Written evidence submitted by Tesco (IBR0087)

Treasury Select Committee: The impact of Business Rates on business

Tesco Submission

Executive Summary

1. The current business rates system was introduced in 1988 and, since then, the burden on businesses has increased consistently – the business rates tax rate (multiplier) has risen from 35% in 1990 to 50% today.[1]
2. The Government has sought to reform elements of the system, such as introducing exemptions for certain sectors and businesses and committing to more regular revaluations.
3. These measures are welcome, but do not address some of the fundamental issues in the system. Rates have:

• Grown faster than comparable taxes.[2]
• Become increasingly disconnected from profitability.
• Not kept pace with the rise of digital technologies.
• Become increasingly concentrated on a decreasing number of ratepayers.

4. These issues are significant and felt acutely in sectors, like retail, which are relatively low margin and property-intensive. At a time when profits in the retail sector have fallen[3] and rents have stayed the same or increased,[4] retailers, who employ 3m people, now pay 25% of UK business rates (£7.5bn).[5] Larger retailers pay 80% of this bill,[6] as the Government has introduced exemptions, removing some businesses from paying rates, with the burden falling on others. Some Tesco stores now pay rates bills that are higher than their rents. This has damaged investment in the retail sector, where more stores closed than opened last year[7] and employment in lower income communities has been hit hardest.[8]
5. For these reasons, we do not believe business rates meet the Committee’s standards of good tax policy. The business rates regime needs to be modernised to address these issues and keep up with the changing nature of the economy. This is not a case of protecting ‘traditional’ sectors, but ensuring UK tax policy is modern, balanced and progressive.
6. We believe the Government should introduce an Online Sales Levy (OSL) with the revenue raised used to reduce business rates for all retailers. This would:
• Create a sustainable (and growing) tax base in the retail sector, reflecting the contribution of both online and physical retailers.
• Incentivise business investment, by cutting business rates by 20% for retailers, benefitting hundreds of thousands of businesses across the UK.
• Be revenue neutral and compatible with existing UK and EU law.
• Level the playing field between online and bricks and mortar retailers.
7. We believe the Government should urgently investigate the potential for an Online Sales Levy, as recommended by the Housing, Communities and Local Government Select Committee (HCLG Sel Co).[9]

Introduction: business rates in recent years

8. Business rates are an important revenue stream for the Treasury – this year they are estimated to raise over £30bn (see Chart 1).[10] The tax has existed, in some form, for over 400 years and has several benefits: it is easy to collect, efficient and hard to avoid.
9. The current regime (in place since 1988) has seen a marked rise in the cost of business rates in the past 30 years, with the multiplier rising from 35% to 50%.[11] This impacts ratepayers across sectors and the burden is expected to increase further in the coming years, growing to nearly £35bn by 2024 (see Chart 1).[12] 

10. Successive governments have endeavoured to make changes to the system to try and ensure that the tax remains effective; benefits local communities and does not penalise some sectors. They have: introduced 100% rates retention for local councils to ensure local areas benefit; introduced reliefs for certain sectors and business sizes to mitigate the impact[13]; committed to more regular revaluations from 2021 (every three years) to ensure rates are in line with property values and pegged rates increases to CPI rather than RPI.[14]
11. However, despite these changes, the rates system is increasingly out dated and doesn’t reflect the modern economy or ‘good tax’ policy (see Annex 1 for detailed overview):

• The business rates multiplier continues to rise increasing the burden on ratepayers, and without a link to the economic performance of a business. Due to the design of the business rates regime, loss-making businesses, and, sectors facing economic challenges can still face high rates bills.

• The expansion of reliefs has concentrated the rising burden on an ever-shrinking number of ratepayers. The Government has looked to exempt some businesses, but this has just increased the burden on others, such as larger retailers, who now pay 80% of retail sector rates.[15]

• Bills can rise, but not fall, as the Government’s Transitional Relief scheme means reductions for some ratepayers are used to soften increases for others, meaning some ratepayers do not benefit even if the property value falls.

• Business rates are exacerbating the distortion in tax rates for online and bricks and mortar retailers with the HCLG Sel Co estimating that business rates for some online retailers are 0.7% of turnover compared with 1.5% - 6.5% for bricks and mortar retailers.[16]

12. For these reasons, we do not believe the tax meets the Committee’s four standards of ‘Good Tax’ policy – be fair, support growth and encourage competition, provide certainty and be coherent (we set out a full evaluation in Annex 1).
13. Below we have responded to the Committee’s Terms of Reference by assessing the impact of business rates on the retail sector; analysing the impact of changes in the rates regime since 2017 and proposing an OSL, as a revenue neutral and legally sound measure to ensure the business tax system for retailers is fair and effective. 

Impacts of business rates on retail

14. The current business rates system has three broad impacts for retailers:

• Damages investment and competitiveness.
• Creates an imbalance between business models.
• Compounds market challenges.

Damages investment and competitiveness

15. Business rates are not simply a land tax. They are a tax on productive property investment, which is a critical input to the retail sector. Business rates have grown to a level where they are now damaging this investment and broader competitiveness in the sector. Business rates have risen faster, in the past ten years, than any comparable taxes[17] with Corporation Tax falling in this same period.[18] The impact on retailers, who are traditionally property intensive and relatively low margin, is acute. Retailers now account for 25% of all business rates (£7.5bn)[19] and as rates have risen, primary costs on retailers (such as rents) have increased[20] and profits have fallen by a third[21]. For large retailers, who do not gain the full benefit of falls in rental value at revaluations (due to transitional relief) and pay for exemptions for other businesses, the increase is even higher. This is significant as larger retailers make up 60% of employment; 50% of sales and are often anchor companies, increasing footfall in local high streets.[22] This squeezing of the sector has led to investment being lower than comparable sectors[23] with 7,500 net store closures in 2018.[24]
16. UK retail global competitiveness is also suffering. The UK has the highest property taxes in Europe, second highest in the OECD and a hypothetical supermarket (50,000 sq. ft.) in the UK would be billed £500,000 in annual property taxes, but less than £250,000 in Europe or the OECD.[25] Revo – the retail property trade association – surveyed 130 international retailers, who listed property taxes as the main deterrent to investing in the UK, with 55% saying other markets were more competitive.[26]

Creates an imbalance between business models

17. Business rates have not kept pace with the changing nature of the economy, creating a competitive tax advantage for online businesses in certain sectors. In the retail sector the HCLG Sel Co, stated that: “business rates are widely seen as giving a competitive advantage to online retailers which tend to have less property at lower rent per square foot and hence at lower rateable value… but, in some cases, much higher turnover.”[27]
18. Tesco is one of the largest online retailers in the UK and so has a stake in ensuring the competitiveness of this growing shopping method. However, we recognise that the tax system has not kept pace with the growth in online retail. Shopping habits are changing and online sales have risen from 3% to 18% of UK retail sales since 2007.[28] The tax system has not adapted and the HCLG Sel Co found evidence that tax rates for some online retailers were far lower (as a proportion of turnover) than those of bricks and mortar retailers.[29]
19. Driven by this competitive advantage, online sales have grown more rapidly in the UK than comparable countries (see Chart 3). As online retail has grown the number of retail rates payers has reduced. The business rates system is constructed to meet a set revenue target, so that if the value of retail ratepayers fall, the system still needs to collect the same amount of money. This has increased the burden on property intensive sectors. Bricks and mortar retailers have seen a doubling of their rates liabilities since 2001 – even though their market share has fallen significantly over the same period (see Chart 4). This trajectory is not sustainable for the future.

Compounds market challenges

20. Business rates, unlike Corporation Tax, can remain high even if a business or sector is facing challenging market conditions because the bill is linked to property value rather than economic performance. Business rates have risen by 15% (multiplier) for retailers at a time when profits have fallen and the sector is undergoing structural change, including an 8% reduction in spending on goods since 2001 and an increase in other business costs (such as the apprenticeship levy).[30] For an individual business or store, this impact can be acute. Across our 3,400 stores, we see some stores paying more in business rates than in rent. We also see examples of stores that make a 5% loss paying as much in business rates (as a share of sales) as stores making a 10% profit. Business rates can, therefore, penalise stores that are already under pressure and across the sector this pressure has led to closures and job losses in recent years: 

• 7,500 net store closures 2018.[31]
• 35,000 employees impacted by the insolvencies of just 8 large retailers in 2018.[32]
• 8% of high street stores lost since 2013.[33]

21. Lower income communities are most impacted by these changes in the retail sector as these communities have (see Chart 5) a higher proportion of retail jobs in these areas.

22. Summary – Business rates are damaging investment and competitiveness; distorting the tax system for different retail methods and compounding the broader challenges in the sector. The Government should address these issues to drive greater growth, investment and competitiveness in key sectors, such as retail.

Changes in the business rates regime since 2017

23. Since 2017, the business rates regime has seen several important changes: the 2017 revaluation; the 2017 extension of small business rates relief and the 2018 Budget measures. These measures have been beneficial for some retailers, particularly small businesses, but have not provided support for all retailers:
• 2017 Revaluation and Transitional Relief (TR): The 2017 revaluation should have led to a 5% reduction in the rates bill for retailers in England, as rental values were found to have fallen.[34] However, the Government’s TR scheme eroded this benefit for some retailers. The TR softens changes in rateable value for those who see their bills rise by levying a surcharge for businesses’ who have seen their bills fall. Larger ratepayers are asked to pay proportionally more than smaller ratepayers do. We understand why this measure was introduced, but the impacts are severe. In Wales, where TR is not in place, a Tesco store saw its rateable value fall by 40%, which resulted in a 40% reduction in our business rates bill. In a comparable store in England, we saw the rateable value fall by 32%, but the bill only fell by 2%. Across our stores, the cost of TR is equivalent to 10% of our total rates bill.[35]
• Reliefs and allowances: In recent years, reliefs have been introduced for some sectors (such as pubs) and some retailers (such as smaller businesses). This has benefited some businesses, but increases the cost for those not exempt, who pay more to offset the exemptions. This can have a significant impact, adding an additional 5% to a retailer’s bill and concentrating a rising bill on a diminishing group of businesses.[36]
• Digital Services Tax (DST): To address the growth in digital businesses the Government proposed a DST to ensure online businesses pay their fair share of tax. However, this will not address the imbalance in the retail sector, as the HCLG Sel Co noted, because the scope is limited (such as on advertising revenues) and it does not address the non-level playing field in retail.[37]
24. We welcome more frequent revaluations and linking business rates to CPI rather than RPI.[38] However, we do not believe these measures will fundamentally address the issues outlined above.
25. Summary – Business rates reform, since 2017, has benefitted some, but not all retailers. The Government should reassess the Transitional Relief scheme, as well as considering more fundamental policy change to level the playing field. We recommend the introduction of an OSL, to rebalance the tax base.

Alternative proposals: Online Sales Levy (OSL)

26. Tesco has analysed a range of potential policy options for reforming the business rates regime and we have concluded that there is one approach that would level the playing field in the retail sector; create a new and sustainable tax base; ensure revenue neutrality and reduce business rates for retailers: an Online Sales Levy.

Business Rates Reform Options

27. Various business rates reform options have been proposed by stakeholders but have mixed degrees of viability/impact:
• Extend or alter reliefs: HMG could increase the level of reliefs for sectors to ease the burden but, as the system is revenue-neutral, this is not a sustainable solution, as the costs would be borne by other ratepayers or the Government, shifting the problem. Some have suggested that exemptions could be removed from certain sectors, such as agriculture, but we believe this would damage important sectors.
• Cut the multiplier: The Government could cut the multiplier to reduce business rates, but this would not be revenue neutral, creating a revenue gap for the Treasury.
• Land value tax: Radical reform could include transitioning to a land value tax, where the land, not the property, is taxed. This would remove the distortion of taxing investment and productivity, but would be a significant and complex overhaul of the taxation system taking many years to implement.
28. We believe these ideas are not realistic or politically/fiscally feasible. We agree with the HCLG Sel Co that an OSL should be fully and thoroughly considered by the Government, as it could be introduced quickly, legally and in a revenue neutral way that would benefit hundreds of thousands of retailers across the UK, as well as the communities they support (see Chart 5).

OSL Design and Benefits

29. The OSL would create a new levy for online sales, which could be used to reduce the significant burden placed on bricks and mortar retailers. Our proposal follows from careful consideration of each aspect of tax design including the options for who pays the tax, what is taxed, how it is taxed and any exemptions. The key design features are:

• Introduce a 2% levy on the online sale of physical goods. Currently revenues from online sales are £69bn in the UK, meaning the levy would raise c. £1.5bn.[39]
• Use the c. £1.5bn levy to fund a 20% cut in business rates for all retailers. A c. £1.5bn cut in retail business rates would reduce the tax rate (multiplier) to around 40% - close to the level following the 2010 revaluation.
• Use existing mechanisms to deliver the reduction in business rates. There are existing processes and mechanisms that could be used to implement the reduction.
• Exempt small businesses from the levy, by using a revenue threshold, to ensure the OSL does not impact small, online businesses.
• Use existing VAT definitions of a physical good and ensure only appropriate sales are targeted.

30. An OSL is economically robust and would, according to Tesco legal advice, be compatible with EU State Aid rules. The OSL would also meet the Committee’s four tests of good tax policy:

31. Some commentators have suggested that an OSL would create a new tax on consumers, but this ignores the fact that it would be applied to revenues rather than transactions, so businesses would pay. Also, we would note that business rates already act as a tax on bricks and mortar retail customers, who are more likely to have lower incomes than online shoppers and would benefit from the reduction in business rates.[41]
32. Concerns have also been raised that an OSL would not be compatible with the UK’s legal requirements. Our legal advice, however, suggests that an OSL could be designed to be compatible with UK, EU and international law. In relation to state aid, we believe that an OSL could be compatible and that the Government could use a straightforward process to work with the EU to determine its viability.
33. Summary – Our analysis shows that an OSL is a progressive, effective and efficient mechanism to support the retail sector, which delivers jobs, investment and growth in the UK. All retailers would benefit and the HCLG Sel Co suggested it merited further investigation.

Conclusion

34. There is overwhelming evidence that the business rates system is not equitable and is damaging investment and growth. HCLG Sel Co’s analysis showed this very clearly and, therefore, failure to act would be an active policy choice. We believe action must be taken to avoid prolonging an anachronistic tax that has not materially changed since 1988 and is damaging communities across the UK. We have set out a proposal that delivers a fundamental and cost neutral reform to drive growth, investment and competitiveness in the UK’s retail sector.
35. We strongly recommend that the Committee and the Government consider the introduction of an OSL in the UK.

Annex – Business Rates and ‘Good Tax’ Policy

Submitted April 2019