What is it?

Tax increment financing (or TIF) is an idea that has come from North America to help facilitate the regeneration of land by providing that any increase in the revenue from business rates arising from a new development (“the tax increment”) is earmarked to meet the original costs of remediating the land and providing the infrastructure that allowed the development in the first place. Nearly all states in the US use TIF as a means of facilitating regeneration.

What models are there?

Currently the most popular model in the US is “pay as you go”. This is popular because all of the risks associated with the availability of future revenue from business rates fall on the developer’s shoulders.

With this model the developer borrows the money, carries out the TIF works and then is given a bond by the local authority entitling the developer to a proportion of the tax increment for a defined period. If the development produces less tax than originally anticipated then the developer bears the risk.

The other available model entails the local authority borrowing the money, paying for the TIF works and then effectively ring-fencing the increase in tax revenue to meet the cost. At the moment this is the most likely form of TIF that will be introduced in the UK, although for public bodies it must be the least attractive as all of the risk stays with the local authority.

Local tax collection

In very simple terms, local authorities in England and Wales collect two types of tax income. The first is council tax (accounting for approximately 20 per cent of their income) and NNDR (National Non- Domestic Rates) colloquially known as business rates. Councils collect business rates and pass what they collect straight to the Treasury. In return, the Government awards them a grant which is intended to reflect their needs having taken into account Council Tax receipts and other factors.

In the context of TIF arrangements, this structure therefore creates an immediate problem in that it does not allow local authorities to both collect and spend business rates. Where such arrangements have been allowed – in the context of Business Rate Supplement arrangements (Business Rate Supplement Act 2009) and Business Improvement Districts (section 41(1) Local Government Act 2003) – these arrangements were specifically prescribed by bespoke legislation.

However, in an effort to think around these problems, as an alternative why could a local authority not simply fix the cost of servicing the future debt incurred by reference to the tax increment, with a mechanism to ensure that the total amount payable at the end of the payment period in no greater than the original capital cost and any rolled-up interest costs?

The possible problem here is that without new laws permitting local authorities to ring-fence part of what they collect as business rates, they would still be required to forward on the business rate receipts to the Treasury and therefore as new businesses began to flourish on the site of the new development, they would have to find the finance from elsewhere.

So where do we go from here?

The Government has identified the need to review local government finance. The detail on this is yet to be published but it may include some changes to allow local authorities to retain some of the business rates they collect – and also to raise additional taxes.

Can a local authority borrow?

A local authority has broad powers to borrow money for (a) any purpose relevant to its functions under any enactment, or (b) for the purposes of the prudent management of its financial affairs.

In the context of (a), presumably this could be linked to the general wellbeing powers under section 2 Local Government Act 2000, the power/duty to promote the economic, social or environmental well-being of their area.

It is intended that the general power of competence will replace these powers. As a general point I am not sure how these new powers will mesh with legislation drafted in this way. The section 2 powers are expressed both as powers and implicitly functions, as they cover the main areas of local government activity. Whereas the power of general competence simply expresses a power to do anything and it would be difficult to imagine that by extension everything they are capable of doing is therefore a function.

However, that said, the promotion of economic development is always likely to be expressed as a function whether by implication or expressly and therefore it seems sensible that a local authority could borrow for those purposes, assuming they act reasonably and are mindful of their duty as custodians of the public purse.

Further, local authorities have a duty to keep under review their borrowing and whether it remains affordable.

Can a local authority charge its assets?

Section 13 Local Government Act 2003 prohibits a local authority from mortgaging or charging any of its property as security for money which it has borrowed or which it otherwise owes. All money borrowed by a local authority together with any interest on the money borrowed must be charged across all the revenues of the authority, and all securities created by a local authority must rank equally without any priority.

If the future receipt of business rates falls within the definition of “property”, then currently the law does not allow such assets to be used as a from of security.

In the simple TIF scenario, the local authority borrows to fund the TIF works and then uses the tax increment to pay off the debt and rolled-up interest – these circumstances should not present too many problems.

Under the more attractive “pay as you go” option the developer pays for the cost of the TIF works and then is entitled to benefit from a proportion of the tax increment over a number of years. Currently the law would not allow the local authority to offer any security for this over and above its covenant.

Other issues …

In the US the TIF arrangements sit along side the development either as part of the development agreement or as a stand-alone financing agreement, depending on the circumstances. The same approach is likely to be adopted here.

A complicating factor in the UK is the intervention of European Law in the guise both of State aid and procurement. In the context of the latter, where local authorities provide finance to a developer to secure development, they may need to comply with the procurement rules in the sense that they are procuring a work, whether immediately or on the basis of securitising an income stream used to meet the cost of carrying out the works. Avoiding this problem will be difficult even in light of the relaxation of the application of the principles in Auroux by the Müller case.

As to State aid, this would be most easily avoided if the market economy investor principle is applied and that State resources are only provided to carry out the development, either by direct purchase or on the “pay as you go” basis.

Final thoughts …

Even before the economic downturn the issue of who and how infrastructure should be funded was highly controversial and becoming increasing problematic. TIF potentially offers a viable solution, albeit that it adopts the well-trodden path of mortgaging the future to pay for the present and all of the consequences that entails. However, at the moment at least, if brownfield sites are to be redeveloped it seems that it may be the only game in town.