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Reform of Business Rates


This paper outlines a method for shifting the basis of business rates (also known as National Non-Domestic Rates (NNDR)) onto site values in a way that is revenue neutral. A five stage transition is proposed, and the basis of valuation is considered.

The effects on sites of different degrees of development are compared and the effect of a shift of incidence from occupier to owner is considered for rented sites. The outcomes predicted include the more efficient use of land and the possibility of a brake to regulate speculative property bubbles.


In their 2010 election manifesto the Liberal Democrats, now a member party of the Coalition Government, included a proposal to:

"Reform business rates, creating a fairer system where rates are based on site values rather than rental values and are the responsibility of local authorities."

The policy of shifting tax from property onto sites was not unique to the Lib Dems. The manifesto of the Cooperative Party which has twenty six serving MPs contained the statement:

"In order to prevent similar problems [of unsustainable property booms] emerging in the upturn, the Government should use taxation to change incentives within the property market, ensuring that it incentivises the productive use of land rather than expected capital gains in an upward market. The Government should replace council tax and national non-domestic rates with a land value tax. While this would be a new method of taxation in the UK, countries such as Denmark, Hong Kong and Taiwan utilise land values to help their economies. Local Authorities in parts of Australia, New Zealand and North America have all adopted local forms of land value taxation. This is likely to not only improve economic stability but also stimulate investment in more productive elements of the UK economy over the medium to long term."

In 2010 the Institute of Taxation completed its Mirrlees Review [1], an extensive review of taxation in the UK. It argued very strongly for the economic case of moving business rates onto a site value basis concluding:

"This is such a powerful idea, and one that has been so comprehensively ignored by governments, that the case for a thorough official effort to design a workable system seems to us to be overwhelming. In particular, significant adjustment costs would be merited if the inefficient and iniquitous system of business rates could be swept away and replaced by an LVT."

This paper examines how this proposal for the reform of business rates (the National Non-Domestic Rate or “NNDR”) by replacing them with a national Land Value Tax (or “LVT”) could be beneficially implemented in the UK, taking into account the present state of its economy. It begins by looking at the present state of the UK commercial property market including the degree of indebtedness associated with it. It then outlines a programme for reform of business rates on the basis that the political parties and IFS have suggested.

The present state of the UK Commercial Property Market

To set the scene a brief overview of the UK commercial property market is presented based mainly on a recent Investment Forum Report [2].

The figures are based on 2009 data so they include the significant decline in property values that took place following the credit crunch of 2008. This is an update of a 2005 report on the market where the main sources of data for the Report were the Valuation Office Agency (VOA) and Office of National Statistics (ONS).

The total capital value of UK commercial property is estimated as £496 billion. Table 1 shows the basic composition of the market.

* e.g. hotels, pubs, leisure, utilities,

In addition Central Government stock was estimated at £217 billion and Local Authority stock at £130 billion.

Of the private commercial sector 38% (£188b) is owner-occupied and investors own the remaining 62%. The owner-occupied sector tends to be the less valuable property. Much of it is in the hands of large corporate bodies. Only 68 retail companies between them hold £68 billion of property assets. There are 755 companies with more than £20 million of property assets who between them hold around £160 billion of property. The investment market, consisting of some 20,000 buildings, is concentrated in high value properties. Table 2 identifies the main owners of commercial property held as investments.

Nearly half UK investment property is owned for the purpose of providing returns to UK pension funds and other personal savings schemes. However this commercial property only constitutes 5% of their total funds invested.

Each year the Department of Corporate Development of the De Montfort University publishes a detailed report of the UK Commercial Property Lending Market. The 2010 report has recently been published [3]. It makes unsettling reading. In the years leading up to the boom there was a large amount of lending against commercial property in the UK at high loan to value ratios. The total now stands at £228.3 billion. Following the recent falls in commercial property values it is estimated that 20% of these loans are in default or breach of covenant. Moreover £161 billion of these loans are due for repayment in the next five years. Much of the credit was supplied by banks that are now in state ownership (e.g. Lloyds supplied £62 billion and RBS, £57 billion). Any reform of NNDR needs to accommodate this delicate situation into account and increase stability rather than decrease it. This will be considered later.

An important additional fact that is relevant to this study is the amount of vacant land in the UK. At present, property that is not usable and vacant is not on the rate register. Muellbauer [4] estimated that if this included land with planning permission for domestic use it might add 25% to the capital value of commercial property i.e. around £125 billion. In 1985 Ronald Banks [5] made an estimate that there are 50,000 ha of land with development potential in the UK. The price of industrial and commercial land varies considerably over the country. Taking a rough figure of £1.3 million per hectare that would give a very rough estimate of £65 billion for its capital value but this did not include land for domestic use that Muellbauer included.

Proposed Reforms

This paper focuses on the practicalities of the reform of business rates described in outline in the Mirlees review and outlined previously by Connellan [6]. The wider context is the CEJ’s (Coalition for Economic Justice) proposal for a general shift of taxation off production and onto land. The economic and social reasons for the reform have been discussed in detail in separate CEJ papers, and will not be given again here.

The present system of non-domestic property taxation has a long history going back over four hundred years. For a long time it was associated with the raising of revenue for local government. Following the Local Government Finance Act of 1998 billing and collection is the responsibility of the local authorities who are funded by the tax, but rather than receipts being retained directly, they are pooled centrally and then are redistributed. Last year (2009/10) the tax raised £23.5 billion which was 4.3% of total tax revenue.

The system of non-domestic National rates (NNDR), or business rates, has the following distinct features:

1) The taxable unit is the hereditament. It is defined as a unit of property capable of commanding a rent. Domestic property is excluded as it is taxed in a different way.

2) From 1) it follows that derelict land, unused land, (and until 2008 unoccupied property) are exempt. Agricultural land has been exempt rates since the 1920s.

3) The tax falls on the occupier of the property.

4) The tax is a nationally defined proportion or rate of the value of the property.  In 2009 the main rate was 46.2% and in 2010 is 41.4% with some reduced rates for special cases.

5) The valuation is based on the existing use of the property.

6) The valuation of the property for the purpose of taxation is not necessarily directly related to the rent the tenant actually pays. It is based on a

hypothetical “reasonable” value a tenant would pay according to valuation criteria.

7) The valuation is updated every 5 years but the values are back-dated so although a new valuation came into force in 2010 it was based on 2008 values, before the significant decrease in values brought on by the financial crash.

8) The rateable values are open to public view and are displayed on the Valuation Office website.

In April 2008 business rates were extended to unoccupied property. In this extension the tax fell upon the owner. One of the main reasons given for the extension was to incentivise the full use of property and hence the land it occupies. However the disadvantage of the reform was that if the owner rendered the property unusable he was exempt from the tax. This has resulted in damage or demolition of significant numbers of potentially usable properties, simply to avoid rates. Owners of empty properties have also avoided rates by employing an agency to provide short-term tenants. During the period of occupation business rates are paid but when the property again becomes vacant, a three or six month rate free period again is claimed. Owners can also avoid empty property rates by "letting" rent-free to charities who are allowed to keep premises empty rate free between charitable uses. The reform proposed here could be seen as a natural extension of the previous reform and one that would overcome these problems.


The following reforms are proposed:

1) The taxable unit to be the site only. To put it another way, buildings and improvements would be exempt. Thus the taxable unit is defined geographically and could be identified for example, by the unique property reference number (UPRN) of every property that exists within the National Land & Property Gazetteer (NLPG). Since 2007 this has been maintained by local authorities under a central agreement involving various government agencies including VOA, OS and Land Registry. For any organisation owning several sites each would be valued independently.

2) Occupied residential land would be excluded. There could also be a threshold of site value below which land would be exempt.

3) The tax falls on the owner, not the occupier. Given that the owner changes less frequently and that the number of owners is much fewer than the tenants this should produce considerable simplification. For unoccupied land the owner would be billed directly. Given that the occupier is much easier to identify, in the case of occupied sites the tax could be levied by billing the occupier and then the occupier subtracting the payment from their rental payments to the owner. The ultimate penalty for non-payment could be forfeiture of the freehold.

4) The tax is a proportion of the site value, an annual rental value of the site, and is paid annually. For the change from the present property based system to one based on land to be tax neutral the rate would be quite a high percentage, close to 100% of the site’s rental value.

5) The valuation is based on optimum permitted use not on existing use. This takes into account planning permissions and local development plans. Optimum permitted use is not necessarily most profitable use. There would be scope here for local communities to become much more pro-active in their planning strategies and to determine for themselves what type of use they wish to permit for the land in their localities.

6) The valuation strategy would have to be very different from that used for business rates where calculations relate to existing use and are based on the nature of the building. It would be based on the annual rental value of the land without improvements. There is a residual method of valuation where the value of the site is obtained by subtracting the value of the construction costs from the market value of the property. However, this tends to undervalue land that is not in optimum permitted use (as any asset stripper knows). There are alternative comparative methods which would make use of both recent market transactions and a survey of the location and the surrounding factors that affect land value [7]. The recent revaluation in Northern Ireland provides an example of how this might be done. It requires the use of Computer Aided Mass Appraisal (CAMA) methods using Multiple Regression Analysis (MRA) and Geographic Information Systems (GIS).

7) Values should be updated annually. Modern computerised methods are capable of maintaining land value maps in real time, making use of property transaction information, already supplied to VOA and Land Registry, to continuously update valuations.

8) The site values should be on public display. The values for each region would be recorded in a GIS and presented in the form of land value maps. The Auditor’s Real Estate Information System (AREIS[8] of Lucas County Ohio, USA, provides an excellent example of an existing system of this kind. In practice this system was shown to have the additional advantage that the ‘positive feedback’ from the value maps leads to a more efficient, better informed property market.

The tax reform would need to be phased over several years as suggested by Connellan. In the transition phase there could be a two-tier scheme of property and land taxation as pertains in many US cities. The scheme illustrated here is a five stage transition which could be introduced for example over five consecutive years. During the transition period the occupier would continue to pay the old NNDR system but with a 20% reduction each year.  Meanwhile the owner would begin paying a site value rate with annual 20% increments over the transition. The rate could be set so that the overall tax take would be approximately neutral compared with the business rate.

Estimates of the proportion of property prices that can be attributed to land vary from 30 – 60%+ for commercial and industrial property. Given that the present rate is approximately 40% it would follow that the site value rate would be close to 100% of the rateable value of the land at the time of the reform.

It has been the practice with business rates that their real value, in terms of yield, remains constant so the yield only increases with inflation. Hence during a property boom the business rates yield decreases as a proportion of property values. This has prevented the possibility of NNDR being used as a tool to control speculative bubbles in commercial property values. The reformed rates would be linked to land values. If land values in general start to rise the revenue yield would follow, providing an effective brake to speculative bubbles since owners would be losing much of the ‘unearned increment’ from such speculation.


The bar charts below give some illustration of the way different sites will be affected by the reform. For simplicity the examples are of a shift from a business rate of 40% to a site value rate of 100%. The first case taken is that of owner-occupiers. The Investment Property Forum Report indicated that this covers 38% of commercial property. Here there would obviously be no change of incidence of tax. The change in the level of taxation will be determined by the ratio of site value to total value which reflects the degree of development of the site in question. There will be both winners and losers.

Figure 1 compares different sites with NNDR rateable values of £100,000. In the extreme a marginal site, i.e. one whose site value rate is below the threshold would pay no tax. This would be the case of a specialised plant such as a waste disposal unit in a remote location. Sites with a site value of less than 40% of the rateable value i.e. highly developed sites would have a reduction in the amount paid.  Sites with a site value of greater than 40% may pay more with the biggest change would be for vacant sites which were previously not included in the NNDR. 

Figure 2 shows the same thing in a different way by comparing sites of the same site value rating but different degrees of development. The same picture emerges, namely that the owners of highly developed sites would pay proportionately less and the owners of underdeveloped sites would find themselves paying more.

The next three charts illustrate case of sites with tenants. Here the incidence of tax changes from the occupier to the owner with the change being phased in over five years. Figure 3 takes the case of a site with rateable value of £100,000. An NNDR of 40% and SVR of 100% are again. Over the transition the tax paid remains the same but is gradually transferred from the tenant to the owner.

The third example, figure 5, is of a site of rateable value £100,000 but with the site value only 30% of the total. One the one hand this could represent a highly developed site such as a high-rise office block in a key location. On the other it also represents the situation close to the margin where site values are low. In both cases, as the transfer is phased in there is a decrease in the tax paid annually.

Effects of the Reform

For owner-occupiers the transfer of the business rates onto land will reward those who have developed the sites they own to the full. It should lead to increased efficiency of land use. For owners of unused and underdeveloped land it should act as an incentive to develop them. There is a large body of empirical evidence from the United States [9] that this type of tax shift does stimulate development. It is important to recognise that any such development must take place within the confines of “optimum permitted use” as determined by planning authorities.

For the tenant it needs to be recognised that rent and rates together constitute an occupational cost - the total rent plus rates payable (“TRRP”), which will always drift to the highest the tenant can afford. Thus if rates increase then rent decreases and vice versa. The most probable response to the change to SVR will be that landlords will attempt to increase rents back to the previous level. This will only be possible where SVR is lower than the NNDR as no tenant will be able to pay more than the TRRP. Comparing the three cases illustrated in figures 3, 4 and 5 it will be seen that in the case of figure 3 (site rate = 40%) an increase in rent to restore the landlord’s net income could be achieved. In the case of the less well-developed site the full previous rent cannot be reclaimed because the extra tax he pays is greater than the decreased payment of the tenant. In the well-developed site the converse is true and the owner could increase his net income as the tax burden has decreased.

Set against this is the effect of the reform on stimulating development. It would be anticipated that there would be an increase in the supply of commercial property which, according to the market principle, would tend to reduce TRRP. Given the time scale for property development there could well be a time lag before this became evident. If it happened the reduction in rent and rates would provide a welcome stimulus for business tenants and could enable growth of smaller traders, in the retail sector for example.

Near the start this document, the delicate state of investors in commercial property was noted. Given that investment property tends to be the high value end, containing well-developed sites, it is likely that these are the sites which would most benefit financially from the reforms seeing a reduction in tax paid. The reforms could thus offer a respite to the heavily indebted owners by enabling increased rental income due to the reduction in the tax burden. If rent is able to take a larger share of TRRP, site owners benefit and should see capital values of their properties rise – if developed to optimum permitted use.

In a similar way, sites that are marginal or close to marginal would also benefit through a reduction of tax paid. Rather than encouraging regional development by offering exemption from NNDR the SVR system would inherently encourage development at the margin through the lower taxation of sites of low site value.

This reform of business rates is likely to have a significant effect on the land market. The value of land, as distinct from developed in-use property, as an investment asset will be greatly diminished. Any projected increase in capital value of sites – but not of buildings - will be absorbed in increased SVR payments. This in turn would affect the basis of valuation of land for tax purposes. The complex and intimate feedback between changes in tax policy and market behaviour and the need for public accountability would make it essential to have regular (at least annual) and transparent site revaluations that are made freely available for all e.g. by publication on the internet and in local libraries.

When effective infrastructure is put in place close to a site, for example a new train line, it is well known that land values increase. With the reformed rate, using annual updates of site value, these uplifts would be captured by the tax. Thus the reformed rate could become a means of financing infrastructure development, more effective than the present system which only captures any of the uplift after at least 5 years (when the next revaluation takes effect). Conversely, if there were a change close to a site that had a negative effect on land values there would be a corresponding reduction in the tax paid.


This paper has been an attempt to flesh out the consequences of the reform to business rates proposed in the Liberal Democrat and Cooperative Party 2010 election manifesto and the Mirrlees Review. In addition to establishing the usefulness or otherwise of the proposal another purpose was to clarify what research it would be useful to undertake to establish how effective the reform would be in practice. A key piece of data that is needed to properly assess the proposal is the ratio of site value to total value for commercial properties.

The proposed changes transform business rates from a property tax into a resource levy. The reform of business rates thus needs to be seen in a wider context of establishing a “sustainable land development policy” that looks in a holistic way at the proper utilisation of this most important resource. Tax revenue is just one component of this. Planning is another aspect as is valuation and the establishment of the identity of owners of all sites.

Copyright (c) Coalition for Economic Justice, February 2011.

[1] Dimensions of Tax Design: the Mirrlees Review, J. Mirrlees, S. Adam, T. Besley, R. Blundell, S. Bond, R. Chote, M. Gammie, P. Johnson, G. Myles and J. Poterba (eds), Oxford University Press 2011.

[2] Investment Property Forum Report, The size and structure of the UK Property Market, July 2010.

[3] Maxted, B. & Porter, T. UK Commercial Property Lending Market Research Findings, Department of Corporate Development, De Montfort University, 2010.

[4] Muellbauer, J. Property taxation and the economy after the Barker Review, The Economic Journal 115 C99-C117 (2005).

[5] Banks, R. Costing the Earth, Shepheard-Walwyn, 1989.

[6] Connellan O. Land Value Taxation in Britain Experience and OpportunitiesLincoln Institute for Land Policy, 2004.

[7] Vickers, A. Visualising Landvaluescape: developing the case for Britain, PhD Thesis University of Kingston Upon Thames, 2009.

[8] ARIES: http://www.co.lucas.oh.us/aries/aries.asp

[9] Plassman, F. & Tideman, N. 'A Markov Chain Monte-Carlo Analysis of the Effect of Two-Rate Property Taxes on Construction', Journal of Urban Economics, 47(2): 216-247, 1999.