Small-scale hydro plant and machinery review: report

Rating of Non-Domestic Property – Background

Rating Principles

20. The non-domestic rating system in Scotland has its roots in the Lands Valuation (Scotland) Act 1854 which establishes the statutory basis that rating assessment should be the annual rental value^[7] of all lands and heritages as defined in the Act^[8].

21. The statutory definition of Net Annual Value (which unless modified by statute equates to Rateable Value) is:

"...the rent at which the lands and heritages might reasonably be expected to let from year to year if no grassum or consideration other than the rent were payable in respect of the lease and if the tenant undertook to pay all rates and to bear the cost of the repairs and insurance and other expenses, if any, necessary to maintain the lands and heritages in a state to command that rent."^[9]

22. Despite numerous changes to the system since 1854, this fundamental philosophy based upon an annual rental value has remained unchanged. Most recently, the Report of the Barclay Review of Non-Domestic rates "concluded that, on balance, a property tax system based on rateable values, as is currently in place in Scotland, best fits the principles [of Fairness, Consistency, Transparency, Simplicity and Accountability] set out above".

23. The fact that parts of the original 1854 Act remain in use today is testament to the efficient and robust nature of the rating local taxation system. The strengths of the system are generally perceived to be that tax avoidance is difficult to achieve as the subjects to be assessed are both immovable and readily identifiable, together with high tax collection levels and relatively low administration and collection costs as compared to other tax systems.

24. The design of the system is based upon the inherent principle that all occupiers pay a share of the rating tax burden in proportion to the annual rental value of the lands and heritages that they occupy. Individual property rental values would be expected to reflect site specific characteristics such as size and location, with one notable exception outlined in paragraph 56. Whilst there is typically no direct link between the rateable value of a property and the level of turnover or income generated by the occupier of that property, the Receipts and Expenditure methodology considers turnover evidence as part of the valuation calculation. The valuation of hydro schemes uses the receipts and expenditure methodology (see paragraph 34).

Revaluations

25. The rateable values of all non-domestic properties are re-assessed periodically by independent assessors (usually every five years but moving to every three years with effect from 2022) – this is referred to as a revaluation. The rateable value of a property is generally based upon its estimated open market value on the 'tone date' were it to be vacant and to let.

26. The 'tone date', also known as the antecedent valuation date, is 1 April two years before the date of the revaluation. For the 2017 revaluation (the most recent revaluation) this was 1 April 2015. The tone date determines the level of value to be applied throughout the period of the revaluation (for the 2017 revaluation that period is 1 April 2017 to 31 March 2022) by the assessors. Subject to the successful passage of the Non-Domestic Rates (Scotland) Bill, revaluations in Scotland will function on a three year cycle from 2022. Then, from the 2025 Revaluation onwards, the system in Scotland will operate on the basis of a one-year tone date i.e. 1 April 2024 will be the tone date for the revaluation which takes place on 1 April 2025.

27. A revaluation results in the preparation of a new rating roll which contains updated values for existing rateable properties and initial rateable values for new rateable properties in an assessor's valuation area. Following a revaluation new values will generally remain unchanged until the next revaluation, unless the property is altered, or other changes take place. This new roll comes into force on the first day of the revaluation. For the 2017 revaluation, there were 233,386 entries in the roll on 1 April 2017 with a total rateable value of £7,358 million.

28. Revaluations are intended to redistribute the rateable value tax base to reflect shifts in market rental values that have taken place since the last revaluation. They are not intended to increase the overall rating tax burden and are generally revenue-neutral with any increase in aggregate rateable value being accompanied by a fall in the tax rate (known as 'the poundage'). In 2017, the Scottish Government opted to forego a revenue neutral revaluation by matching the English non-domestic rates multiplier. According to data from the valuation roll, this decision reduced income from non-domestic rates by £88 million a year relative to a revenue neutral revaluation.

Rating Valuation Methods

29. There are three recognised main valuation methods upon which the valuation for rating purposes may be undertaken. These are the comparative method, the contractor's method (now known as the contractor's basis) and the revenue method (now known as the receipts and expenditure method).

The comparative method^[10]

30. The most commonly used method, the comparative method is based upon the premise that open market rental evidence is the best indication of the annual rental value that a subject could be expected to achieve. Where sufficient comparable property rental evidence is available, that evidence can be appropriately analysed and adjusted to reflect the individual nature of the property under consideration in line with the statutory requirements. Where this method of valuation is possible – and there is significant valid rental evidence - it will generally provide an accurate guide to annual value.

The contractor's method^[11]

31. The contractor's method of valuation (or contractor's basis of valuation) is frequently used when there is insufficient rental information for the comparative method to be employed. The overall aim of the contractor's basis is to arrive at the effective capital value primarily through considering the cost of providing the building, and then converting that cost into an annual rental value.

32. The theory underpinning the method is that the rental value of an existing property can be ascertained by considering what it would cost a hypothetical tenant to create an equivalent property for their own occupation. In this situation the rental value of the property will be related to the annual equivalent of the capital cost of building such a property, including provision of the site.

33. The method seeks to estimate the replacement cost of the property including the land value and any rateable plant and machinery and applies a statutory decapitalisation rate in order to generate an annualised cost/rateable value.

The receipts and expenditure method (R&E) (formerly known as the revenue method).^[12]

34. A third valuation method can also be employed when there is insufficient comparative rental evidence available. The method seeks to derive a net annual value figure by calculating the gross income receipts that can be derived from occupation of the property, including grants and subsidies, adjusted to reflect the expenditure necessary to derive that income. The net figure, known as the divisible balance, is the sum available to be shared between the landlord and the tenant.

35. The Divisible Balance comprises two main elements:

(i) The Tenant's Share – to provide a return on any tenant's capital employed and a reward to the tenant for his venture reflecting the extent of the risk and the need for profit. This is deducted from the Divisible Balance to leave:

(ii) The Landlord's Share, i.e. the rent payable (which then determines the rateable value).

36. It is considered particularly appropriate to use the R & E method where receipts are derived from a specific monopoly attaching to the property. Monopoly value may be derived from law, e.g. by way of licence, or from geographical location or sometimes from a combination of both. Valuations for small hydro are currently derived using the receipts and expenditure method.

Plant and Machinery Regulations

37. Certain elements of plant and machinery have been considered rateable since rating was introduced in Scotland in 1854^[13]. The principle is that investment in significant items of plant and machinery, particularly in the civil construction elements of plant and machinery, is no different to investment in buildings and other lands and heritages. As such, this investment should be subject to rating in the same way as buildings.

38. Reflecting changes in the industrial landscape and the development of new technologies, several reviews have been established to consider any changes necessary to accommodate changing circumstances. A full history of the various changes to the rating of plant and machinery is given within the Wood Committee Report 1993^[14].

Wood Committee – Five rules

• The land and everything that forms part of it and is attached to it should be assessed.
• Process plant and machinery which can fairly be described as 'tools of the trade' should be exempt within certain limits.
• Such plant and machinery which is or is in the nature of a building or structure or performs the function of such should be deemed to be part of the hereditament or subject.
• Service plant or machinery (sometimes 'motive' plant), and items forming part of the infrastructure of the property should be rated.
• Sensible lines must be drawn in the case of plant and machinery which performs both functions which will indicate exactly how much falls to be rated and how much does not.

39. The Plant and Machinery Regulations have evolved over time but have effectively been designed to apply in the form of four distinct classes of plant and machinery. These are broadly stated as:

Class 1 Power: Plant and machinery used or intended to be used mainly or exclusively in connection with the generation, storage, primary transformation or main transmission of power in or on the lands and heritages, together with associated list of accessories.

Class 2 Service Plant: Plant and machinery used or intended to be used in connection with services to the lands and heritages or parts of them (other than those used mainly or exclusively as part of manufacturing operations or trade processes), together with associated list of accessories.

Class 3 Conveyance / Communications / Distribution: A collection of items ranging from railway lines to electricity cables and pipelines.

Class 4 Items that are, or are in the nature of, a building or structure: Two tables (Tables 3 and 4) contain lists of items from which, if the item is considered to be a building or structure, or in the nature of a building or structure, it will be rateable. Note items contained within Table 4 only are further qualified such that the named items are rateable unless they are less than 400 cubic metres and are readily capable of being moved from one site and re-erected in its original state at another without the substantial demolition of any surrounding structure.

40. The various classes within the plant and machinery regulations are not mutually exclusive and each item of plant must be separately tested against each class. The 2000 Regulations prescribe four classes of plant and machinery as lands and heritages. If an item of plant and machinery satisfies the requirements of one or other of the prescribed classes, it is lands and heritages. The approach is sequential and inclusive^[15]. An item which is not prescribed as lands and heritages by Class 1 may nonetheless be prescribed as lands and heritages by Class 2, or Class 3, or Class 4. Non-inclusion under one class does not stamp an item as non-rateable - it merely means that it is not prescribed as lands and heritages under that class.

41. In considering items of plant and machinery under the different classes, rating valuers are not constrained by narrow, technical description of items. Rather it is appropriate to apply a wider, non-specialist, application of language to items of plant and machinery. Further, it should be noted that the regulations do not attempt to define plant and machinery by reference to particular industries.^[16]

Exemptions to the P & M Regulations

42. A small number of exemptions have been built into the plant and machinery regulations over the years. These include, for example, plant and machinery which has micro generation capacity which is exempt from all classes of plant and machinery and "excepted plant and machinery" which means plant and machinery on the lands and heritages used or intended to be used for the generation, storage, transformation or transmission of power, where the power is mainly or exclusively for distribution for sale to consumers is exempted from Class 1 although such plant and machinery could subsequently be considered rateable as being in the nature of a structure or building.

43. For sites which are generating electricity for distribution to consumers, the elements which may be rateable within the heritage are the land, buildings, site improvements (fencing, paths, roads), all works associated with connection to the grid and any foundations. For identical sites generating electricity for a single user (e.g. power to a factory), all elements including the generation facilities will be considered rateable and can thus attract a significantly higher Rateable Value.

44. The group noted that the Wood Committee deemed that all structures should be rateable. The Wood Committee commented "that process plant and machinery which can fairly be described as 'tools of the trade' should be exempt within certain limits" but those limits included 'if they were in the nature of a building or structure'. The second Wood Committee report published in 1999 recommended that a "tools of the trade" exemption should apply to generating plant and machinery belonging to the power generators, although such plant which was in the nature of a building or structure should continue to be rated.