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