Rating Policy Review

(Department of Finance and Personnel)

Members present:
Mr P Doherty (Chairperson)
Mr Neeson (Deputy Chairperson)
Mr Armstrong
Mr Clyde
Mr McClarty
Dr McDonnell
Ms Morrice
Dr O’Hagan
Mr Wells

Witnesses:
Mr S Pearson ) Rating Policy Branch, Department of Finance and Personnel
Mr B McClure )

The Chairperson:

Good morning, Gentlemen. I welcome Mr Brian McClure and Mr Stephen Pearson from the Rating Policy Branch of the Department of Finance and Personnel. After your presentation, Committee members will ask you questions.

Mr McClure:

I am head of the Rating Policy Branch in the Department of Finance and Personnel’s central finance group. Stephen Pearson is principal economist in the Rating Policy Branch. Thank you for this opportunity to give an overview of the review of rating policy and to speak about industrial derating. This is regarded as the start of the consultation. We are happy to return to the Committee at any point during the consultation.

Twelve key issues have been identified in the consultation paper. All Ministers have had the opportunity to contribute to the paper, which was prepared by an interdepartmental steering group. The key issue that we are concerned with this morning is industrial derating, although we shall be happy to discuss any other matters on which the Committee wishes information.

Among the other 11 issues are domestic re-evaluation and the funding of the Water Service; small business relief and hardship relief may be more directly concerned with industrial derating.

However, the main issue this morning is whether the removal of industrial derating should be considered; before I speak about that, there are some points to note about the wider review. The Executive initiated the review in 2000 after the outcry about the increases in the regional rate. I hope that it will be completed in the autumn; it is difficult to be precise about when in the autumn, because we do not know what sort of response to expect from the public. The response will determine when the review will be completed.

We are having a review because Ministers considered the system to be out of date; it does not meet present needs and is not as fair as it could be. The public consultation began on 27 May with the Minister’s statement, and I gave evidence to the Committee for Regional Development on 29 May.

Public consultation events took place on 11, 12 and 13 June in Enniskillen, Londonderry and Belfast. Attendance was disappointing, as only a handful of people turned up for each. However, the web site has had 9,000 visits since 27 May; 2,500 of which have downloaded the document. The events kicked off the process. Opportunities will be afforded to interest groups and organisations to present their views.

Although 16 September is the closing date for responses, the Minister is aware of the timetable for Committees and district councils — more time will be afforded to them.

The question is asked when change will occur. The decision-making process will commence after the autumn when the responses from the public consultation are known. At that time, impact analysis will be carried out and the Executive will have recommendations and options. Legislation will have to be approved by the Assembly during 2003-04 and beyond.

Industrial derating is the major relief in the Northern Ireland rating system, and its costs are £64 million rate revenue foregone. If the industrial sector was fully rated and the same amount of revenue raised from the rates, a regional rate reduction of 16% would result in the non-domestic sector; this would reduce rate bills by about 8%. There are two ways of looking at it: either £64 million is foregone or everybody would pay a little less.

Winston Churchill introduced industrial derating into the United Kingdom in 1929 when he was Minister of Production. However, it is now unique to Northern Ireland; no other jurisdiction offers relief on local property taxes to the industrial sector. It applies to all businesses that produce or alter an article by manual labour. The legislation for this is based on the Rates (Regional Rates) Order (Northern Ireland) 1997 and the Factories Act (Northern Ireland) 1965. Any premises where an article is manufactured by manual labour, except for premises predominately used for retail or storage would, prima facie, be entitled to industrial derating.

Among the premises entitled to industrial derating are Quick Copy in Bedford Street, Belfast. Its premises have a net rateable value of nearly £22,000, and the rates bill would be about half that. The Newtownards Chronicle is also entitled to industrial derating. The cases quoted have been brought before the Lands Tribunal, which decides these matters. Another example is R K Trucks of Carryduff.

A striking example is Granville Cold Storage in Dungannon. Its premises are used for European Union intervention storage, which was deemed to be the altering of an article by the storage of meat on the premises. It may not usually be associated with manufacturing, but the courts decided that it is entitled to industrial derating.

Dr McDonnell:

What was altered?

Mr McClure:

The court decided that molecular alteration to the meat rendered it suitable for sale. It was rather a strange decision; nevertheless, it must be followed.

The interdepartmental steering group handling this review commissioned a firm of consultants to carry out a study of industrial derating on Sliderobes (NI) Ltd. The steering group comprised the Department of Finance and Personnel, the Department of the Environment, the Department for Regional Development, the Department for Social Development, the Department of Enterprise, Trade and Investment and the Economic Policy Unit. The terms of reference were drawn up by a sub-group, the chairperson of which was from the Department of Enterprise, Trade and Investment, with the involvement of the Department of Finance and Personnel and the Economic Policy Unit. As a result, DTZ Pieda Consulting, a firm of economic consultants, was selected and the study was signed off in March 2002. The Committee Clerk has been provided with a copy of the DTZ Pieda Consulting report.

The study was to consider the effectiveness and continuing relevance of derating as a tool to assist international competitiveness. That was the original aim of industrial derating in 1929. A cross-section of derated companies was interviewed, and representative groups such as the Confederation of British Industry and the Institute of Directors were consulted. Comparisons were drawn with elsewhere.

The study found that the rationale for derating is questionable. The economic impact evidence suggests that rates would raise costs by an average of less than 0·5% of turnover. However, the study found that derating may be important to small firms; a disproportionate amount of their outgoings is spent on rates.

The conclusion was that removing derating would have little long-term impact, and the consultants recommended that there was a case for phased removal.

The DTZ Pieda report informs the debate on the issue; the Confederation of British Industry, however, has a different view. Derating partially compensates for extra costs on electricity and transport and the general costs that fall to Northern Ireland because of its peripheral location. The other opinion is that it is a powerful incentive for inward investment and a good counterbalance to the attractive fiscal regime of the South of Ireland, particularly in corporation tax.

Others believe that there is considerable dead weight in blanket derating. “Dead weight” is an economist’s expression, meaning that it benefits many people who do not need benefit. For example, if derating is given, the benefit passes to landlords who simply seek more rent. However, not all premises are rented; there is considerable owner-occupation in the industrial sector in Northern Ireland. Nevertheless, it is a consideration.

Finally, if the additional electricity costs faced by Northern Ireland industry are an impediment to economic prosperity, there is an argument that electricity should be subsidised instead of doing that through the tax base.

A strong view was expressed that industrial derating is important to sustain employment. One questioner who read the report felt that 0·4% of turnover, which was identified as an average effect on a firm, is a significant amount. A representative of the software industry asked why it had not been consulted for the study. The software industry is not generally entitled to industrial derating because of the stipulation about the use of manual labour in a process. A view was expressed that it should be extended to other important sectors such as the hospitality and tourism industries. A contrary, and perhaps extreme view, was that the agriculture industry should be rated. Another questioner asked whether domestic ratepayers should, in effect, be subsidising business.

It is clear that derating is important to some firms and attracts inward investment. The key question is: how significant and important is that? Many in the industrial sector did not recognise this subsidy. It was interesting that only a small percentage of those who were surveyed in the study knew their rate liability.

The review rules nothing in or out, except for agricultural rating and domestic water metering. Responses from the consultation and the impact analysis will feed into the process before decisions are contemplated. Any change will be phased in gradually, and transitional arrangements will be put in place to protect vulnerable groups and those facing hardship.

The reinvestment and reform initiative is important, but fairness was the driving force behind the rating review. However, the reinvestment and reform initiative adds focus to the rating review.

Mr Wells:

We have heard the views of the Confederation of British Industry. I may be the only member of the Committee old enough to remember the introduction of industrial derating in 1982, which was one of the few achievements of the old Assembly. I remember clearly everyone dancing in the aisles in 1982 when we achieved that concession from the Department.

It was introduced because Northern Ireland was uncompetitive, particularly in energy prices, and also because it was on the periphery, although that has become less important. However, there was a gap between the energy prices endured by our companies and the next lowest region of the United Kingdom. The Confederation of British Industry said that when energy prices, which are a mixture of distribution and generation costs, are tackled it would accept industrial derating. We are all working towards that goal, but we are nowhere near it. Would it not be unfair to inflict industrial derating on our big employers until there is a level playing field with the rest of the United Kingdom and with the Republic?

Mr McClure:

Until 1982, 75% derating was applied; in 1983, that was extended to 100%. There is an argument that the service sector suffers as much as the energy sector through costs. I am aware of the evidence given by the confederation, and we have met it to discuss the additional costs. That is tied up with the 10-year electricity supply contracts. The Confederation of British Industry view is that once the contracts come to an end, there is a case for phased removal.

Mr Wells:

Is that not a reasonable stance?

Mr McClure:

Is there not a better method? Another view is to subsidise electricity rather than use the local tax base to compensate. The service sector as well as manufacturing faces disproportionately high electricity costs.

Mr Wells:

Let us assume that it is only 0·4% — £61 million. That is £61 million from the bottom line. Including the rates and levying the charge at £61 million is net additional cost, which will simply transfer to the profit figures. That is significant. Companies get nothing for the £61 million; it is money down the drain. Bombardier Shorts will pay £1 million to get its bins emptied and the streets swept, but they will not be swept any better because the company is paying an extra £1 million a year. There is no benefit to the companies; it is purely tax. That will translate through the balance sheets as a loss or a smaller profit.

Mr McClure:

According to the DTZ Pieda Consulting report, the cost will not be significant for most firms.

Mr Pearson:

Presumably it would hit the smaller firms harder.

Mr Wells:

It is a tax of £425 a job. If you add up all the employers who will be affected and divide that by £61 million, it works out at £425 a job. Some companies will decide not to extend their recruitment or will lay off staff because of that significant burden, particularly companies with a small staff and a high rate liability. That is the average. Companies could have to pay £1,000. I am playing devil’s advocate. It could come on top of a 1% increase on National Insurance contributions up to the highest salary, fuel duty and other expenses. Businesses would ask whether that was fair.

Mr McClure:

Fairness between the manufacturing sector and other sectors is an issue. Even in the manufacturing sector, the software industry is not entitled to rating relief.

Mr Wells:

Not unless they put their computers into cold storage.

Mr McClure:

That seems to be the trick.

Mr Pearson:

It is telling that only 7% of the firms surveyed said that industrial derating was of any significance to them. A representative sample does not seem to think it important to business.

Mr Wells:

However, all their umbrella bodies are vociferous about it. Mr Neeson and I gave a presentation at the Federation of Small Businesses conference. The federation was clearly concerned, as are the Confederation of British Industry and major employers such as Bombardier Shorts. Bombardier Shorts considers this a major issue — £1 million in one fell swoop. There is always difficulty in border areas. They do not have to be in Northern Ireland; they can hop across the border and set up in the Republic.

Mr McClure:

I accept your point, but derating is a blunt instrument. Some of the businesses I cited are not competing internationally. That is also an issue. They are local businesses competing with other local businesses. The fiscal regime in the South is attractive to industry. Derating is such a blunt instrument that it applies to many businesses that are not inward investment businesses.

Many businesses that benefit from derating are not inward investment businesses; small business relief may help them, as it would apply to all sectors and not just to manufacturing. Small business relief could be available to all service sectors including manufacturing and software. There are proposals to introduce that in Great Britain in the future.

Mr Armstrong:

What was your objective for derating and why could it not stay as it was? Was it to encourage more revenue into Northern Ireland or was there another reason?

Mr Pearson:

There are several aspects to derating. It has been in place since 1929 and it is now out of date. At the time, it was applied to assist with international competitiveness when most of the industrial base was the production of widgets. We have moved on in 75 years, and the economy is now much more diverse. Many argue that it is not adequate for present needs.

Mr Armstrong:

Some companies are derated to make them more competitive in the export market. We must compete with the rest of the world; therefore we must have an incentive to make exporters more competitive. If revenue is needed it should come from some other source.

Mr Pearson:

That is a valid point, and the question is still open. However, derating may not be the most effective way of achieving that because of the range of properties it applies to. It excludes certain sectors and includes other that may not fit the criterion and are not export companies.

Mr Armstrong:

Should companies that export still have that facility, and should those that supply the home market be fully rated?

Mr Pearson:

We are interested in such a response, and if the consultation finds opinions strongly in favour of that approach, it will be reported to the Executive.

Mr Armstrong:

We need an incentive in Northern Ireland to export our many products. If extra revenue is needed for hospitals or roads, it should come from another tax. Although we do not have the remit, I would be in favour of a 1% increase on tax. That would solve many problems, including derating.

Mr Pearson:

There is also a European Union dimension in terms of providing assistance to industry. State aid could be used to help Northern Ireland with its exports.

Mr McClure:

Industrial derating is registered as state aid.

Ms Morrice:

Is it legal under European Union law?

Mr Pearson:

Industrial derating is legal and registered as state aid; it is subject to annual review. There was an opinion in favour of local income tax on each day of the consultation. Local income tax is not covered in the consultation paper; however, if there is a strong opinion in favour of it, it will be reported to the Executive.

Mr Armstrong:

Not every rated company is a profitable company. Income tax will only take tax off profit. The companies that are not doing well will not pay tax. I do not mean a Northern Ireland income tax; it should be a Westminster tax, but we have no say over that.

Mr McClure:

There are much wider issues associated with that.

Mr Neeson:

The Assembly should have tax-varying powers, and the Committee endorsed that view in its response to ‘Strategy 2010’. It is sad that that is not considered in the review. DTZ Pieda Consulting has underestimated the strength of feeling among companies about the derating proposal. Is there a time scale for the gradual phasing-in?

Mr McClure:

No. DTZ Pieda Consulting identifies a two-year period in the report. That is very sudden. I am not sure whether it would be possible to avoid hardship while introducing a measure over two years. However, that is the consultants’ recommendation.

Mr McClarty:

What size was the sample survey of companies?

Mr Pearson:

One hundred companies were surveyed, which represents about 2·5% of the derated manufacturing sector.

Mr McClarty:

Does that mean that the vast majority of them said that there would be no incentive?

Mr Pearson:

Seven per cent felt that there was no significant incentive in industrial derating.

Mr McClarty:

Seven per cent of the 100 companies surveyed?

Mr Pearson:

Yes, 7% of the sample.

Mr McClarty:

Therefore 93% felt that there was?

Mr Pearson:

The remainder either did not know or said that it would have no effect.

Ms Morrice:

How does it compare with the corporate tax relief in the South?

Mr McClure:

There is no comparison. No in-depth analysis of the two regimes was carried out. The derating that applies here would still not match the package available in the South.

Ms Morrice:

Should that not be taken into account in the review? Has research been done to compare state aid to industry north and south of the border to create a level playing field?

Mr McClure:

That must be completed before a final decision can be made. However, DTZ Pieda Consulting found that derating seemed to be of most importance to locally based firms that compete with one another rather to than those that compete in an international market place or those that could be classified as inward investment cases. DTZ Pieda Consulting did not find that to be an important location factor to those firms that settled in Northern Ireland. A full study of the economic impact would be required before change happened.

Ms Morrice:

On the island of Ireland, I think.

Mr McClure:

Yes.

The Chairperson:

What is the monetary value of the policy to industry?

Mr McClure:

Sixy-four million pounds.

The Chairperson:

Thank you for your evidence. Will you be available if we have further questions for you?

Mr McClure:

Yes, of course.

19 June 2002 (part ii) / Menu / 26 June 2002