ERINI argued for the exercise of caution before introduction a blanket relief on rates for small businesses and saw no justification for a global relief. Small businesses do need help but this has to be carefully tailored to their circumstances. Assistance with start-up capital and sound business advice is much more important than a general subsidy for property, and such help is best administered selectively. 8 Assessing the effects of local taxation using microgeographic data, G Duranton, L Gobillon and H G Overman, London School of Economics, 20 June Rate Reliefs for Business in Northern Ireland, July Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

24 Department of the Environment (London), Following the introduction of the Uniform Business Rate in April 1990 a Department of the Environment (UK) commissioned study examined the significance of rate costs for businesses in 1992/93 in England and Wales, and how this varied for different sizes and types of firm. For firms with a turnover of less than 50,000 the study found that the average cost of rates as a percentage of operating profit was 35.9% compared with an average of 19% for all firms in the study. The study cautioned that the rates/profit measure was the least reliable measure of impact given the volatility of operating profits and that the profitability of business at the time needs to be taken into account in interpreting this measure. The Institute for Fiscal Studies, An analysis of the relationship between non-domestic rates and commercial rents was conducted by the Institute for Fiscal Studies (IFS) for the Department of the Environment in The key findings were that increases in non-domestic rates result in lower property rents than would otherwise have occurred. In the long run much of the burden of higher business rates shifts to property owners in the form of lower rents, though it was not possible to establish the precise length of time for this process to occur. 10 The Relationship Between Rates and Rent, The Institute for Fiscal Studies, Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

25 3. SMALL BUSINESS RATE RELIEF SCHEMES IN THE REST OF THE UK 3.1 This section describes the small business rate relief schemes currently operating in the UK and the planned replacement for the Scottish scheme. It includes an interim evaluation of the existing Scottish scheme and also background and rationale for the introduction of the Welsh scheme. Scotland Non Domestic Rates- Small Business Rate Relief Scheme 3.2 The Small Business Rates Relief Scheme in Scotland was introduced on 1 April All non-domestic subjects in Scotland with a rateable value of 11,500 or less in are eligible for a discount of between 5 and 50 per cent on the poundage rate. The poundage rate for is 44.1 pence. Non domestic subjects in Scotland with a rateable value greater than 11,500 and up to 29,000 in fall into the "buffer zone" and pay the standard poundage rate (44.1p). Non domestic subjects with a rateable value in excess of 29,000 in pay the standard poundage rate plus a small supplement (0.3p in ) to cover the additional costs of the scheme. 3.3 The discount on the poundage rate depends on the total rateable value of the non-domestic subjects occupied as set out below: Less than 3, % 3,500 or above but under 4, % 4,500 or above but under 5, % 5,750 or above but under 7, % 7,000 or above but under 8, % 8,000 or above; or eligible for other mandatory relief... 5% Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

26 3.4 The small supplement (0.3p for ) is payable by non domestic subjects with a rateable value in excess of 29, From 1 April 2008 the Small Business Bonus Scheme replaces the Small Business Rates Relief Scheme in Scotland. As a rationale for the scheme the Scottish Government see small businesses sitting at the heart of local economies, and is determined to help them gain a competitive advantage. There is evidence that rates account for a higher proportion of turnover of small businesses than they do for larger businesses. The Small Business Bonus aims to target additional help at genuinely small businesses. The Small Business Bonus Scheme will, from 1 April 2008, progressively reduce the rates burden for businesses with properties of which the combined rateable value is 15,000 or less. 3.6 The Scheme will be delivered in full by April Projected relief rates for each of the next three years are set out below: Table 3.1: Scottish Small Business Bonus Scheme Combined rateable value of all business properties in Scotland Percentage relief available, subject to eligibility up to 8,000 80% 100% 100% 8,001 to 10,000 40% 50% 50% 10,001 to 15,000 20% 25% 25% 3.7 The level of relief for each business will depend on: (i) the combined rateable value of all properties in Scotland of which the business is in rateable occupation or (if vacant) which the business is entitled to occupy; (ii) whether or not each property is eligible for one of the existing rates relief schemes; and (iii) the level of other public sector assistance received by the business (see below). 16 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

27 If a business has received other public sector assistance in excess of 200,000 (approximately 150,000) over a rolling three-year period (the de minimis limit for State aid), it is possible that it may not qualify for relief under the Scheme. 3.8 Under the former Small Business Rate Relief Scheme, all properties with a rateable value of 11,500 or less received automatic rate relief of 5%, whatever the combined rateable value of all the business s properties. This is no longer the case, as the new Scheme has been designed to target the smallest businesses. 3.9 The additional cost of the Small Business Bonus will be met by the Scottish Government. Larger businesses will continue to make a small contribution towards the cost of the Scheme by a modest supplement on the rate poundage for all subjects with a rateable value above 29,000. In this supplement will be 0.4p on rate poundage of 45.8p. England Small Business Rate Relief 3.10 This relief came into effect on 1 April Eligible businesses with rateable values of below 5,000 get 50% rate relief on their liability. This relief decreases on a sliding scale by 1% for every 100 of rateable value over 5,000, up to 10,000. The local billing authority calculates the exact decrease. The relief is available to ratepayers with either: one property, or one main property and other additional properties, providing the additional properties do not have individual rateable values of more than 2,200, and the combined rateable value of all the properties is under 15,000 (or 21,500 in London). The threshold for the combined rateable value is dependent on the location of the main property. The main property is the only one that has the relief Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

28 applied to it. Additional properties have their charges calculated using the standard multiplier In addition to this relief on liability, eligible businesses with rateable values of between 10,000 and 14,999 (or between 10,000 and 21,499 in London) have their liability calculated using the small business multiplier The Small Business Rate Relief scheme is funded by a supplement on the rate bill of those businesses not eligible for the relief. This supplement is built into the standard multiplier From 1 April 2007, eligible ratepayers need only apply once during the revaluation period for relief, including those with rateable values between 10,000 and 14,999 (or between 10,000 and 21,499 in London). If a business ceases to be eligible on a day during the financial year, the relief will cease on that day. Application for the relief must be submitted to the relevant local authority within six months of the end of the financial year to which it relates Assuming a business meets the eligibility criteria, the relief can only be granted if the property the business occupies is on the rating list from 1 April. The date of occupation of the property is irrelevant, the key date is the effective date given to the property in the rating list. If the property has an effective date after 1 April, then the relief can only be applied for from 1 April of the following year. 11 The multiplier also sometimes referred to as the Uniform Business Rate (UBR) is a key factor in the calculation of the rates bill. It is set annually by central government and determines the percentage (expressed as pence in the pound) of the rateable value of a property that has to be paid in business rates. Since 1 April 2005, two multipliers have been in effect. The small business multiplier, applicable to those businesses eligible for Small Business Rate Relief, is set, for 2007/08, at 44.1p. The standard multiplier, which includes the supplement to pay for Small Business Rate Relief, is set, for 2007/08, at 44.4p 18 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

29 Wales 3.15 The Welsh Assembly Government replaced the rural rate relief scheme with a small business rate relief scheme for the whole of Wales on 1 st April This scheme provides rates relief of 50% for businesses with a rateable value under 2000, and 25% for businesses with a rateable value between 2,000 and 4, In addition there is enhanced rate relief for Post Offices in all parts of Wales. Post Offices with a rateable value under 9,000 receive 100% relief, and those with a rateable value between 9,000 and 12,000 receive 50% relief The relief is applied automatically to rate bills there is no need to apply. In addition the scheme is entirely funded by the Assembly Government unlike the rural rate relief scheme which required a contribution from local authorities The provision of a rate relief scheme to small businesses in Wales is regarded as an essential part of the Assembly Government s social policy, particularly to ensure that businesses are sustainable in deprived communities. By extending rate relief to all parts of Wales small businesses in even the poorest communities get help to enable them to stay in business where they are most needed. The enhanced provision of rate relief to Post Offices is a major contribution to the Assembly Government s policy of keeping Post Offices open Rates Relief is not regarded as a driver for economic investment because the Assembly Government is able to use other mechanisms to achieve that objective. The scheme is based solidly in the context of social policy with the objective of ensuring businesses can remain viable in all communities. Table 3.2 below summarises the GB schemes. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

30 Table 3.2: Small Business Rate Relief Rateable Value Thresholds England Scotland Scotland Wales (from 1 April 2005) (from 1 April 2003) (from 1 April 2008) (from 1 April 2007) < 5,000 RV - 50% relief < 3,500 RV - 50% relief <= 8000 RV = 100% relief < 2000 RV - 50% relief 5,000-10,000 relief decreases by 1% for every 100 of RV over 5000., < 4,500 = 40% 4,500 - < 5750 = 30% < 7,000 = 20% 7,000 - < 8000 = 10% ,000 = 50% relief 10,001-15,000 = 25% relief 2,000-4,999 25% relief ,500 = 5% 10,000-14,999 ( 10,000-21,499 in London) liability calculated using small business multiplier > 11,500-29,000 pay standard rate > 15,000-29,000 pay standard rate No buffer zone 15,000 + ( 22,000 in London) standard multiplier (with built-in supplement) > 29,000 pay standard rate + supplement > 29,000 pay standard rate + supplement 5,000 + pay standard rate Enhanced relief for Post Offices: RV < 9000 = 100% relief; RV 9,000-11,999 = 50% relief Scheme self funding Scheme self funding Scheme funded by supplement and Scottish Government Funded by Welsh Assembly DTZ PIEDA Evaluation of the Scottish Scheme (2004) DTZ Pieda Consulting was commissioned by the Scottish Executive to undertake a study into the operation of the current Small Business Rate Relief scheme The Report of the Scottish Parliament Local Government Committee on Nondomestic Rates, published in June 2001, concluded that small ratepayers face a disproportionate rates burden and considered that a permanent small business rates 12 DTZ Pieda Consulting, Evaluation of the Impact and Effectiveness of the Small Business Rates Relief Scheme, Final Report to the Scottish Executive Finance and Central Services Department, December Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

31 relief scheme, more focused than the existing 1p discount, should be introduced so long as the scheme could be designed to avoid small changes in rateable values producing large increases in rates bills An analysis of the data from the Valuation Rolls of 11 local authority areas and on take up showed that: The rates of relief that businesses receive was largely being applied appropriately, but there appeared to be cases in which businesses were not receiving the relief rates to which they are entitled. Take up of the higher rates of relief was short of 100% though it was not possible to calculate the precise take up rate. With the bulk of the funding going to the smallest properties, the relief was being targeted at helping those companies that may have most to gain from the relief. The value of the 5% relief to individual businesses ranged from 30 per annum to 200 while the higher rate relief produced savings of 300 per annum to 650. The effect of the Scheme was to transfer resources from urban to rural areas and from public sector organisations to the private (especially retail) sector. The Scheme is cost neutral, but redistributed around 15 million each year. However, it seemed to be of most benefit to those companies that are receiving relief at least at the 10% level. It seemed to have a very minimal benefit for those companies receiving 5% rates relief The survey of 30 companies was undertaken in four local authority areas. The main conclusions from the survey of 30 ratepayers were as follows. Few companies appeared to know their costs or the amount they paid in rates. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

32 Only 16 of the companies were aware of the SBRR. Only 13 companies claimed that they were receiving SBRR, when 18 appear to have claimed the higher rate and the other 12 automatically get 5%. All those ratepayers that have applied for the higher rate found the application process easy or very easy. 8 of the 13 companies that knew they were receiving SBRR claimed this made a significant impact on the company mainly on profit margins. Personal taxes were rated as more important than rates to the ratepayers surveyed It was difficult to draw definitive conclusions concerning the impact of the Scheme from the survey evidence. Nevertheless, while 8 of 13 companies claimed that the Scheme had a significant impact on the firm, in 8 cases this effect was simply to increase profits which implies no definite change in activity or employment. It is intuitively difficult to accept that an increase in profit of, at most, 700 per annum can be critical to many ratepayers. The suggestion that some firms would close down on the basis of such an increase in costs is plausible only if these ratepayers were highly marginal For a very few ratepayers, the support provided by the SBRR may be important one can imagine this being the case in a small and marginal retail operation but it is implausible that the scale of support could be regarded as sufficient to affect the viability or growth of whole sectors or groups of firms The overall conclusions were that: The SBRR provides a small measure of support to ratepayers amounting to no more than 700 per annum per business and in, most cases, rather less than this. The existing body of research on the impact of rates, for example DTZ Pieda s work in Northern Ireland, does not suggest that such a financially limited measure will have widespread effects on the behaviour or performance of many 22 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

33 ratepayers. Moreover, it is possible in theory that any such effects could be offset by consequent changes in property rents. The limited survey work undertaken suggests that, for most firms, rates relief is just a supplement to profits. It is possible that the rates relief helps maintain the viability of some very small and marginal businesses, but any businesses which survival is dependent upon a few hundred pounds of costs per annum must already be on the margin of viability. The sectoral analysis does, however, suggest that one of the main beneficiary groups is composed of small scale retailers and it is, therefore, possible that the Scheme is of specific benefit in helping maintain marginal retail enterprises, e.g. in rural areas. At any economy -wide level, the effects of the Scheme will be nil or negligible given that it involves some marginal reallocation of, rather than any increase in, the resources available to business activity. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

34 4. THE SMALL BUSINESS SECTOR IN NORTHERN IRELAND Introduction 4.1 This section examines the structure and performance of the small business sector in Northern Ireland drawing on material from the Small Business Analytical Unit of the Department of Business Enterprise and Regulatory Reform (BERR). It should be noted that the estimates of the number of small businesses in Northern Ireland are derived from a variety of sources and that the overall figure in Table 4.1 covers all of the private sector including agriculture and construction. Analyses elsewhere in the report focus on a narrower range of businesses in the rateable valuation data from the Land & Property Service 13 where a valuation definition of small (less than 10,000 Net Annual Value) may not necessarily correspond with the employment based definition of small (less than 50 employees). 4.2 No single source exists which estimates the total number of businesses in Northern Ireland. The Inter-Departmental Business Register (IDBR) is the most comprehensive in coverage in that it records all businesses registered for VAT and PAYE. It does not, however, take account of unregistered businesses which are neither registered for VAT (below the 60k threshold or are exempt) nor PAYE (have no/limited employees). Given this, the IDBR is particularly unrepresentative of the small business sector. 4.3 To account for this, the focus shifts to the self-employed, including sole proprietors and partnerships. The principal source of data here is the selfemployment estimate from the Labour Force Survey (LFS). An estimate is made of how many self-employed people are registered for VAT/PAYE on the IDBR. A 13 Data source No. of small businesses Overall estimate (BERR) 113,945 IDBR (VAT & PAYE) 69,510 LPS (< 10,000 rateable value) 42, Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

35 further estimate is then made of how many businesses are run by the remaining selfemployed (using the HMRC s Survey of Personal Incomes (SPI)). This provides the estimate of the unregistered businesses in Northern Ireland which, added to the IDBR businesses, provides an overall estimate of the business population in Northern Ireland. The Size and Contribution of the Small Business Sector in Northern Ireland 4.4 Small businesses (i.e. those firms employing fewer than 50 people) are an integral part of the Northern Ireland economy. There currently over 100,000 such businesses in Northern Ireland, employing 317,000 people and contributing almost 26 billion to the local economy in terms of turnover. This contribution from the small business sector represents just less than 60 per cent of total private sector turnover and 64 per cent of total employment for the region. Table 4.1: UK Small Business Private Sector Make-up 2005 Industrial Sector Number of Small Business (<50 Employees) Employment (000's) Turnover millions Enterprises % Employment % Turnover % All Industries Northern Ireland All Industries Wales All Industries Scotland All Industries England 113, , , , , , ,747,150 8, , Source: Small Business Service Analytical Unit 4.5 Table 4.1 above highlights that Northern Ireland s SME business sector makes up approximately 99 per cent of private sector enterprises; a similar proportion to England, Scotland and Wales. However, in relative terms, the small business sector plays a much greater role in terms of contribution to overall turnover in Northern Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

36 Ireland, 60 per cent compared to 36 per cent, 40 per cent, and 46 per cent for England, Scotland and Wales respectively. 4.6 Just under two-thirds (64%) of total private sector employment in Northern Ireland is created by small businesses. This is similar to Wales (62.3%) but significantly higher than England (45.5%) or Scotland (47.5%). This emphasises the importance and dependence of the Northern Ireland economy on the small businesses sector relative to England, Scotland and Wales. 4.7 In the two year period , the percentage of private sector turnover created by the small business sector in Northern Ireland increased from 56 per cent to 59 per cent. This was the exception compared to England, Scotland and Wales which all experienced a decline of between 2 and 3 percentage points. This could indicate the growing importance of the small business sector or it could reflect the closure of one or two large companies. 4.8 Employment in the small business sector during the same period also rose for Northern Ireland from 63 per cent to 64 per cent. Small business employment in Wales rose by 2 per cent during the same period from 60 per cent to 62 per cent; England experienced a nominal change of 0.7 per cent, while Scotland s employment in the sector actually fell in the intervening time from 38 per cent to 36 per cent. 4.9 As highlighted below, Northern Ireland s private sector employment is dominated by small business, making up 64 per cent of the private sector employment. Further, the small business sector accounts for 41 per cent of the entire economy s employment compared to just 32 per cent for the UK as a whole. Medium to Large enterprises (i.e. those businesses with more than 50 employees) employ around one quarter (24%) of the workforce compared to 37 per cent for the UK. Public sector employment is relatively high compared to other UK regions, at 29 per cent of total employment (22% UK). Unemployment is amongst the lowest of the UK government office regions at 4 per cent (34,065). (Oct 2007) Source: DETI 26 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

37 Figure 4.1: Distribution of the Northern Ireland Labour Force, 2007 Medium/Large Enterprises 24% Agriculture 2% Unemployed 4% Public Sector 29% Small Business 41% Source: 2007 LFS Figure 4.2: Northern Ireland Small Business Turnover by Sector (2005) Source: Small Business Service Analytical Unit Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

38 4.10 The Wholesale and Retail Trade sector and the Hotels and Restaurants sector are the largest contributors to total small business turnover accounting for 42 per cent of total turnover. This reflects the composition of these sectors which include a large number of small shops and restaurants. These sectors contribute a relatively high percentage of total small business turnover particularly when compared to the percentage of employment they constitute (30%). The next largest small business sector is Construction which accounts for 17 per cent of total turnover. In total these three sectors make up (59%) of the total turnover from small businesses. The remaining 41 per cent spreads across the remaining 11 sectors. Figure 4.3: Northern Ireland Small Business Employment by Sector (2005) Source: Small Business Service Analytical Unit A, B: Agriculture, Hunting and Forestry; Fishing C: Mining and Quarrying D: Manufacturing E: Electricity, Gas and Water Supply F: Construction G: Wholesale and Retail Trade; Repairs H: Hotels and Restaurants I: Transport, Storage and Communication J: Financial Intermediation K: Real Estate, Renting and Business Activities M: Education N: Health and Social Work O: Other Community, Social and Personal Service Activities 28 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

39 4.11 Figure 4.4 shows how the small business sector contributes to total employment for each Industrial sub-sector. Small businesses dominate sectors A and B (Agriculture, Hunting and Forestry; Fishing) with 97 per cent of everyone employed in this sector being employed by a business with less than 50 employees. Another sector which is made up predominantly of small businesses is F (construction) this is looked at in more detail below. The sector concerned with Electricity, Gas and Water Supply (E) is less likely to consist of small businesses, with only 34 per cent being employed by small enterprises. Figure 4.4: Small Business Sectors Proportion of Employment by Industrial Sub-Sector Classification- Northern Ireland (2005) Percentage- Small Business Contribution to Total Sector Employment 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 97% 34% 88% 62% 55% 60% 73% A, B C, D, E F G, H I Sector Classification J, K M, N, O Source: Small Business Service Analytical Unit: BERR 4.12 When we look at small businesses by industrial sector, we can see that for all GB regions the construction sector is dominated by small firms. This is particularly true for Wales and again in Northern Ireland. The small business sector in Northern Ireland employs over 87 per cent of those working in the construction sector and generates 76 per cent of the turnover for that sector. In England 73 per cent of construction workers employed by a small enterprise, and generate 54 per cent of turnover for that sector. This further emphasises the dependence on the small business sector for wealth creation in Northern Ireland. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

40 Figure 4.5: Small Business Construction Sector (2005) Percentage Small Bussinesses attribute to the Construction Industry 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 100% 88% 76% Construction Northern Ireland 99% 67% 52% 100% 86% 74% Construction Construction Wales Scotland Regions 100% 74% 54% Construction England Enterprises Construction % Employment Construction % Turnover Construction % Source: Small Business Service Analytical Unit: BERR Figure 4.6: Small Business Sales by Broad Destination 2006/07 NI Percentage of Goods 70% 60% 50% 40% 30% 20% 10% 3% Rest of World Great Britain Northern Ireland 4% Rest of Europe Republic of Ireland 14% 20% 59% 0% Rest of World Rest of Europe Great Britain Republic of Ireland Northern Ireland Destination Source: Export orientation among small businesses in Northern Ireland is low. Figure 4.5 highlights that the majority of small business sales by Northern Ireland manufacturers are to local markets (59%). The most important market outside Northern Ireland is the Republic of Ireland. Just 14 per cent reaches Great Britain. 30 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

41 This would suggest that most of the competition that exists between small businesses in Northern Ireland is at the internal local level. Issues Impacting on Small Business 4.14 Figure 4.7 presents data from the Annual Small Business Survey (ASBS) (2006). The ASBS reveals that the main obstacles to small business success include the Economy, Cash Flow, Tax, Recruitment, Transport, Competition, Regulation and Finance. From the 2006 Annual Small Business Survey it would appear that Competition is a major factor hindering small business success in Northern Ireland when compared to the rest of the UK. Nearly a quarter (24%) of Northern Ireland s businesses reported competition as an obstacle. This is 8% percentage points above the UK average (16%) and twice as high as Scotland and Wales (12%). This could be put down to a higher concentration of small businesses in particular areas and or the emergence of large supermarket in recent years (Retail and Hospitality sectors make up 42% of total Small Business employment see Figure 4.8). Figure 4.7: Main obstacles to business success: UK Regions 2006 Percentage of Businesses Recording as Obstacle 30% 25% 20% 15% 10% 5% 0% 11% 7% 7% 8% The economy 10% 10% 9% England Scotland 15% 12% 12% 12% 13% Wales Northern Ireland 6% 6% 7% 5% 1% 0% 2% 0% 15% 12% 12% 24% 14% 15% 11% 12% Cash flow Tax Recruitment Transport Competition Regulation Sought Finance in Obstacle Last year 23% 29% 24% 27% Source: Annual Small Business Survey 2006 BERR 2 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

42 Figure 4.8: Future Growth Expectations for Small Businesses; UK Regions 2005 *2006 Percentage Expecting Growth 80% 70% 60% 50% England Wales Scotland Northern Ireland 65% 61% 64% 62% 53% 58% 53% 52% 66% 71% 69% 70% 40% 30% 20% 20% 23% 18% 18% 25% 26% 24% 24% 19% 22% 20% 24% 10% 0% % w ith more employees than a year ago* %expect more employees in a year's time* % intend to grow business* % w ill move into new market (w here intending to grow ) % w ill introduce new products (w here intending to grow ) % looking to close or retire (w here not intending to grow ) Source: Cash flow also appeared slightly more important to Northern Ireland based small businesses. This was a key concern for 15 per cent of small businesses here compared to 10 per cent for both England and Scotland and 9 per cent for Wales In the 2005 Annual Small Business Survey, Northern Ireland s small business s were twice as likely to list Tax as an obstacle to business success compared to their UK counterparts (13% and 6% respectively). In the 2006 survey, 13 per cent of local small businesses highlighted this as an issue, similar to the UK average The demand for finance is broadly similar amongst the UK regions. In Northern Ireland 27 per cent of businesses had recently sought external finance. This percentage was slightly higher than the equivalent figure for London where only 26 per cent of small businesses had recently sought finance. Out of the Northern Ireland businesses who had recently sought finance, 90 per cent obtained it without difficulty this was above the UK average of 77 per cent (SBS ASBS 2006) The Annual Small Business Survey (2005)*2006 reveals that Northern Ireland s small business owners are as optimistic in terms of expected business growth as their GB counterparts. When asked if they intended to grow their business in the 32 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

43 following year, 62 per cent answered positively, broadly in line with Scotland (64%), Wales (61%) and England (65%) In contrast, Northern Ireland had the highest proportion of small business s seeking to close or not grow in the following year. It is important to note that this survey was carried out before the recent financial crisis which has impacted both on business confidence and ability to access credit across the UK. Business Support 4.20 Business growth and innovation are essential to the small business sector if it is to survive in increasingly competitive market conditions. However, establishing policy regarding the correct form of assistance is where difficulties lie. Currently, support from government for the small business sector is principally channelled through the Invest NI which provides both financial and practical advice for small firms showing growth and export potential. This government agency provides advice on obtaining commercial sources of financial support is available and where private funding is not feasible Invest NI is able to commit its own resources. Equity participation, capital grants, revenue grants and loans are the main financial instruments offered by Invest to local manufacturing and tradable service businesses that have potential to grow in export markets The small business community has also benefited from investment in local infrastructure, for example, in 2005; Northern Ireland became the only European geographic region with 100 per cent broadband coverage. In addition, Northern Ireland enjoys some of the lowest broadband connection costs in the EU Further support for small firms comes in the form of university links. Small and medium sized enterprises in Northern Ireland are currently interacting with Institutes of Technology and other third-level institutions in order to improve their existing products and help develop new ones. By working with the small business sector; the universities and local government, are increasingly contributing resources and skills which enhance local enterprise and promote small business success. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

44 4.23 With continued investment in the local skills base by government and a higher proportion of eighteen year olds entering third level education in Northern Ireland relative to any other UK region (37% in NI relative to 30% in GB), Northern Ireland should be well positioned to supply the human capital required for small entrepreneurial units to develop and grow Ultimately support to the small business sector comes in a variety of forms in Northern Ireland, the litmus test however for extending or contracting current levels of support lies in the success of the current small business sector over the recent and short-term business cycle and, in addition, the ability of government to recognise and intervene in areas where market conditions are hindering small firm growth is also crucial. Conclusion 4.25 This chapter has demonstrated that small businesses are a vital and a growing element of the Northern Ireland economy. The small business community employs a growing proportion of private sector employees, and enjoyed 10.5 per cent 5 growth in employment between 2003 and Its contribution to the local economy in terms of GVA is 7.35billion per annum (54% of total GVA) and for this reason small business is often high on the agenda for policy-maker The small business sector accounts for a greater proportion of turnover and employment compared to the UK as a whole. This in turn highlights the relatively smaller contribution which large firms make to the economy. The sector is largely local market focused so there is a considerable amount of internal competition for goods and services. This is reflected in the significantly larger proportion of small businesses in Northern Ireland who cite competition as a major obstacle to success compared to the other UK regions. Growth aspirations however are strong. 34 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

45 5. REVENUE IMPLICATIONS OF A SMALL BUSINESS RATE RELIEF SCHEME IN NORTHERN IRELAND Introduction 5.1 Small Business rate Relief Schemes have to be paid for and the cost of such schemes is therefore of some importance. This section is concerned with estimating the revenue cost of such schemes. In practice the costs may not fall on the exchequer since there is an option to make the scheme self financing by passing the costs onto some or all of those businesses not eligible to benefit from it in the form of a premium to their rates. To give substance to the calculations the analysis focuses on the form of schemes already in operation or projected for other parts of the UK. In principle of course there are a great many permutations that can be built into a SBRR scheme but the schemes in Great Britain are sufficiently diverse to illustrate the main points of the cost calculation. A further complication that is unique to Northern Ireland is the distinction between a Regional Rate which is set centrally by the Department of Finance and Personnel and the District rate which is set by the District Councils. The revenue from the Regional rate is part of the resources available to the Northern Ireland Executive to fund services within the Assigned Departmental Expenditure Limit (DEL), such as health and education while money from the District Rate helps to fund services provided by local government. The Tax Base 5.2 The Net Annual Value of commercial property is the base upon which any rate relief scheme would be founded and the revenue consequences of adopting a small business rate relief scheme along the lines of the English, Scottish and Welsh models in each case depends on the nature of this tax base in Northern Ireland. 5.3 Currently the non-domestic sector raises approximately 441 million from the Regional and District non-domestic rates after the various rates reliefs have been taken into account. The bulk of this revenue is obtained from the Other property type Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

46 or distinguishment. The remaining property types are either exempt from rates or already benefit from substantial rate relief as Table 5.1 shows. Table 5.1: Non-Domestic Net Annual Values by Distinguishment for Northern Ireland at February 2007 Distinguishments NAV ( ) Properties Existing Relief (%) Industrial 146,781,619 4, Sport & Recreation 7,244, Freight Transport 6,647, Other 1,018,066,106 56,392 0 Exempt 111,837,620 9, Mixed domestic 1,192,244 3,731 0 Total 1,291,770,177 74, It follows from this that any small business rate relief scheme should only be based the Other (OT) category. Furthermore, this distinguishment includes a wide range of public sector properties, such as schools, hospitals, law, order and defence establishments, that receive funding through the public expenditure system, so that any rate relief would simply be circular money. For this reason these types of property have been excluded and so the coverage of the analysis is explicitly on private sector non-industrial businesses (referred to here as commercial in Table 5.2). Table 5.2: Commercial Property Tax Base: Other Distinguishment (filtered) Revenue ( ) NAV ( ) Total 311,814, ,259,624 Mean 8,900 17,989 Median 2,895 5,850 Properties 35, The size distribution of the commercial sector properties in Table 5.3 shows that the majority are small with over two thirds having a NAV of 10,000 or less. However, 36 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

47 it is the relatively few larger properties which account for the bulk of the rate revenue and an approximate Pareto type distribution can be observed where around 20% of the properties generate about 80% of the rate revenue in the commercial sector as chart 5.1 illustrates. Table 5.3: NAV Size Distribution of Commercial firms and Rate Revenue NAV Size Bands Firms % of Firms Rates ( ) % of Rates 2,500 7, ,588, ,000 7, ,070, ,000 7, ,112, ,000 3, ,259, ,000 1, ,473, ,000 1, ,463, , ,391,277 4 Over 30,000 4, ,454, Total 35, ,814, Chart: 5.1 Cumulative frequency distribution of firms and rate revenue 120% % cumulative frequency of revenue 100% 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100% 120% % cumulative frequency of firms Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

48 SBRR Simulations 5.6 This section attempts to gauge the revenue cost of a small business relief scheme in Northern Ireland and an obvious starting point is to simulate the schemes that already operate in the rest of the UK. These schemes have been described in section 3 already but a key characteristic of the English and Scottish (current scheme) simulations is that both are self funding whereas the Welsh model is not and implies a loss of revenue to the Northern Ireland Executive as would the new Scottish bonus scheme to a much greater extent. For the purposes of the simulations the coverage of the payer group has been expanded to include all properties in the Other distinguishment category. Doing this spreads the additional payment over a wider group of properties and so minimises the poundage increase for the payer group. English Simulation 5.7 Adopting the English scheme would provide approximately 16.6 million in relief at an average relief of 710 for each business which would be paid for by the firms with NAVs of 15,000 and over at a cost to them of an additional 2p (4%) above the normal 2007/08 average non-domestic rate of 49.37p (consisting of a Regional Rate and a District Rate). The average relief for a business would be 710. Scottish Simulations 5.8 The current Scottish SBRR version would cost nearly 13 million which would then be passed onto properties with NAVs over 29,000 through an extra 1.8p (3.6%) on the normal non-domestic rate. The amount of relief for the average small business would be Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

49 Table 5.4(a): Northern Ireland Small Business Rate Relief: English Simulation Relief NI firms Rates payable ( ) Cost of relief ( ) NAV Relief Thresholds Less than % 15,437 19,316,297 9,658, or above but less than 10,000 1%-49% 7,989 27,930,328 6,982,582 approx Total 23,426 47,246,625 16,640,731 Buffer Zone 10,000 to 14,999 3,547 21,313,336 Additional payer zone 15,000 and over 11, ,147,035 Implied rate poundage (2p above current rate) Table 5.4(b): Northern Ireland Small Business Rate Relief: Scottish Simulation Relief NI firms Rates Payable ( ) Cost of Relief ( ) NAV Relief Thresholds Less than 3,500 50% 11,141 10,429,458 5,214,729 3,500 or above but under 4,500 40% 3,023 5,924,382 2,369,753 4,500 or above but under 5,750 30% 3,065 7,692,962 2,307,889 5,750 or above but under 7,000 20% 2,363 7,389,996 1,477,999 7,000 or above but under 8,000 10% 1,509 5,552, ,237 8,000 to 11,500 5% 3, ,907 Total 24,793 54,467,318 12,799,514 Buffer Zone Over 11,500 to 29,000 5,939 52,492,720 Additional payer zone Over 29,000 6, ,906,628 Implied rate poundage (1.8p above current rate) Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

50 5.9 The replacement for the current Scottish scheme the Small Business Bonus scheme - is much more generous in the amount of relief it gives to small businesses. If it was replicated in Northern Ireland it would cost the Executive over 44m in revenue foregone assuming that the larger businesses make the same contribution as planned for Scotland, an extra 0.4 pence on the standard rate poundage ( 48m if no contribution is made from the larger businesses). If all the larger businesses were to pay in full for the relief, then this implies an extra 6.79 pence in the pound. The average amount of relief for eligible small businesses would be Table 5.4(c): Northern Ireland SBRR: Scottish Small Business Bonus Scheme Simulation Relief NI firms Rates payable Cost of relief Less than % 21,183 37,313,199 37,313, to % 2,349 10,458,462 5,229, to % 3,505 21,259,558 5,314,890 27,037 47,857,320 Additional payer zone Over 29,000 6,196 Implied rate poundage (full payment) 395,964, p additional Implied rate poundage (partial payment) 351,135, p additional 44,828,788 to raise 2007/08 NI rate poundages used. Welsh Simulation 5.10 The Welsh scheme provides the lowest relief of the GB schemes with an average relief of 367 but, because it is not self funding, would cost the Northern Ireland Executive nearly 6 million in foregone rates revenue. 40 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

51 Table 5.4(d): Northern Ireland Small Business Rate Relief: Welsh Simulation Relief NI firms Rates Payable ( ) Cost of Relief ( ) NAV Relief Thresholds Less than % 5,847 3,341,425 1,670, or above but less than % 9,590 15,974,872 3,993,718 Total 15,437 19,316,297 5,664,430 No Buffer Zone No Additional payer zone 5.11 The Welsh scheme includes a specific rate relief for Post Offices. The thresholds are 100% relief for Post Offices with a rateable value less than 9000 and 50% relief for rateable values between 9000 and If this scheme was duplicated in Northern Ireland, then approximately 459 Post Offices would be covered at an average rate relief of 1,368. The total amount of rate revenue foregone would be in the region of 628, It should be noted that this is very much a rough estimate as the LPS valuation data only identifies 304 separate properties as Post Offices while information from the National Federation of Sub Postmasters gives a figure of 543 Post Offices in Northern Ireland. It is thought that the difference is accounted for by Post Offices contained within other properties such as supermarkets and therefore subsumes within that property s valuation. The table below factors up the LPS data to derive an overall estimate of rate revenue generated. Other SBRR Schemes 5.13 Other variants of an SBRR are, of course, possible by adopting different levels of NAV thresholds, but this would merely shift the balance between recipients and funders in the case of a self funding scheme, or change the amount of revenue lost in the case of a Welsh type scheme. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

52 Table 5.4(e): Estimated Post Office Rate Relief in Northern Ireland Rateable Values Post Offices Rates Revenue ( ) % Relief Rates Relief ( ) Average Relief ( ) < , ,868 1, , ,050 2,601 > ,634,814 nil 0 0 Total 543 3,327, ,918 1,368 Note: Based on LPS data adjusted to include all Post Offices It is also possible to envisage schemes which target only new small businesses, or those which are predominantly export orientated, or businesses in, say, areas of relatively high deprivation, or even businesses deemed to be of particular community significance such as Post Offices. Each of these targeted variants of an SBRR scheme have their own difficulties. New Small Business Start Ups 5.15 New businesses are generally most vulnerable during the period after start up when they are trying to build market share but very often are constrained by the availability and cost of finance and the general costs of doing business. It might therefore be argued that a time bounded form of rate relief for new start ups would be appropriate. However, such a selective relief would amount to a subsidy to some businesses to compete against similar but older businesses that would not qualify. In addition there are administration costs for such a scheme including the costs of policing the rules. If the subsidy was attractive enough, for instance, some businesses might find it attractive to close at the end of the qualifying period and to then re-open and qualify again elsewhere. Exporting Small Businesses 5.16 Targeting exporting type small businesses is attractive because it helps the regional balance of payments and avoids the problem of subsidising internal 42 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

53 competition. Of course it is the fact that rate relief for these companies effectively subsidises competition with businesses outside Northern Ireland that makes this assistance problematical. This is especially so where the export market for assisted firms is outside the UK since that clearly raises European State Aid issues. In addition like all targeted schemes this one would require identification and burdensome monitoring of exporting small businesses. Areas of High Deprivation 5.17 As a general rule administrations are keen on providing assistance for areas of high and/or multiple deprivation. Unfortunately as Annex B shows, a general scheme based on aiding small businesses on grounds of assisting areas of multiple deprivation would not be particularly effective as there is little or no correlation between areas of deprivation and small firm s rates bills. Funding a SBRR and the Regional District Dimension 5.18 Unlike the rest of the UK Northern Ireland does not have a uniform nondomestic rate, rather two non-domestic rates are struck; a uniform (across Northern Ireland) Regional rate is set by the Executive and the revenues from this contribute to funding the Northern Ireland Budget; and a rate struck by each of the current 26 District Councils which funds Council expenditure. Businesses therefore face a combined bill of Regional and District rates 15 and Table 5.5 estimates what the costs of the SBRR schemes would be if they were split between the Executive and District Councils. Table 5.5: Cost of NI SBRR: Regional-District Dimension Scheme Regional District Total English 9,808,492 6,832,238 16,640,731 Welsh 3,338,767 2,325,663 5,664,430 Scottish 7,544,376 5,255,138 12,799,514 Scottish New 28,208,386 19,648,934 47,857, The average non-domestic rate poundage for 2007/08 is 49.37pence, consisting of a Regional rate of 29.10p and an average (over the 26 Councils) District Council rate of 20.27p. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

54 5.19 The options for funding a SBRR can be divided into two categories: selffunding, as with the English or old Scottish schemes (the new Scottish scheme is only partially self-funding), or taken as a loss to the relevant Exchequer. Self-funding in Northern Ireland presents its own problems due to the Regional District split in the rate poundage and this is discussed later. If the cost of a scheme is taken as a loss in revenue to the Executive Budget, then several funding permutations arise because of the Regional-District dimension. The Regional rate can fund all the costs of a scheme with the Districts being compensated for their loss in revenue. This would be similar to the arrangements with industrial derating where Districts are compensated through the General Grant for the loss in revenue they incur due to industrial derating; The relief could be given only on the Regional rate with the choice being left to the Districts to give relief and bear the cost on their portion of the overall nondomestic rate; The relief could be given only on the District rates with each District deciding whether to give relief and at what level. or both Regional and Districts rates could bear their respective revenue losses Whatever the option, there would need to be consultation and consensus with District Councils and fairly complex rating legislative considerations to be taken into account. Self-funding Issues 5.20 A self funding SBRR scheme is one where the cost of providing the relief is carried by other ratepayers. In principle this could include domestic rate payers but in practice it is other non domestic ratepayers or some sub group that meets the cost by having a premium attached to their rate bills Self funding schemes in Northern Ireland would present several implementation difficulties: 44 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

55 The Northern Ireland tax base has relatively fewer of the larger businesses needed to fund a scheme compared to GB. In England, for example, 29% of nondomestic properties have a NAV of 15,000 or more while the percentage in Northern Ireland is just under 21%. Even the North East region which has much the same number of non-domestic properties as Northern Ireland has a higher percentage of larger firms at 23%. What this implies is that the larger businesses in Northern Ireland have to face a greater additional poundage - about 2p compared to the 0.3p differential between the non-domestic small business rate and the normal rate in England - in order to fund the smaller businesses rate relief. The self funding problem is greatly increased for schemes that cover the District rate. The distribution of larger NAV commercial properties in Northern Ireland is by no means uniform so District Councils with very few larger properties face the prospect of imposing very substantial premia in order to fund a SBRR scheme. There are technical problems with striking a non-domestic rate and a supplementary non-domestic rate for larger businesses in the Northern Ireland local government context with its uniform Regional rate and 26 District Council rates. The District rates are set by each of the 26 District Councils in Northern Ireland and essentially their domestic and non-domestic rates are struck as one rate with conversion factors used to derive the separate non-domestic and domestic rates. To strike what is essentially two non-domestic rates, the District domestic and non-domestic rates would have to be decoupled and this would involve consultation with Councils and complex changes to the rating legislation. Administrative costs would be incurred for application based schemes and could be in the region of 500,000, though an automatic scheme such as the Welsh one would be less expensive. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

56 6. CONSULTATION AND SMALL BUSINESS SURVEY: RESULTS AND ISSUES Introduction 6.1 ERINI approached 32 organisations with regard to the investigation into a Small Business Rate Relief scheme in Northern Ireland. In total, five responses to the consultation process were received from the following organisations; National Federation of Sub Postmasters (NFSP) Federation of Small Business (FSB) Confederation of British Industry (CBI) Ulster Society of Chartered Accountants (USCA) Invest NI A summary of the comments made by each organisation are outlined below. National Federation of Sub Postmasters (NFSP) 6.2 The National Federation of Sub-Postmasters (NFSP) represents the interests of Sub-Postmasters throughout the UK. As an organisation it places strong emphasis on the unique social value and sheer diversity and range of services provided which distinguishes them from other retailers. They make a number of points in relation to this network including: Its valuable role in supporting local communities particularly in disadvantaged and rural areas (just over 70 per cent of Post Offices are located in rural areas). Its valuable role in supporting vulnerable residents including the elderly and disabled. Its importance to the well-being of other small businesses and local economies in general. 46 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

57 6.3 The Northern Ireland Committee of the NFSP make the following key points in relation to the implications of a Small Business Rates Relief scheme to the 543 Post Offices located in Northern Ireland: Sub-Postmaster s overheads are rising and an estimated 40 per cent are making losses, unable to cover staff costs, overheads and personal drawings. Research commissioned by the NFSP finds that two-thirds of Sub-Postmasters have experienced increasing overhead costs and for one-fifth of those, business rates made a contribution to those increase costs. The NFSP quotes research from the Federation of Small Businesses suggesting that business rates are the 3 rd largest expenditure item, are proportionally greater for small firms that large firms and are the only major business tax not related to the ability to pay. Many Post Offices across England, Scotland and Wales are eligible for business rates relief through a small business or rural rate relief scheme. The response makes direct mention of the Scottish Executive evaluation of the impact of small business rates relief scheme in Scotland which highlighted that one of the main beneficiaries of the relief is small scale retailers. Further it references the specific benefit the scheme in Scotland has had in helping to maintain marginal retail enterprises particularly in rural areas. The NFSP highlights that 7 in every 10 Post Offices are located in rural areas. 6.4 In conclusion, the NFSP would like to see a relief scheme in place in Northern Ireland which would help alleviate financial pressures facing many Post Offices and assist in maintaining the viability of these vital local services. Specifically they would like to see a scheme in place that had: Automatic reductions to eligible Post Offices (in light of poor uptake elsewhere on application based schemes). Higher level rates relief for Post Offices (as in Wales). Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

58 Federation of Small Business (FSB) 6.5 The Federation of Small Business (FSB) represents the views of 7,000 small businesses in Northern Ireland. It makes a number of points in relation to the review as follows: The importance of small firms to the Northern Ireland economy 98 per cent of business are small businesses and 90 per cent employ fewer than 10 people. The non-domestic rates burden is significantly greater for smaller trading companies with a turnover of less than 100,000. Research by DTZ Pieda concludes that rates are usually the 3 rd expenditure after wages. largest Northern Ireland is the only part of the United Kingdom which does not have a Small Business Rates Relief Scheme even though it has the greatest dependence on small firms. The Rates Reinvestment Fund 6.6 The FSB had previously suggested that a local SBRR take the format of a Rates Reinvestment Fund. In broad terms this scheme would allow the Assembly to reward successful companies and provide the basis to encourage businesses to reinvest their savings into their businesses, offering an incentive to expand and modernise. The more detailed elements of such a scheme would include: It would be open to all businesses - large and small, indigenous and externally owned. It should be in place for up to 10 years to maximise benefits. During this period it would be subject to periodic review. 50 per cent rates relief would be made available over a ten year period conditional on savings being reinvested into the business. 48 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

59 To qualify, a business would have to demonstrate clearly how they intend to use the capital saved e.g. increased staffing, new equipment, upgrading premises etc. 6.7 The FSB believe the benefits of such a scheme would: Ensure greater capital investment by the indigenous business sector. Prove an attractive incentive to FDI. Be more effective than a Corporation Tax cut in that many small businesses don t pay Corporation Tax. Ease the burden of businesses suffering the cost of compliance. Ulster Society of Chartered Accountants (USCA) 6.8 In overall terms, the USCA is in support of a SBRR scheme but believe it should be funded independently by government. This would help boost small business in Northern Ireland without adding an extra tax burden on larger businesses. 6.9 The USCA undertook a survey of members to determine if a rationale for a Small Business Rate Relief scheme existed and if so, how that scheme should be funded. In total, 61 members responded to the survey. The following key points are noted; Support for the Scheme The overwhelming majority of members (85%) believe that a rationale exists to introduce such a scheme. The reasons put forward by members focus on the high costs businesses currently face including commercial rates, refuse collection and potentially water rates. High rates were considered by some members as a threat to viability (particularly vis-à-vis the Republic of Ireland). Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

60 Members view small business as the cornerstone of the local economy deserving greater support. Funding/Administration of the Scheme Around 3 in every 4 members believe the scheme should be funded independently, paid for by the Northern Ireland Assembly. Further, 13 per cent felt that larger businesses should cover the cost while 3 per cent wanted a combination of both. Some 7 per cent were undecided. The reasons why the burden should not fall on larger businesses were two-fold. First, members perceive this to be a deterrent to encourage business to set up in Northern Ireland. Second, large businesses already pay more by virtue of being larger. Some suggested that the scheme be linked not only to turnover and size but to the number of jobs created by the business. Other Comments The idea of charging rates for vacant premises should be revised as businesses are paying where no service is being supplied. Confederation of British Industry (CBI) 6.10 In substance the CBI believe that...a case does not exist to support a blanket relief to smaller businesses. The issues which the organisation raises in relation to this include; That the scheme is a blunt instrument which provides relief to all small business, many of which supply local markets, have low productivity and growth aspirations, when what Northern Ireland really needs is to encourage growth in more value added and export led businesses. 50 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

61 The introduction of the relief could act as a barrier/disincentive to small firm growth. The value of the relief will be insufficient to have any impact e.g. at best it will have a marginal impact on employment. The scheme focus should be on high value jobs not jobs per se Should a scheme proceed the CBI make the following points: Northern Ireland does not have sufficient numbers of large firms to enable a revenue neutral scheme to work. Large firms should not bear the burden of the scheme. The scheme should be funded by the Executive out of central/local government expenditure. If such a relief were to be introduced it should be automatic and not application based In summary, the CBI believes that a Small Business Rate Relief scheme should not be introduced without a clear rationale. A balance needs to be struck between the benefit of the relief and any impact on the broader environment in which companies compete. The rationale should consider the: Impact on competitiveness. Predictability of future bills to allow planning. The fair distribution of the rates burden. The burden, complexity and cost of administering a wide ranging relief scheme. That rating policy should encourage fair competition not lead to distortions in competition. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

62 The CBI believes that tax revenue would be maximised by growing the business base. The growth in business rates should be constrained. Invest NI 6.13 Invest NI made the following points; Small businesses have growing concerns over increased operating costs so a scheme which brings about a reduction in such costs is to be welcomed. However, large business should not bear the burden of such a scheme. Reasons include the small number of large businesses to which the cost would transfer and the significant burden the imposition of further costs would have in light of already increasing energy, rating, logistic and other costs. Summary of Consultation Feedback 6.14 Four of the five organisations responding to the consultation are in favour of the introduction of a Small Business Rate Relief Scheme. In overall terms, the arguments made for its introduction include the following: Northern Ireland is the only region of the UK which does not have a small business rate relief scheme; The rates burden falls heavier on small firms compared to large firms in relation to costs; The viability of many businesses is under threat in light of increasing costs; Small businesses are integral to the local economy and deserve greater support; and The introduction of the relief is important in maintaining rural services. 52 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

63 6.15 Arguments against the scheme, while limited, include: The scheme does not distinguish between high and low value added small business - as such any impact will be diluted to the extent that impact will be at best minimal; It could act as a disincentive to growth among small businesses by encouraging businesses to stay small In terms of the administration of such a scheme comments made were as follows: The scheme should be automatic as opposed application based; It should be funded by government and not large firms asking large firms to pay will act as a disincentive to investors; There should be a higher level of rate relief for Post Offices; The scheme could be linked to the turnover/employment in businesses also The Rates Reinvestment Scheme proposed by the FSB requires separate consideration in that it puts forward an entirely different scheme from that focused on small business. The ERINI Small Business Rate Relief Survey Introduction 6.18 An important part of the study on a Northern Ireland Small Business Rates Relief Scheme was to provide an assessment as to the potential impact of such a scheme on businesses in Northern Ireland. One of the means by which ERINI sought to establish such impacts was to undertake a large scale postal survey of businesses. In total, a sample of just over 1,000 businesses was selected from the Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

64 Rating Database to take part in the postal survey. Businesses were selected on the basis of NAV (less than 30,000) There was a disappointing response to the survey. From the 1,020 questionnaires posted just under 50 were completed and returned. Numerous attempts to follow up by telephone were largely unsuccessful. It is difficult to surmise whether this is as a result of 1) that rates are a non issue for business or 2) it merely adds to their high burden of regulation, or perhaps some combination of both The low response rate means that while the survey can provide some insights into the position of businesses vis-à-vis the impact of any potential relief, only limited conclusions can be drawn. It does present an opportunity to make recommendations on the nature of information required to be collected by the LPS to assist in any future reviews In broad terms, the questionnaire focused on the following key areas: Background to the business Property Issues Business Costs Key Concerns to Business Impact of potential Business Rate Reductions A copy of the full questionnaire can be accessed in Annex D. Background to the Businesses 6.22 In broad terms, the background of the businesses was as follows: One-third were sole traders, 28% partnerships and 24% private limited companies. 70% have been in business 10 years or more. 54 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

65 Respondents operate in a diverse range of sectors however, the most significant sector is Retail (30%) followed by Construction and Wholesale. Just one business had more than 50 employees. Average employment is 8 the largest mean employment is in private companies (18 employees) followed by sole traders and partnerships (5 employees). For 50% of businesses, all sales are within Northern Ireland for a further 30 per cent less than 10 per cent of sales were sold outside Northern Ireland. The Republic of Ireland was the most important export market. 50% said that all supplies/inputs were obtained within Northern Ireland. The majority (90%) do not receive any government assistance. Property Issues 6.23 Just over two-fifths of the businesses are currently renting their premises. The average lease period specified was 5 years and ranged from 1 to 15 years. The average period until renewal was 3.5 years. Rental costs averaged just over 15,000 annually, ranging from 500 to 40, The Net Annual Valuation averaged 8,000 and ranged from 190 to 24,500. This is based on the actual NAV of the business recorded on the Rating database. Only half of the businesses specified their NAV and even then, just 13 provided the correct valuation. Others were different by some considerable margin The actual Rates bill of businesses, in their estimation, averaged 5,740. The average bill for commercial properties with an NAV under 30,000 is 3,480. Just three respondents reported having more than one property. Business Performance and Costs 6.26 Turnover ranged from 3k up to 33m, averaging 1.7m overall. Median turnover was 300k. Pre- tax profits averaged just over 100k (median 40k). Two businesses recorded losses. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

66 6.27 Businesses were also asked to give, on average, their rates bill as a percentage of pre-tax profit. Responses ranged from as little as 1% to as much as 2,500%. The median value was 15%. The most significant costs to business are materials and labour followed by transport, rent and insurance. Issues Affecting Business Performance 6.28 Businesses were asked to rank the main pressures facing them. The level of non-domestic rates was perceived as one of the key pressures on business. Other major issues include the state of the economy as well as increased competition. Rent costs were low on the list of pressures although this can be explained by the fact that under half of the respondents rent their property. Very few businesses said that corporation tax was an issues but this could be because only a few of these businesses have to pay corporation tax. Other issues raised include the state of the housing market, advertising costs, and general upkeep. Figure 6.1: Main Issues Impacting on Business Performance 80% 70% 60% 50% 40% 30% 20% 10% 0% Rates Increased Competition The State of the Economy cash flow cost of insurance difficult to recruit staff Administration burden Regulatory burdens Labour costs Energy costs Rent costs Transport costs Corporation tax Obtaining finance Source: ERINI Small Business Rate Relief Survey 56 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

67 6.29 There are some notable differences in terms of key pressures faced by those businesses who rent their premises compared to those who own their premises (Table 6.1). Table 6.1: Main Issues Impacting on Business Performance Main Pressure Rent Premises Main Pressure Own Premises 1 Cash Flow 1 Level of Non-Domestic Rates 2 Increased Competition 2 Burden of Administration 3 Level of Non-domestic rates 3 State of the Economy 4 State of the Economy 4 Difficulty in recruiting staff 5 Level of Energy Costs 5 Increased Competition Source: ERINI Small Business Rate Relief Survey 6.30 While the level of non-domestic rates remains the most significant pressure facing those who own their premises, cash flow becomes a priority for tenants. Indeed, issues around costs and finance appear more important to those who rent their premises including energy, rental and transport costs along with finance. Potential Impact of Business Rate Reduction 6.31 Businesses were asked how they would react to a 25% or 50% reduction in their rates bill. If the rates bill was to be reduced by 25 per cent, around 1 in every 4 businesses would not do anything, a similar proportion would invest in new equipment while a slightly smaller proportion would hire additional staff. They would be least likely to move to larger premises or perhaps unsurprisingly, reduce prices to customers Businesses estimate a more marked impact if the non-domestic rates bill were halved. Just over 1 in every 10 businesses now stated that they would do nothing in light of a 50% rate cut. The reduction would most likely result in the purchasing of new equipment followed by hiring additional staff. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

68 Figure 6.2: Impact of Rate Reductions on Business Decisions % 50% Reduce price Hire additional staff Invest in new equipment Move to larger premises Do nothing other Source: ERINI Small Business Rate Relief Survey Assistance to Small Business 6.33 Businesses were asked an open ended question about the sort of assistance which would be most helpful to small business. There was an obvious focus by businesses on reducing the rates burden. Apart from lowering the rates bills, other suggestions included rate relief for start-up businesses and reduced rates for business locating in town centres. Other issues raised are list below: Reducing bureaucracy/regulation/administration burden Information seminars on cashflow, employment etc. Simpler employment laws Tax reduction corporation/income Lower borrowing costs Employment/capital grants 58 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

69 Summary 6.34 With such a low response rate, no definite conclusions can be drawn from the survey. Rather the results should be interpreted as a pilot, indicating areas of importance or concern In summary, the survey has highlighted that: There is an extremely diverse range of businesses operating across the small firm sector in terms of sector, size, cost structures and business performance. Allied to this, the survey would suggest that the impact of rates on costs and profits is also exceptionally diverse. The distinction between those who own and those who rent their premises in terms of the issues impacting on their businesses along with any associated impact of rates relief is worth further consideration. Unsurprisingly, the larger the relief the more significant the impact. However, the survey has highlighted that the relief is most likely to impact on capital expenditure and recruitment. Deadweight is quite significant in that 1 in every 10 businesses highlighted that even a 50% relief would have no impact on investment decisions. The LPS Rating Database/Annual Business Inquiry Database Introduction 6.36 One of the most difficult aspects of the Review has been to gauge the impact of the rates bill on the profits of small businesses as ultimately the impact of any relief will be reflected in the bottom line of the business. The issue here is that profits can be highly volatile while rates are levied on property holdings which may have no particular relationship to profit for any company. The ERINI Small Business Rate Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

70 Relief survey highlighted that the median value of rates to profits for businesses was 15 per cent but the volatility was very significant. This section attempts to examine this relationship using an alternative data source, the Northern Ireland Annual Business Inquiry As was highlighted in the Review of Industrial Derating (ERINI, 2007), no financial or detailed sectoral information on companies liable to rates has been collected by Land & Property Services. As a result, ERINI sought to establish alternative ways of measuring impact and identified the Northern Ireland Annual Business Inquiry (NIABI) as one of the most effective potential sources of data. NIABI collects financial and employment information from a survey of businesses and other establishments. The type of information it holds includes Total Turnover Gross Value Added (GVA) Employment levels Employment Costs Purchases Net Capital Expenditure. More recently, the survey has requested information on business rates. The latest data available for NIABI is for In order to identify the impact non-domestic rates have on the profits of small businesses a random sample of 200 businesses with an NAV of less than 10,000 were matched with the ABI database. Only those businesses on the ABI which had provided actual information were eventually selected which reduced the numbers of matches substantially. The matching exercise was further complicated by the issue of multiple premises. The ABI covers the business as an entity whereas the Rating database covers individual business premises. When those businesses with multiple premises were removed, the matched sample fell to 38 businesses. The issue here is that although individually each premises had an NAV of less than 10,000, when each businesses premises NAVs were totalled two thirds were greater than 10,000. It is worth noting that of those 38 businesses with an NAV less than 10,000, 17 had more than 50 employees The interpretation of the results below must be treated with extreme caution. This is a very small sample of businesses which are unlikely to be reflective of the small business population as a whole. The exercise has highlighted the difficulties of trying to match two very distinctive databases. ERINI would like to continue with this 16 ERINI are most grateful to James Gillan and the statisticians at DETINI for access to the NIABI. 60 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

71 research and make recommendations to the LPS as to how to maximise the use of its own database in any further impact analysis that may take place Table 6.2 highlights preliminary results on the impact of rates on the purchases, turnover and profit of these businesses according to employment size. The information obtained from these businesses would suggest that rates are a relatively small proportion of costs and profits. However, rates do appear to be a more important cost to the smallest businesses in this sample. Table 6.2: Rates as a % of Purchases, Turnover, Profit (NAV < 10k) by Employment Size Total Employees Rates as % of Purchases Rates as % of Turnover Rates as % of Profit < Source: NIABI, LPS Rating Database 6.41 A similar picture is established when we examine the impact of rates on purchases, turnover and profits according to the NAV of businesses. This again appears to highlight that rates are a greater cost to smaller businesses as measured by their NAV. Table 6.3: Rates as a % of Purchases, Turnover, Profit (NAV < 10k) by NAV Size NAV Rates as % of Purchases Rates as % of Turnover Rates as % of Profit <2.5k k-5k k-7.5k k-10k Source: NIABI, LPS Rating Database Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

72 6.42 It has been widely held but largely unsubstantiated that the burden of rates impacts hardest on small businesses. This very limited analysis would suggest that the overall impact of rates on the profits of businesses is small but that it is the smallest businesses where the impact is greatest. Much more detailed analysis is required to confirm these findings. 62 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

73 7. ASSESSMENT OF THE POSSIBLE EFFECTS OF SUBSIDISING SMALL BUSINESS Introduction 7.1 The purpose of a Small Business rate Relief scheme is to provide a subsidy to the small business sector. Such a scheme provides assistance to a defined group of businesses paid for either by other, larger, businesses or as a loss of revenue to the exchequer and hence a diminution of other public services. Since rates are a tax on property providing rate relief is in the first instance a subsidy to property costs regardless of the type of activity that takes place in that property. If the scheme is extended to take other criteria into consideration, such as the nature or location of the business, it becomes a selective scheme and requires additional administrative processing. Thus in assessing the effects of a SBRR a number of factors have to be taken into consideration. Foremost among these is the existence of a need for such a scheme in the sense of an economic dysfunction in the operation of markets. There is then the issue of who actually benefits from such a subsidy since there can be a wide gap between the formal incidence of a subsidy and its final beneficiary. The wider economic impact of a scheme in terms of employment or output, for example, is also important. Finally there is the issue of equity in the sense of Northern Ireland small businesses being denied access to some form of rate relief scheme which their counterparts elsewhere in the UK already enjoy. This section looks at these matters drawing upon the previous analysis and the wider literature on subsidies for small firms. Rationale or Need for a Scheme 7.2 The evidence on the performance and obstacles facing small businesses in Northern Ireland suggests that there is no significant market failure that a policy instrument such as a rate relief scheme could appropriately address. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

74 7.3 According to the Annual Business Survey small businesses in Northern Ireland appear least worried about the present structure and performance of the economy with only 10% of those businesses surveyed listing it as an obstacle. On the other hand Corporation tax is perceived to be one of Northern Ireland s greatest obstacles to small business success, 13% of Northern Ireland s enterprises believe Corporation Tax to be an obstacle to business compared to the UK average of 12%. This is perhaps because Northern Ireland, unlike other UK regions, shares a land border with the Republic of Ireland (RoI) which is a low corporation tax state. Competing with neighbouring firms who enjoy a 12.5% corporation tax, compared to 17.5% in the North, presents companies in Northern Ireland with a further challenge which similar firms in England, Scotland and Wales do not encounter. 7.4 It should be noted, however, that the mood among small businesses can change quickly in response to fluctuations in the wider economy. Thus the Annual Business Survey occurred before the recent credit crisis became apparent and a more recent survey of 400 small businesses by Hewlett-Packard in association with the Federation of Small Businesses in Northern Ireland and the Small Firms Association in the Republic of Ireland found that uncertainty about the economic outlook is now the principle concern among small firms. Nevertheless, for small businesses in Northern Ireland some 65 per cent expected to grow their business over the coming year and a third planned to expand operations in the Republic or abroad. 7.5 The rationales for the schemes in Great Britain centre on equity issues, either because there is evidence that rates form a larger proportion of small business profits or turnover compared with larger businesses, as indeed the evidence for Northern Ireland also suggests, or to achieve particular social objectives. 7.6 Wales is a case in point where the provision of a rate relief scheme to small businesses is seen as part of the Assembly Government s social policy, particularly to ensure that businesses are sustainable in deprived communities. The enhanced provision of rate relief to Post Offices is seen as a major contribution to the Assembly Government s policy of keeping Post Offices open. It is made clear that rates relief is not a driver for economic investment because the Assembly Government is able to use other mechanisms to achieve that objective. Nevertheless, they consider that this 64 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

75 scheme will make a significant contribution to ensuring businesses can remain viable in all communities. 7.7 The new Scottish Small Business Bonus scheme also cites as a rationale that rates account for a higher proportion of turnover of small businesses than they do for larger businesses and that the Scottish government is determined to help small businesses gain a competitive advantage. 7.8 In Northern Ireland there is not a strong case for targeting deprivation through a general small business rate relief as the majority of small businesses are located in the least deprived wards as Annex B shows, though this does not necessarily preclude a selective rate relief to assist small businesses in the worst deprived wards. However, producing a geographically discriminated relief scheme would inevitably lead to problems at the boundaries as the experience with Enterprise Zones has amply demonstrated. Impact and Incidence of a Scheme 7.9 The simulations of the various relief schemes when applied to Northern Ireland show that the amount of individual relief would be slight and therefore unlikely to generate significant additional investment or jobs. State Aid de-minimus rules could also constrain the amount of relief that could be given over any 3 year rolling period. Duplication of the new Scottish scheme would be very expensive for the Executive to adopt without alternative sources of funding or expenditure cutbacks The evidence on where the relief might fall (its incidence) points to the majority of any rate relief being captured by the landlords of those businesses that rent their property through the process known as capitalization. Basically this means that as rates are held down by the subsidy landlords push up rents faster than they would be able to do otherwise. Estimates of capitalization effects vary with some studies suggesting that in the long term up to 100% of the subsidy is captured by landlords. Depending on local circumstances a figure of one half might be a more likely lower estimate. This could mean that up to 50% of small businesses in Northern Ireland Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

76 may see no benefit from a rate relief scheme. It would be a political judgement whether landlords were particularly deserving of assistance on this scale A general point about focussing relief on small businesses is that it theoretically could give a perverse incentive to stay small to avoid straying over the NAV thresholds, or, conversely, encourage medium size businesses to down-size their property to take advantage of the relief There is also the issue of deadweight where businesses would expand investment or employment anyway, even if a rate reduction was not available. The sample survey suggests that around 25% of businesses would do nothing if rates were reduced by 25% To give some feel for the magnitude of impact Table 7.1 attempts to illustrate the potential gross job generation, all other things being equal, of the various schemes if all small businesses react to the relief by employing more staff, landlords absorb some of the relief through higher rents and deadweight is present. It can be seen that only the most expensive scheme can generate up to 1000 jobs at a recurrent cost of almost 48 million per annum. This would be an extraordinary cost per job year and could not be justified on value for money terms. Table 7.1: Illustrative Job Impact in Northern Ireland of Various SBRR Schemes SBRR Schemes Cost of Relief in NI ( m) Gross Job Impact Jobs Adjusted for Capitalisation Jobs Adjusted for Deadweight Scottish (2008 scheme) ,994 1, Scottish (2003 scheme) English scheme Welsh scheme Notes: Assumes that 50% of small businesses rent and of these, landlords would capture 75% of the relief through higher rents. Assumes deadweight at 25%. The average labour cost embodied in the calculation is estimated at around 24, Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

77 The Parity Argument 7.14 A popular argument in favour of introducing a SBRR in Northern Ireland is that such schemes already exist in England, Scotland and Wales and by denying the same treatment to small businesses locally they are put at a competitive disadvantage relative to their counterparts in Great Britain. This is what might be described as the parity argument for a local SBRR scheme. The parity argument does not necessarily imply that rate relief schemes are a good way of assisting small businesses merely that because they exist elsewhere there should also be a scheme in Northern Ireland. That is a perfectly legitimate argument from a political perspective but there are a few difficulties that have to be faced. The most important is that because there are now many different schemes in operation in Great Britain which one should parity be linked to? This is important because the different schemes have widely different cost implications for the Northern Ireland Executive or larger businesses in the region who may have to pay for it A second problem is the competition issue. The overwhelming majority of small firms that would qualify for a SBRR scheme serve local markets so that their competition is other local firms. The bulk of the subsidy would therefore go to subsidizing internal competition and because the amount of subsidy going to a firm (after capitalization), under even the most generous scheme would be very modest, it is difficult to see what the point of such an exercise would be. Implementation Issues 7.16 A small business rate relief scheme in Northern Ireland would impose administrative costs on government and compliance costs on businesses if the scheme is application based. As estimated earlier, administrative costs for application based schemes could be in the region of 500,000, though an automatic scheme such as the Welsh one would be less expensive Also there are technical and legislative problems with striking a non-domestic rate and a supplementary non-domestic rate for larger businesses in the Northern Ireland District Councils and funding issues in general as noted earlier. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

78 8. CONCLUSIONS AND RECOMMENDATIONS Introduction 8.1 Local services provided by both the Executive and District Councils have to be financed and one of the sources of finance is the rates. Thus any proposal to grant a relief on rates implies either that services that would otherwise be provided have to be sacrificed or that rate payers who do not qualify for the relief have to pay higher rates than they would in the absence of the relief. Ideally the rate base should be kept as wide as possible so that the level of the rates can be held to a minimum compatible with the amount of revenue to be raised. In other words rate reliefs should be very rare. That approach spreads the benefits of low rates widely while at the same time avoiding distortions to the true price of accommodation. However, Northern Ireland is very far from this position. Over time a very wide range of reliefs and exemptions such as reliefs on industrial premises and exemptions for agriculture, have hollowed out the tax base. In these circumstances a new Small Business Rate Relief scheme that would reduce the rate base even further or impose an additional premium on larger companies would need very compelling justification. Justifying a Small Business Rate Relief Scheme 8.2 Policy interventions in support of particular sectors or even individual industries relies on the economic argument that for some reason the market is failing to promote the efficient use of resources and corrective action has to be taken by the State. In addition the instruments used to correct for market failure have to be appropriate otherwise the problem might be compounded. 8.3 The small business sector is rightly seen as important for the economy. By far the largest proportion of businesses in Northern Ireland (and everywhere else) are small in terms of numbers of employees and many are sole traders. It is also the case that it is from this sector that the larger endogenous businesses of tomorrow must come. Thus the small business sector enjoys a special status and all 68 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

79 administrations are keen to both encourage new entrants to the sector and help existing small companies to expand, particularly if they have an export orientation. That said there is little evidence that the market systematically fails small businesses. Of course, starting and maintaining a small business is not easy and many small businesses struggle to survive but that is a natural part of the business environment and based on the record of births and deaths in the small business sector in Northern Ireland the region is much less volatile than other parts of the UK. 8.4 To the extent that small businesses do have market problems many of these revolve around obtaining good information and being able to act upon it through sound management. Addressing these issues and those that arise from the bureaucracy that small firms face are commonly high on any survey of small business concerns. 8.5 If the evidence for intervention to support small firms on economic efficiency grounds is weak there are other justifications based on political and social considerations that have been used. Indeed all of the existing SBRR schemes in the UK have been defended on precisely these grounds, most notably in the case of the scheme in Wales. Suitability of SBRR as a Small Firms Support Instrument 8.6 Even if a case can be made to intervene in the economy to support small businesses this is not an automatic endorsement for a SBRR scheme as the instrument for intervention. Indeed as the preceding analysis has made clear there are very serious deficiencies inherent in using the rating system to provide support for small firms. The principal problems are: Since the SBRR is a property linked subsidy it does not cover all small businesses. Capitalization means that a large proportion of the rate relief is captured by landlords instead of small businesses. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

80 There is inevitably a large measure of deadweight in such schemes since the benefit is granted indiscriminately. If the scheme is to be kept affordable the actual level of relief is invariably very modest and will likely make no impact on the performance of the business. The relief is therefore essentially a windfall gain. If the scheme is to be self financing there must be a sufficient number of larger businesses to keep the premium they have to pay to tolerable levels. This would be a particular problem in Northern Ireland. Efforts to target the scheme on selected businesses (e.g. exporters) could raise State aid issues. Because of the existence of both a Regional Rate and a District Rate in Northern Ireland there are significant technical problems in introducing a self financing scheme that gives relief on both rates. Relative to the cost the economic benefits that would flow from a SBRR scheme are trivial. 8.7 Taken in the round therefore we are of the opinion that introducing a SBRR in Northern Ireland could not be justified on economic grounds. There are also reservations about the utility of such a scheme to meet social and political objectives and in particular to address issues of deprivation. The Form of a Northern Ireland Scheme 8.8 If the Executive and the Assembly feel compelled to introduce an SBRR scheme despite all of the reservations that have been described above then the form of scheme that would be appropriate is that adopted by the Welsh Assembly Government. The reasons for this recommendation are as follows: The Welsh scheme is simple to understand and simple to administer. 70 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

81 The scheme is the most affordable option though the resulting benefits to individual businesses are quite modest. The Welsh model already exists so minimising the development costs. The Welsh scheme makes particular provision for Post Offices and we recommend that these provisions are also adopted 17. Since the scheme is funded by loss of revenue it avoids the complications of a self financed scheme in the circumstances of Northern Ireland. It would also be relatively easy to extend the scheme if that could be afforded. Other Issues 8.9 During the course of the investigation for this report some data issues emerged with the Land and Property Services valuation database. It is recommended that the LPS adopts the standard industrial classification for businesses and includes owner/renting information in its non-domestic valuation database. This would greatly assist in assessing the incidence of rates on businesses. 17 As this report was being finalised it was announced that 42 Post Offices, mostly in rural areas, would close outright and a further 54 would close but be replaced with lesser facilities. Since 2003 over 160 Post Offices in Northern Ireland have closed. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

82 ANNEX A: STATE AID State Aid Implications A.1 State aid is a Member State s financial aid to business which meets all the criteria in Article 87(1) of the updated European Community (EC) Treaty. Article 87(1) declares that State aid, in whatever form, which could distort competition and affect trade by favouring certain undertakings or the production of certain goods, is incompatible with the common market - unless the Treaty allows otherwise. A.2 State aid has four characteristics or criteria: (i) It is granted by the State or through State resources. State resources includes public funds administered by the Member State through central, regional, local authorities or other public or private bodies designated or controlled by the State. It includes indirect benefits such as tax exemptions that affect the public budget. (ii) It favours certain undertakings or production of certain goods. It aids an undertaking, i.e. an entity engaged in economic activity. Economic activity is activity for which there is a market in comparable goods or services. It can include voluntary and non profit-making public or private bodies such as charities or universities when they engage in activities which have commercial competitors. It includes self-employed/sole traders, but generally not employees as long as the aid does not benefit the employers, private individuals or households. The aid is available to certain undertakings but not others in the Member State, eg it selects individual businesses, sectors, areas, sizes of business, or production of certain goods (a benefit available to all businesses is not State aid but a general measure). It favours them by conferring an advantage on them. An advantage may be direct or indirect, eg grants or favourable loan terms or services provided at less than market cost, or relief from charges a business would normally bear. 72 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

83 (iii) It distorts or threatens to distort competition. It potentially or actually strengthens the position of the recipient in relation to competitors. Almost all selective aid will have potential to distort competition - regardless of the scale of potential distortion or market share of the aid recipient. (iv) It affects trade between Member States. This includes potential effects. Most products and services are traded between Member States and therefore aid for almost any selected business or economic activity is capable of affecting trade between States even if the aided business itself does not directly trade with Member States. The only likely exceptions are single businesses, eg hairdressers or dry cleaners with a purely local market not close to a Member State border. The case law also shows that even very small amounts of aid can affect trade. A.3 Normally an operating subsidy such as a small business rate relief would breach the 4 tests above. There are Group or Block Exemptions which allow aid to small and medium sized enterprises for investment, consultancy or research and development but relief aimed at rates would be unlikely to fit within these exemptions. A.4 Small Business Rate Relief is more likely to be covered by the De Minimis Aid Regulation which covers small amounts of aid ("de minimis aid) which do not count as State aid in the sense of Article 87(1). The de minimis rule does not apply to: Undertakings active in the fishery and aquaculture sectors; Undertakings active in the primary production of agricultural products; Undertakings active in the processing and marketing of agricultural products (i) when the amount of aid is fixed on the basis of the price or quantity of such products purchased from primary producers or put on the market by the undertakings concerned; (ii) when the aid is conditional on being partly or entirely passed on to primary producers; Export-related activities towards third countries or Member States (namely aid directly linked to the quantities exported, to the establishment and operation of a distribution network or to other current expenditure linked to the export activity). Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

84 The de minimis regulation sets a threshold figure below which Article 87(1) can be considered not to apply. As such the measure need not be notified in advance to the Commission. This is based on an assumption that in most cases, aid up to this amount will not affect trade and competition between Member States. A.5 The total de minimis aid granted to any one undertaking must not exceed 200,000 ( 140,000) over any period of three fiscal years. For undertakings active in the road transport sector, the total de minimis aid shall not exceed 100,000 ( 70,000) over any period of three fiscal years. These ceilings shall be expressed as a cash grant. The figures should be gross, before any deduction of tax or other charge. Where aid is awarded in a form other than a grant, the aid amount shall be the gross grant equivalent of the aid. Aid payable in several instalments must be discounted to its value at the moment of its being granted. The interest rate to be used for discounting purposes and to calculate the gross grant equivalent shall be the reference rate applicable at the time of grant. A.6 If aid given exceeds the de minimis ceiling, the de minimis regulation cannot be used, either at the time the aid is granted or subsequently, even for the part of the aid amount that does not exceed the ceiling. This regulation applies only to transparent aid. Transparent de minimis aid means: loans where the gross grant equivalent has been calculated on the market interest rates that apply at the time of the grant; aid given as capital injections where the total amount of the public injection does not exceed the de minimis ceiling; aid given in risk capital measures where only capital up to the de minimis ceiling is provided to each target undertaking; individual aid provided under a guarantee scheme when the guaranteed part of the underlying loan provided under the scheme does not exceed 1,500,000 per undertaking ( 750,000 per undertaking when the undertaking is active in the road transport sector). The guarantee shall not exceed 80% of the underlying loan. The above ceilings apply to the total amount of de minimis aid to a single recipient from all sources of de minimis aid. De minimis aid cannot be given towards the same costs that are being supported under another block exemption or notified scheme if it means that the aid intensity would exceed what is allowed under the block exemption or notified scheme. 74 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

85 ANNEX B: EQUALITY AND NEW TSN ASSESSMENT Small Business Rate Relief Equality Impact Assessment Section 75 B.1 Section 75 and Schedule 9 to the Northern Ireland Act 1998 places a statutory obligation on public authorities in carrying out their various functions relating to Northern Ireland, to have due regard to the need to promote equality of opportunity between persons of different religious belief, political opinion, racial group, age, marital status or sexual orientation; between men and women generally; between persons with a disability and persons without; and between persons with dependants and persons without. B.2 In addition, without prejudice to this obligation, Public Authorities are also required to have regard to the desirability of promoting good relations between persons of different religious belief, political opinion, and racial group. Methodology B.3 An Equality Impact Assessment (EQIA) is the analytical tool used to determine the extent of any positive or negative impacts that a new policy such as a small business rate relief might have upon the Section 75 groups described above. B.4 The methodology for the EQIA adopted here uses a generic type of small business rate relief rather than mirroring any specific scheme. It assumes that rate relief is provided to small commercial businesses with NAVs of less than 10,000 and that, if the scheme was to be self funding, those businesses with NAVs of 30,000 and above would pay for the relief through a supplementary rate. The data sources used were the 2001 Census of Population and the LPS valuation data. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

86 B.5 The rate relief recipients (businesses with less than 10,000 NAV) were divided into District Councils with above and below average rate relief based on the overall Northern Ireland average. The population characteristics of the two groups of District Council areas were found from the Census and percentages for each section 75 subgroup calculated. Pair-wise comparisons were then made between the sub groups and tested for significance using a rule of thumb test (if the difference between two sub group percentages was greater than plus or minus 20% then the difference was deemed to be significant). The same procedure applies to the larger funding group of businesses. Assessment B.6 The table shows the comparisons for the various Section 75 sub-groups. It should be noted that sexual orientation and political opinion are not included due to lack of statistical information. Significant differences emerge between four of the sub-groups: Within the marital status category separated and divorced persons are over represented in Districts which would receive above average SBR relief, but equally also over represented in areas where larger businesses would pay an above average funding supplement. This pattern is repeated for the Other (non-white) sub-group in the race category Within the religion category the Other/none group is also over-represented in Districts which would receive above average SBR relief, and in areas where larger businesses would pay an above average funding supplement. No significant differences are evident between the other groups. 76 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

87 Small Business Rate Relief Equality Impact Assessment Rate Relief Receivers (< 10,000 NAV) Rate Relief Funders (=< 30,000 NAV) Section 75 Groups Sub Groups* Districts with above average rate relief (%) Districts with below average rate relief (%) Districts with above average rate relief (%) Districts with below average rate relief (%) Age Persons Persons Persons aged Gender Male Female Marital status Single Married Re-married Separated Divorced Widowed Dependents No dependent children Child Children Race White Other Religion Catholic Protestant Other/None Disability Households with 1 or more persons with a limiting long term illness Households with no persons with a limiting long term illness *Some groups may not sum to 100 due to rounding. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

88 Small Business Rate Relief New TSN/Lifetime Opportunities Assessment Lifetime Opportunities Strategy B.7 Lifetime Opportunities is government s Anti-Poverty and Social Inclusion Strategy for Northern Ireland and is the result of a commitment by the previous Executive to review the New Targeting Social Need policy. B.8 The Strategy Lifetime Opportunities is structured around a number of general challenges which become the priorities for future policy and action. These are as follows: Eliminating Poverty - Despite improvements in general prosperity and social conditions in recent years, 327,000 people, including 102,000 children and 54,000 pensioners, remain in poverty. Eliminating Social Exclusion - The priority is also to provide opportunities for everyone to participate fully in the social and economic life of our community. Tackling Area Based Deprivation The concentration of multiple deprivation such as high unemployment, crime and low educational attainment in mainly urban areas poses particular challenges for government. For the 284,000 people who live in such areas there is much greater risk of poverty, poor health, both physical and mental, and the despair that comes from having no apparent prospect of improvement. Tackling the multiple deprivation that has persisted in many areas for decades, is a priority within the overall strategy. Eliminating Poverty From Rural Areas - While poverty and multiple deprivation tend to be concentrated in urban areas, pressures on the agricultural sector, demographic change and the physical isolation leave many in rural communities in or at serious risk of poverty and social exclusion. Here the challenge and priority is to build a strong rural community infrastructure which will help provide economic and social opportunities for everyone, but in particular for young people who want to live and work in the countryside. 78 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

89 Shared Future Shared Challenges - Against the backdrop of 30 years of conflict and a longer history of community division in Northern Ireland, the promotion of respect and tolerance between the two main communities is a significant challenge but an essential condition nonetheless for achieving the pace of further economic and social change needed to eliminate poverty and social exclusion here. Tackling Inequality in the Labour Market - Just as it is important to continue to create employment as a route out of poverty, it is equally important to promote equality of opportunity for all in accessing employment. Inequalities in the labour market persist, including those based on religion, gender and disability. Policy and legislation must be used as a means of removing barriers to participation in the labour market. Tackling Health Inequalities - People who are better off tend, for the most part, to live longer and healthier lives than those living in poverty. It is important therefore to reduce inequalities in health between geographic areas, socioeconomic and minority groups and to direct spending towards those in greatest need. Tackling Cycles of Deprivation - Policy must break the cycle and the process that results in children who are born into poverty developing into underachieving young people with limited aspiration and low levels of educational qualifications and skills. They in turn become working age adults living in low incomes often in poor health and benefit dependence, with the prospect of a shorter, less healthy, comfortable and financially secure older age. They are also the adults most likely to be parents of children again born into poverty with the cycle continuing. Policy must disrupt this process focussing on different priority needs and different times in people s lives, from early years through to childhood, adult working life and later years. Assessment B.9 The extent to which a small business rate relief could impact on the Lifetimes strategy is likely to be quite modest given its relatively small estimated employment Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

90 effects and even here it is uncertain to what extent the various target groups would actually benefit. B.10 The charts below depict the relationship between small commercial businesses and multiple deprivation at ward level based on the Noble indicators 18. They show that small businesses are concentrated in the less deprived wards in Northern Ireland and this suggests that a simple general SBRR would not effectively target areas of multiple deprivation. This, of course, does not preclude a SBRR scheme which would only target areas of highest deprivation, but the point about a modest impact would still apply. Deprivation and Small Businesses (less than 5000 NAV) No. of small businesses Multiple deprivation score 18 The NISRA paper Measures of Deprivation in Northern Ireland (2005) sets out a range of indicators of deprivation at ward level (often referred to as the Noble indicators), including a Multiple Deprivation Measure. 80 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

91 Small Business Rate bills v Multiple Deprivation at Ward level Deprivation Score Average rate bill Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

92 ANNEX C: LIST OF CONSULTEES Confederation of British Industry (CBI) Federation of Small Business (FSB) Invest NI National Federation of Sub Postmasters (NFSP) Ulster Society of Chartered Accountants (USCA) 82 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

93 ANNEX D: ERINI QUESTIONNAIRE ON SMALL BUSINESSES AND NON- DOMESTIC RATES Questionnaire No... QUESTIONNAIRE ON SMALL BUSINESSES AND NON-DOMESTIC RATES The Economic Research Institute of Northern Ireland (ERINI) has been commissioned by the Department of Finance and Personnel (DFP) to undertake an independent investigation into the case for rate relief for small businesses in Northern Ireland. Please take a little of your time to fill out this brief questionnaire to help us identify the importance of this issue for your business. Alternatively, the questionnaire can be completed electronically and is available at: by following the link to the investigation into a small business rate relief scheme. Name of respondent Position in business Contact telephone number address PLEASE NOTE THAT ALL RESPONSES ARE CONFIDENTIAL THANK YOU FOR YOUR CO-OPERATION Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

94 ABOUT YOUR BUSINESS: 1. Name of business 2. Type of Business (please tick) Sole Trader.. Partnership.. Franchise..... Private Limited Company.. Private Unlimited Company. Other (please specify).. 3. Full address of business (include post code) 4. What District Council area is your business in? 5. Please describe what your business does? 6. How many people do you employ? Total.... (Male. ) (Female....) None.. I am a sole proprietor 84 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

95 7. Tick below what sector description bests fits your business. Agriculture, hunting, forestry Fishing Mining & Quarrying Manufacturing Construction Retail trade Post Office Wholesale trade Repairing (of motor vehicles, personal & household goods) Hotels & restaurants Transport, storage & communication. Financial services Real estate, renting and business activities Other (please specify) 8. What percentage of your sales are currently sold to the following areas? Northern Ireland Great Britain Republic of Ireland Rest of European Union Elsewhere % of sales 100% 9. What percentage of your business inputs or supplies do you currently obtain from the following areas? Northern Ireland Great Britain Republic of Ireland Rest of European Union Elsewhere % of supplies/inputs 100% Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

96 10. Do you own or rent the property? Please Tick (own ) (rent.) 10a. If renting, what is the length of your current rental/lease agreement and how long until renewal? Length (in years).. Period (in years) until renewal 11. If renting, what is your Annual Rental Cost?. 12. What is the Net Annual Valuation of the property and your actual rates bill for 2007/08? (this information is available on your Rates bill) NAV... Rates bill... 12a. If you have more than one business property please list their Net Annual Values (Information available from your Rates bill) Property No 2 Property No 3 Property No 4 NAV Rates bill 13. What is the turnover of your business( ) for 2006/07? (or latest available year please specify). 14. What is your estimate of pre-tax profit (or loss) ( ) for 2006/07? (or latest available year please specify) Pre-tax profit.. 14a. On average, what is your rates bill as % of your pre-tax profit?.. 86 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

97 15. What are your main costs? Energy (electricity, gas, oil) Property insurance Transport Labour costs Interest on borrowing Materials Rent Rates Other (please specify) ( estimates for or latest available please specify) 16. What are the main pressures facing your business? Please select the most relevant pressures and rank their importance to your business, with 1 = very important to 5 = not important. You can give equal ranks if appropriate. Pressures The state of the economy Increased competition Level of Corporation Tax Level of non-domestic rates Burden of administration/record keeping for tax purposes - VAT, PAYE, National Insurance Other regulatory burdens e.g. health & safety Difficult to recruit suitable staff High labour costs Cost of insurance Rent costs Level of energy costs Transport costs Cash flow Obtaining finance Other (please specify) Rank Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

98 17. If your rate bill was reduced by 25% or 50% how would your business react? Please select the option(s) you are likely to take under each reduction and rank with 1 = most likely, 2 = fairly likely, 3 = unlikely. You can give equal ranks if appropriate. 25% reduction 50% reduction Reduce your prices to customers Hire additional staff Invest in new equipment Move to larger premises Do nothing Other (please specify) 18. Are you currently in receipt of any Government financial assistance? If so, please state what sort of assistance and the amount(s) received: Please indicate yes or no.... If yes, please specify amount of assistance.. And type of assistance How long has your business been in existence? (Please indicate relevant period) Less than 1 year 1 year to less than 5 years 5 years to less than 10 years 10 years or more 88 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

99 20. Are you a member of any business organisation? Please indicate yes or no... If yes, please specify. 21. Generally speaking, what sort of assistance do you see as being most relevant to help small businesses? Thank you for your co-operation Please return the completed questionnaire by Friday 30 November 2007 to: Economic Research Institute of Northern Ireland 2 nd Floor Floral Buildings 2-14 East Bridge Street Belfast BT1 3NQ Tel: Fax: Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

100 ANNEX E: ERINI RESPONSE TO REVIEW OF RATING POLICY, RATE RELIEFS FOR BUSINESS IN NORTHERN IRELAND, JULY 2005 CONTENTS Introduction Support for Businesses in Northern Ireland Rate Relief for Small Firms (a) The Case for Relief in Principle (b) The Case for Relief in Practice Conclusions 90 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

101 Introduction The Economic Research Institute of Northern Ireland welcomes the opportunity to comment on the government s proposals for rates relief for businesses in Northern Ireland. These proposals are a continuation of the work on reform of the rating system which began in 2002 and which has already seen decisions to rate unoccupied non- domestic properties and the phasing out of industrial de-rating, as well as significant changes to the domestic rating system. The current proposals concern a range of possible reliefs for the agricultural and business sectors which mirror similar tax breaks available in the national non-domestic rates applied in Great Britain. The focus of the ERINI response to this consultation is on the proposals for rate relief for small businesses. From an economic perspective the rates are important for at least two reasons. First, under the financial regime applying to a devolved administration (which has been maintained under Direct Rule) revenue from the rates can be used to boost public expenditure. This had not previously been the case when Northern Ireland had a purely expenditure based fiscal system (annual expenditure is agreed independently of revenue) and money from the rates was treated solely as a financing item for a set amount of expenditure. The rates therefore provide the only direct link between local taxes and local expenditure and bring home very clearly the opportunity cost to people in Northern Ireland of allowing expenditure to grow. Second, allowing relief from rates is the only locally controllable tax break in a system of financial support for businesses that is otherwise entirely based on grants. ERINI has recently undertaken a comprehensive survey of the costs of doing business in Northern Ireland and we are obviously interested in any action by government that could alter the existing cost structure and hence the incentives for doing business in the region. Support for Businesses in Northern Ireland Systematic financial support for businesses in Northern Ireland has been available in various forms for most of the past century. Initially most of that support went to manufacturing industry in the form of grants or rates relief and was focused on larger enterprises. Over the past forty years however the focus has changed in a number Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

102 of ways. First, there has been a significant shift away from more or less automatic grant aid towards selective financial assistance on a case by case basis. Second, new inward investment to re-invigorate the industrial base has been favoured over continuing support for domestic business, though the latter remains high by UK standards. As the amount of mobile industrial investment has declined this approach has been extended to capture tradable services. Finally, there has been a much greater interest shown in the promotion of small businesses and entrepreneurship as the seed corn for future growth. The economic rationale for almost all forms of government assistance to business has now been based on the notion of addressing market failures, that is, making good deficiencies which affect markets for technical or structural reasons. In the case of small business for example, such failures can occur because the market takes too harsh a view of the risks involved in financing such ventures or owners do not properly assess the costs and benefits of exporting. The approach which has been adopted in addressing these issues is to create a range of instruments, some of which are financial in nature and some a benefit in kind, such as expert advice, which are tailored for each situation. The great advantage of this approach is that it minimises the amount of deadweight in the system which is a measure of the amount of aid that is given when it is not needed and allows more to be done where a difference can be made. The disadvantage is that targeted support is more costly in administrative overheads and requires officials to exercise a degree of judgement in deciding who is helped and how much should be given. Rate Relief for Small Firms The consultation document advances two arguments for considering rate relief in the particular case of small businesses. First, the general desire to stimulate small firm growth and the development of new businesses which has been recognised as a desirable priority in the Programme for Government. This is what might be called the justification in principle. Second, there is evidence that rates are a higher percentage of overheads for small firms than for larger enterprises and rate relief would be an obvious way of offsetting this penalty. This is very much a practical argument for granting reliefs. Both of these arguments are worth looking at further. 92 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

103 (a) The Case for Relief in Principle The argument here is that small businesses are good for the economy and should be encouraged. Relief from non-domestic rates makes setting up and running a small business more attractive than would otherwise be the case and is therefore justified as a means of obtaining many more small businesses than would otherwise be the case. The first of these arguments may be true (though not necessarily if small businesses actually make poor use of resources by producing things that people don t want to buy) but it does not follow that the second argument is justified. Rate relief is a global form of assistance even when applied to a category such as small businesses. Everyone falling in that category gets the relief whether they need it or not. It is therefore a crude form of assistance with inherently high levels of deadweight. In terms of administration there are also difficulties since the rates are levied on heriditaments defined by their Net Annual Value so additional identifiers specific to small businesses would need to be identified, claimants registered and the system policed. All of this would incur additional administrative costs. Thus while the principle of supporting small businesses may be sound it is by no means clear that the most effective and economic way of doing so is through a blanket rate relief. (b) The Case for Relief in Practice Rates are a charge on property so relief from rates is in the first instance a subsidy to property. Subsequently, of course, since money is fungible the final incidence of the subsidy may end up elsewhere. Now if there was evidence that property costs for businesses in Northern Ireland and for small businesses in particular were grossly out of line with elsewhere in the United Kingdom there could be a case for a subsidy of this sort. Unfortunately the evidence to support this is not there. Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

104 The DTI (2005) 19 sets out a capital and rental value index for industrial and office accommodation costs for January 2005 (see Figure A and B below). The results indicate that in terms of Industrial and Office accommodation costs, Northern Ireland displays lower than average costs relative to the UK as a whole. Figure A Capital value index of Industrial Property Cost, Jan Index UK= NE W EM WM NW SC NI SW Y&H UK ENG E SE L Source DTI (2005) Figure B Rental Value Index of Office Accommodation, Jan UK= W EM SW NW NI Y&H WM E NE UK ENG SE SC L 19 DTI (2005) Regional Competitiveness & State of the Regions, April, Department of Trade and Industry. 94 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

105 Providing a subsidy for property also introduces distortions into the business decisions of firms. In particular the choice of size and location of property may not be optimal because its costs are artificially depressed by rate relief. This phenomenon was apparent in the location of industrial sites in Belfast when industrial de-rating applied and can be seen most vividly in the occupation of prime retail sites by charity shops that do not pay rates. It is important to note that this is a misallocation of resources not only for the individual enterprise but for society as a whole since the true location value of land is not being realised by the activities carried out on it. It is also argued that rates represent a higher proportion of turnover and costs for smaller firms than for larger ones and rates relief would address this burden. It is true that there is an inverse relationship between rates and turnover. Indeed the GB Green Paper Local Government Finance, published in 2000 reveals that the relative impact is most severe for firms with a turnover of less than 50,000 per annum, as the table below shows: Table 1. Relative Impact of Rates Based on Notional Rates Costs Rates % of Turnover Rates as % Overheads TOTAL Turnover Less than 50k k K 499.9K K - 1.9K m - 9.9k m k m k bn or more Source: Local Government Finance 2000 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

106 The IDBR 20 (2004) reveals that 53.1% of VAT registered businesses in Northern Ireland had a turnover of less than 100k but the highest incidence of businesses with a turnover of less than 50K occurs in Agriculture (63%) and, in terms of tradable services, less than 13% of VAT registered businesses had a turnover of less than 50k. Thus the type of businesses most likely to justify for relief on this criterion are not those most favoured by economic development objectives. Conclusions All of these arguments point to the exercise of caution before introduction a blanket relief on rates for small businesses. Indeed there is no justification for such a global relief. Small businesses do need help but this has to be carefully tailored to their circumstances. Assistance with start-up capital and sound business advice is much more important than a general subsidy for property, and such help is best administered selectively. ERINI note that the government do not intend to introduce small business rate relief at this time but will keep open the possibility of introducing such a scheme in the future. The evidence for doing so would have to be more convincing than that which is currently available. 20 NISRA (2004) Facts and Figures from the Inter Departmental Business Register (IDBR), Department of Trade and Investment. 96 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008

107 APPENDIX F: BIBLIOGRAPHY Department for Business Enterprise and Regulatory Reform, The Annual Survey of Small Businesses Opinions 2006/07 (ASBS 2006/07), Summary report of findings among UK SME employers, URN 07/389, IFF Research Ltd, February 2008 Department of the Environment (London), The Impact of Rates on Businesses, The Institute for Fiscal Studies, 1995 Department of the Environment (London), The Relationship Between Rates and Rent, The Institute for Fiscal Studies, 1995 DETI, Interdepartmental Business Register, Edition 9 Facts and Figures from the IDBR, June 2007 DETI, The Future of Private Services in Northern Ireland, NIERC & Regional Forecasts, April 2004 DETI, The Future Role of Manufacturing in Northern Ireland, PWC, July 2005 DETI. Quarterly Economic Review, Winter 2007 DFPNI, Review of Rating Policy, Initial Integrated Impact Assessment (IIA) into Rate Reliefs for Business in Northern Ireland, March 2005 DFPNI, Review of Rating Policy, Rate Reliefs for Business in Northern Ireland, A Policy Paper, March 2005 DFPNI, Review of Rating Policy, Rate Reliefs for Business in Northern Ireland, Consultation Report, April 2006 DFPNI, Review of Rating Policy, The Rating of Vacant Property and the Removal of Industrial Derating, April 2003 Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March

108 ERINI, Response to: Review of Rating Policy, Rate Reliefs for Business in Northern Ireland, July 2005 F Chittenden and B Sloan, Report for the Small Business Service, Taxation and Small Businesses: a Review of the Literature, Manchester Business School, November 2006 Federation of Small Businesses, Business Rates: the small business perspective 2003 Federation of Small Businesses, Lifting the Barriers to Growth, The FSB biennial membership survey, 2004 G Duranton, L Gobillon and H G Overman, Assessing the effects of local taxation using microgeographic data, London School of Economics, 20 June HM Treasury and HMRC, The Relationship between National Non-Domestic Rates and Rent on Commercial Property: Empirical Evidence from Enterprise Zones, Cambridge Econometrics, 2007 McDonald, JF, Maximisation of Non-Residential Property Tax Revenue by a Local Government, Centre for Urban Real Estate, College of Business Administration, University of Illinois at Chicago, February 2007 Poutziouris P, Chittenden F, Watts T, Soufani K, A comparative analysis of the impact of taxation on the SME economy: the case of UK and US New York State in the year 2000, Environment and Planning C: Government and Policy 2003, volume 21, pp The Chambers of Commerce of Ireland, Commercial Rates the Business Burden, October 2003 Varney, Sir David, Review of Tax Policy in Northern Ireland, December Investigation into a Small Business Rate Relief (SBRR) Scheme In NI, March 2008