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Death and taxes – the causal link in UK retailing?

By 20th August 2018 No Comments

In the 2018 the number of retail closures and examples of retailers in distress has taken many by surprise. The Centre for Retail Research data shows that this year 27 retail companies have failed, 1,965 stores affected and 38,855 employees. If you go back to January 2009 when the structural changes to retail began when over 800 Woolworths closed on one day causing mild hysteria for towns and shoppers alike then the numbers between then and now look like this;

2009 – Aug 2018 (source Centre for Retail Research)

Retail company failures – 366

Stores affected – 23,294

Employees affected – 231,295

The peak for closures as the chart below shows was 2012 and this was mirrored in The Local Data Company’s (LDC) shop vacancy rate that rose to 14.6% in that year.

Fig 1. Retail company failures 2009 -2018 (Source Centre for Retail Research)

A word of caution in these numbers is that they capture the large multiple retailers and not the 265,000 independents that account for 65% of the occupiers according to LDC data. The regular six monthly reports that LDC and the British Independent Retailers Association (bira) have published on the openings and closures of independents have illustrated the large swings that can happen between these retailers opening more shops than close and also closing more than they open. In part this is the nature of the beast as many that open will be new businesses and the Small Businesses Association report that one in three new businesses fail within two years.

So how significant is 2018 as a year for distressed retail?

Looking at the data then you could argue that 2018 is on track to equal the number of retail company failures in 2012. To date in in 2018, 27 companies have failed and in 2012 the total was 54. The store numbers reflect a similar pattern but the area that varies significantly is the number of employees affected. In 2018 it stands at 38,855 and in 2012 the figure was a staggering 48,142. This slowdown reflects the general industry reduction in headcount due to automation and the significant direct and indirect costs of employing people. To put these headline numbers in context Tata Steel employ 8,500 people in the UK, Toyota 3,000, Nissan 7,000, Jaguar Land Rover 40,000, Amazon 24,000, Google 3,280 and the British Army 78,000.

Much has changed for retail and indeed every sector since the scale and impact of the change launched itself on our high streets with the 800 Woolworths closures in one day and let’s not forget the failure of Northern Rock and the queues of people outside branches before they closed. We have come a long way from the Armageddon that was talked about then to significant challenges but not Armageddon today. Perhaps Friedriche Nietzsche was right when he said “That which does not kill us, makes us stronger.”

What is of note for me during this time is the extremes in behaviour when it comes to finance be it the public sector or the private sector. Whilst austerity has reigned we have also seen significant sums of foreign capital come into the UK especially into property and retail be it Russian, Chinese, South African or North American. This has driven a polarised market and also created a growth frenzy in certain retail and leisure sectors such as food and beverage operators and fashion. What 2018 (and for me since 2016) has shown with the raft of closures ( House of Fraser, Poundworld, Gaucho, Jacques Vert, Bench, Conviviality Retailing, Countrywide Farmers, Toys ‘R’ Us, Maplin, Warren Evans and East clothing to highlight a few!) is that investors have been keen to invest in the UK economy as one of steady growth and stability (a few might have changed their view since the Brexit vote) and this has led to an explosion of new space, new operators and aggressive expansion plans of existing operators to capture market share. As profitability becomes harder volume becomes more significant. Supermarkets are a classic case in point when it comes to the sales versus profitability. Public and private ownership has also driven different behaviours with many more short term in their approach rather than long term – buy, scale and sell all within 3-5 years. The multiple layers of finance in some cases remind me of the days of pyramid selling!

The big change for retail has been the rise of the internet as a new sales channel. In January 2009 online retail sales were 6% and in July 2018 they are 17% (Source ONS). There is increasing seasonality in the numbers as in November 2017 the number was 19.9%. Figures out last week from the ONS stated the figure is now 18.2% after a 15.3% rise on last year. What is clear is that this number will continue to grow and could be as high as 35% within five years. The changes in technology have been an amazing positive for society and we have only just seen the start of what is possible but what it does mean is that, as with evolution, those who cannot adapt will die when it comes to corporate health. The internet has democratised retail and put consumers at the centre as no longer do they have to go to their local shop and pay the local price they can purchase globally and get delivery within hours should they wish. The internet has been the grim reaper to those businesses who were always average and only survived because their customers had no other choice and Woolworths was the first of many that have suffered the consequences. Other factors are clearly important such as costs of operating a business and product proposition but ultimately what the last 10 years have shown in many sectors (food excluded) is that people will pay for good product, good price, good service and most importantly for the experience that that engagement brings. Experience has replaced transaction as the key activity. The latter will follow if you get the former right.

 

Figure 2. Internet sales as a percentage of total sales (Source ONS)

Back to the core subject matter of death and taxes. We have seen the number of deaths and many of these have been caused by a multitude of factors of which one is an increasing tax burden on operating a shop especially those who operate at scale. The Living Wage, Apprentice Levy, Business Improvement District levies and Business Rates are the key taxes and then you can add in rents, lease lengths, currency rates, utility costs, production and transport costs and you have the perfect storm and a storm which many retailers have struggled to manage due to the velocity of change but also their ability to change be it as a result of management or their current commitments.

Technology will help reduce costs in a number of these areas such as the need to employ people but one that will not benefit is business rates. So what are business rates?

“Business Rates (also known as National Non-Domestic Rates) are a tax on business properties.  The tax is set by the government and business rates collected by local authorities are the way that those who occupy non-domestic property contribute towards the cost of local services.  Under the business rates retention arrangements introduced from 1st April 2013, authorities keep a proportion of the business rates paid locally.  The money is used to help pay for the services Dudley Council provides.

All businesses have a rateable value which broadly represents the annual rent that the property could have been let for on the open market in 2015.  The rateable value of non-domestic property is fixed in most cases by an independent Valuation Officer of the Valuation Office Agency.” (Source www.dudley.gov.uk)

For the historians the heritage of business rates goes all the way back to the Poor Relief Act of 1601. This was a tax to raise ‘competent sums of money for the necessary relief of the poor.”

A big question and debate arise around whether business rates are a property tax, a services tax, a combination of both or just another form of tax and an important one in terms of value.

Retail business rates account for nearly £8bn of tax receipts and has the highest payment and lowest evasion rate so in pure collection terms works very well. There are a number of issues with it as a tax and these include the tie to rental values which change frequently and there can often be a difference between the headline rent (rent paid) and the effective rent which takes into account any incentives that reduce the rental levels. To monitor and measure this and create the valuation costs a significant sum and is carried out by the Valuation Office Agency (VOA). The VOA employs 3,300 people across 49 offices and is responsible for £51 billion of revenue in non-domestic rates and council tax in England and Wales. Remember that retail is a part of this at £8bn and with retail sales at £400bn (both off and online this would represent 2% of the total retail sales). The VOA’s total spending in 2017/18 was £193.8 million and the CEO’s remuneration was £220,00 for this period (Source VOA annual report). It is a large and important organisation for the Exchequer.

The most recent change to business rates occurred in 2017 after a two year delay but typically this has been a five year cycle but the government has committed to move this to a three revaluation cycle from 2022. There has been no indication from the VOA as to how this might increase its current costs. The system by nature is quite adversarial with a whole industry of surveyors and lawyers working on behalf of clients to reduce their business rates and the number of appeals has historically been very high but due to a new and highly controversial “Check, Challenge and Appeal” system this number reduced to just 1,210 between April and December 2017, a 99.3% drop on the previous year!!

With the traditional lease structure of upward only rents along with a race for space in certain locations driving rents up then the net result has been an increase in business rates for many retailers just at the time when they are trying to reduce costs to adjust to the new world of online and offline retail and a very demanding consumer. Other areas which have seen the lion’s share of closures have seen rents reduce. The highly controversial subject of online only retailers and their tax has been further fuelled by the fact that the rents on ‘warehouses’ are much lower than shops and that they typically rise at a much slower rate than traditional shops. In the past one of the attractions of out of town retail parks for retailers were the much lower rents as well as the ability to add a mezzanine floors and thereby reduce the overall costs further per square foot of space. Next was the pioneer in this regard. On both accounts this has changed with all floorspace be included in the valuation but also a significant increase in rents over time with some flagship retail parks commanding much higher rents than in town stores. A combination of this, changing consumer habits and the significant reduction in car ownership overall and especially by millennials means that I believe that smaller retail parks will become less relevant in the next 10-15 years whereas towns and cities will grow in relevance and thus return as a destination of choice for retailers.

 

Figure 3. Changes in business rates 2014-15 to 2017-18 (Data DCLG)

So the questions I have on business rates are;

  1. What is the purpose of the tax? This is increasingly important as councils will get 100% of the revenue in the future, which means those in strong economic areas will get more and those in weak economic areas will get less and should arguably get more in order to aid regeneration or will government fund this centrally and if so on what basis?
  2. With the rate of change in technology, lease lengths, turnover of shops (over 100,000 open and close every year according to LDC) and complexity of what the real rent is, is a valuation based on rental value the best way to collect this tax? The purpose is key here in terms of a property tax, a services tax or ???
  3. What is the true cost of collecting the tax and will this increase when the revaluations increase to every three years? With current market trends is three years now a lifetime so it needs to be automated in some way to take account of this?
  4. If Government tax is moving towards self-certification which it is in a number of areas is there a way to do this for retail property and maintain the certainty of income to government?
  5. How do we create a fair system that drives economic growth and not one that penalises the use of physical space. Shops are no longer solely transactions points and having vibrant occupied premises in towns up and down the country is increasingly important for social and health well-being of communities. Only this week the ONS published that by 2066 1 in 4 people in the UK will be over 65. Towns provide the best space for all age communities, services, transport hubs and experiences.

Figure 4. Diverging views- Google results on business rates – 17 August 2018.

There is much talk about taxation and most recently an Amazon tax has been spoken about. There are two fundamentally different issues at play. One is around corporation tax and the likes of Amazon and others basing their tax entities in countries such as Luxembourg and therefore paying little or no corporation tax in the UK. With regards to this issue then it is worth consideration of how this issue was dealt with in the 1990s with the gambling industry and as such I would recommend the Chancellor to read this academic research paper by the lead academic, Professor Leighton Vaughan Williams who is Professor of Economics and Finance at Nottingham Business School, on the change from General Betting Duty to a Gross Profits Tax. His research paper can be viewed here.

The next taxing question is around the modern relevance and management of business rates as a tax. The key question is should Amazon and other online only retailers such as Asos, Boohoo, AO.com et al be paying a more proportionate tax to those who occupy shops? This is not new to the UK with our history of catalogue shopping but the extent and impact of this channel has. Does one say leave it to market forces or does one say that we need to retain physical infrastructure (albeit less) in our towns that provide shops and services in order to retain wider economic and social value? To achieve this then those who take money from these economies need to support them through a greater (or indeed equitable) tax burden.

When the Grimsey Review team wrote the latest review (published July 2018) we had great debates about what to say or recommend on business rates but it is such a large subject and just a part of one (taxation) of the areas that we addressed that we did not see fit or indeed qualified to write a root and branch review. There are many others better qualified and more knowledgeable in this respect as it is a very complex and highly contentious area with significant commercial interest. That said it did make me think or ask the question of would there be a way to adopt something similar in retail where business rates could be replaced by a form of sales tax at the point of consumption. So whether you bought your shoes in a shoe shop for £50 or ordered them from Amazon the retailer would pay a sales tax. Now as alluded to earlier the current retail business rates income equates to 2% of total retail sales so one suggestion would be that it would be 2% so the retailer (where ever they were) would pay £1 sales tax. This would be collected and then distributed by Government and if sales were apportioned via geographical location then grants or sales taxes could be allocated to the relevant local authorities. In addition Government would derive valuable data on consumption of goods and services by area and the true economic value of the retail sector with regards retail sales to which you could add employment and infrastructure. By knowing all of this you can create a robust strategy and plan to repurpose and re-energise our towns and cities. A sales tax is one way to level the playing field and reflect the nature of the sector which is about consumption and not out of date rental values that are costly to track, assess and challenge?

The fact that in this weekend’s papers that HM Revenue and Customs has been forced to second a team of experts to the VOA due to the problems created by the new ‘Check, Challenge, Appeal’ appeals system illustrates just how complex and increasingly irrelevant this variable tax on space and by location is. Surely if a system can be introduced that provides the same level of tax income but in a simpler and fairer way then the Government should look to enable this but the bigger question with Brexit et al is how high is the economic health of our towns and cities and their shops and services at the current time.

What do you think?

What we do know if we read the press, is that many senior retailers are relating the changes in business rates as a cause to shut up shops or go out of business for ever. For the future of our towns, cities and communities we cannot allow an outdated and controversial tax to cause the closure of sustainable business that employ people, provide local economic growth and act as important social hubs. The internet is here stay and is here to enable society and shops so let’s harness it rather than fight it. Amazon is a successful online business due to us, the consumers using it, so let’s make sure we don’t disadvantage others through taxation but enable all to compete on a level playing field.

So if you are a bricks and mortar or online retailer would 2% of your sales be more, less or the same than what you are paying in business rates currently?

It is time for government to create a fair and appropriate tax system on retail in the UK to enable both online and offline shops to compete equally and thus reduce the hollowing out of town centres by shops and services that would continue to trade profitably if it was not for an outdated and costly tax that is not linked to the modern reality of space and place.

“Building relationships is not about transactions—it’s about connections.”  

Michelle Tillis Lederman

 

 

Matthew Hopkinson

Author Matthew Hopkinson

Matthew Hopkinson provides practical and trusted advice on data optimisation and storytelling. He helps people, places and companies achieve great things through leadership, action plans and communications. Co-author of The Grimsey Review (2013) and Grimsey Review 2 (2018). Visiting Professor at UCL and Prince’s Trust Business Mentor.

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