House of Commons - Communities and Local Government Committee

Select Committee on Communities and Local Government Committee Fifth Report

2 Chapter Two: Establishing PGS liability

10. The Government has indicated that it believes the most appropriate point in the planning process at which to levy PGS is the granting of full planning permission, which it defines as "permissions granted under all enactments, including final reserved matters approval where outline consent has been given, the making of a Local Development Order or permission under other legislation such as the Electricity Acts".[19] A number of our witnesses pointed out that sometimes full planning permission, as defined by the Government, is not granted prior to the commencement of development. The Royal Institution of Chartered Surveyors (RICS), for instance, said that "Reserve matters can often not be agreed until the end of a development, or ever in some cases".[20] Leaving the assessment of liability, however, until the completion of a development project would not provide certainty for developers nor provide the funds required for infrastructure provision in a timely manner. Moreover, such an approach could encourage prolonged negotiations on outstanding reserve matters as a means of deferring payment. Some witnesses suggested that PGS should be assessed at the point at which the land is sold for development or that there should be several tax points within the planning process.[21] Neither suggestion is practical. In many instances, there is no transfer of land ownership and multiple tax points would reduce certainty and add to administrative costs. We agree with the Government that the granting of planning permission is the most appropriate point at which to calculate PGS liability as it is a clearly identifiable point in the planning process and would capture the majority of any land value uplift. It should, however, be defined as the point at which sufficient planning permission has been granted in order for development to commence.

Calculating PGS liability and valuation methodology

11. The Government proposes that PGS liability would be calculated by subtracting the current use value (CUV) of a site from its value at the moment after full planning permission has been granted (its planning value or PV) and then multiplying the difference, the land value uplift, by whatever percentage rate PGS is set at:

PV - CUV x PGS rate (%) = PGS liability

Thus two separate valuations would be required to determine PGS liability: one to establish CUV and a second to establish PV.

12. The Government defines CUV as "the market value of the land the moment before full planning permission is granted assuming that it is and will continue to be unlawful to carry out any development other than development permitted under the General Development Order 1995 or development in accordance with planning permissions granted before an appointed day".[22] It adds, in respect of PV, that "the expected costs of developing the land, including remediation costs, could affect PV. Contributions made under a reformed planning obligations regime […] would be taken into account for the PV and therefore would be factored into the land value uplift calculations made to determine PGS liability".[23]

13. In the Barker report, it was suggested that these calculations might be based on average land values in a particular area. The Government discounted this approach in its consultation document, stating that "analysis of the potential accuracy of average valuations has shown that, while they were potentially credible for residential developments on agriculture greenfield land, it was not feasible to apply average valuations to non-agriculture greenfield land, brownfield sites or commercial sites".[24] Nor in general were our witnesses persuaded of the benefits of using average valuations: as the HBF told us, in any one area "there is a whole spectrum of sites and, therefore, land values. Some have substantial value and some could have a negative land value; so to have an average applied to that would be clearly neither fair nor very sensible if you were to try to promote more land coming forward" for development.[25]

14. Several witnesses suggested actual sale prices as a basis for valuation.[26] This proposal has the merit of simplicity and would reduce the potential for disputes but it neglects the fact that many developments do not involve a transfer of land ownership and therefore that there is no actual market price. Moreover, actual market prices may reflect a range of external factors, including hope value which may never be realised. This means that CUV, the calculation of which excludes hope value, will frequently be below market value.

15. The Government favours basing CUV and PV on actual valuations. This, it argues, would "prove fairer for PGS payers and would be more cost-effective to administer".[27] Some witnesses, such as the City of London Corporation and the Confederation of British Industry, agreed but many also had concerns over the administrative practicalities that would be involved and upon which the consultation document is sketchy.[28] (We discuss these issues in paras 20-39 below.) We agree that actual valuations should be used in the calculation of current use value and planning value for PGS purposes.

Valuations

16. Valuation is frequently referred to as more of an art than a science.[29] One witness explained that:

The imprecise nature of valuation is clearly demonstrated by the different market values house builders bid for a residential site in a competitive tender. Each bids a 'market value', but because of different assumptions about likely sale prices and sales pace, different estimates of land preparation, infrastructure and build costs, and different assumptions about overheads and profit, different companies arrive at different residual values.[30]

As a result, without a robust set of standard definitions and procedures for establishing CUV and PV, the scope for disputes is huge.[31] South West Property Industries, for instance, saw potential for "extended wrangling".[32] Other witnesses agreed.[33] The risk is that developers expend time and effort to reduce their PGS liability thus replacing one set of protracted negotiations with another, devaluing PGS receipts, delaying payment and, ultimately failing to secure the provision of infrastructure that PGS is intended to stimulate. Our evidence reveals, and the Government accepts, that the definitions of CUV and PV outlined in the consultation document are not sufficiently developed. For instance, while it is clear that hope value should be excluded from the calculation of CUV, it is not clear precisely which costs can be offset against calculations of PV.[34] The Government needs to be absolutely clear on the definitions it will accept for both CUV and PV and on the procedures to be used to determine them. Without such a scheme, the potential for developers to minimise liabilities, thus reducing PGS revenues, for disputes over the level of liability to delay payments, for increased uncertainty and for an unnecessary additional administrative burdens on all parties, is too great. Standard definitions and procedures will be critical to the success of PGS and thus will determine the extent to which it can contribute to the provision of infrastructure and growth in the housing supply. We recommend that the Government conduct a further round of consultation with industry and other stakeholders specifically on definitions and procedures relating to current use value and planning value. Such consultation has to be concluded prior to any implementation of PGS.

17. Indeed, some questioned whether, even with strong procedures and definitions, it was possible to reach sufficiently robust calculations for CUV and PV. We reject that argument. As the Town and Country Planning Association (TCPA) pointed out, valuations may involve complex processes, but "they are carried out on a regular basis already".[35] The Government, too, is convinced that the required expertise exists. John Healey MP, Financial Secretary to the Treasury, stated that "developers already obtain valuations on the land that they are using, and they do it as part of their normal business planning".[36] The HBF pointed out that similar "valuations are carried out day in, day out, in the market place; done by trained experts with a wealth of experience", although it was less convinced that Government itself had the required skills.[37] If the valuation skills required to establish CUV and PV were lacking in Government, (although we note the Financial Secretary's comment that "in Government we are involved with businesses of all types, including developers, in regularly checking valuations of property and land as part of other tax regimes"), such skills could be bought in.[38] This would, however, be an expensive operation and add to the administrative burden PGS would impose. We prefer the Government's proposal that developers should be responsible for calculating current use value and planning value, drawing on the existing expertise within the private sector, through a system of self-assessments monitored and endorsed by the Valuation Office.

18. We fully endorse the Government commitment to encourage brownfield development. Some witnesses pointed out that valuations relating to brownfield sites, where a complex web of land interests and ownership may be involved, could prove particularly difficult.[39] We do not dispute the additional complexities associated with brownfield sites but, given the fact that at present some 70 per cent of all development takes place on brownfield sites, it is clear that the market can reach a valuation.[40] The PGS proposals imply, and Ministers confirmed, that if redevelopment of a brownfield site results in a negative land value, this would be reflected in PV.[41] As English Partnerships argued, if the Government were to set a minimum value for CUV of zero, there would be no liability for PGS for that portion of any land value uplift to bring PV to zero.[42] We recommend that the Government set a minimum value of zero for current use value. This would reduce any perverse disincentive to brownfield site development which PGS could otherwise represent.

19. The Government's proposal that both CUV and PV should be "assessed on the basis of an assumed unencumbered freehold interest with vacant possession" was also objected to by a number of witnesses. English Partnerships pointed out the weaknesses in assuming freehold value: existing tenancies and leases could produce an income stream, or the value of a particular site to a particular occupier—such as a specialist factory—could mean that actual value would exceed current use value.[43] Similarly, liabilities or patterns of land interests and ownership may make it impossible for developers to realise the full freehold value. Thus, as RICS pointed out, "not valuing what is there" could represent a significant disincentive to brownfield site development.[44] We recommend that calculations of current use value and planning value reflect actual site conditions, including implemented planning permissions, as well as actual patterns of land ownership and actual liabilities and interests. No assumption of freehold vacant possession should be made.

Self-assessment approval

20. The granting of full planning permission can be the trigger for payments for land or for the start of development works. Developers, however, are unlikely to wish to commence development works while their self-assessed liability for PGS is still subject to Government approval. Thus, if Government is to avoid imposing unnecessary additional uncertainty upon developers and risking a delay in development, the period within which it can challenge self-assessments will have to be short and finite. Even so "it would still leave the developer and land owner in limbo until either the challenge period had lapsed, or any dispute had been resolved".[45] Potentially, this is a significant risk. It could deter development or delay the commencement of works (and thus reduce and delay PGS receipts). The HBF advocated a pre-clearance system in which the Government agreed PGS liability with developers, subject to planning permission, in advance of such permission being granted, to be coupled with a very short challenge period.[46] This would remove much of the uncertainty surrounding self-assessments and mitigate the risk of delays in development. We recommend that the Government work with the Home Builders' Federation and other stakeholders to develop a pre-clearance system for PGS self-assessments and that such a system be incorporated into the PGS regime.

PGS liability and option agreements

21. The Government will also need to consider how PGS will affect sites where developers have existing option agreements with the landowners which may limit their ability to reflect PGS costs in reduced payments for land. Typically, under option agreements, landowners agree to sell to a particular developer at a discount—typically around 80 or 85 per cent of market value—if and when planning permission is granted. The discount reflects the fact that the developer can incur substantial costs in obtaining planning permission. The Government have not yet indicated how these arrangements would be reflected in the PGS regime. If the discount on optioned land is not reflected in calculations of CUV, in effect developers would be liable for PGS on the costs associated with obtaining planning permission as well as any land value uplift. Many option agreements have 'get out' or deferment clauses which release developers from their obligation to purchase and landowners from their obligation to sell if land prices rise or fall beyond certain limits. English Partnerships predicted that, without adequate arrangements for land with option agreements, there would be widespread tax avoidance or, more probably, that such land would not be brought forward for development in the first place, "causing housing supply to move sharply downwards".[47] One possibility would be for the Government to introduce transitional arrangements which exempted land with options from the provisions of PGS but the timescales for such exemptions would have to be long: option agreements often last for 10 years but can be as long as 21 years.[48] Moreover, we are concerned that excluding such developments from PGS could both distort the market and significantly reduce PGS receipts for the period of the exemption. We put these issues to the Minister who told us that the Government was considering both the role of option agreements in the development market and considering what transitional arrangements would be required.[49] We welcome the Government's willingness to consider the impact of PGS on development on land with option agreements. Any special arrangements will need to be agreed and promulgated prior to the implementation of PGS.

Scope

22. A recent Government study indicates that in England, in 2003-04, Section 106 planning obligations were attached to just 6.9 per cent of all planning permissions granted (up from 1.5 per cent in 1997-98) and to 40 per cent of all major residential developments (up from 25.8 per cent over the same period).[50] In her review of housing supply, Kate Barker recommended the introduction of a planning gain supplement on "the granting of planning permission" in respect of all land released for housing development.[51] The Government's proposals for a planning gain supplement extend the scope of Kate Barker's recommendation, encompassing all land in respect of which planning permission is granted regardless of the nature of the development (but see paras 47-8 below, relating to minimum development value thresholds). A number of our witnesses were critical of this extension. Business in Sport and Leisure, for instance, told us that "the sport, leisure and hospitality industry is hugely concerned that this new development tax may seriously damage the future expansion of our sector and be a barrier to economic growth" and that as a result it had concluded that PGS "should be introduced only for housing" developments.[52] We are not persuaded. We discuss the case for PGS exemptions and discounts for low value developments below (see paras 40-8) but we recognise the advantages of broadening the scope of land value capture: to do so will result in a fairer regime which treats all developers equally; it avoids potential market distortions between different types of development; and, most significantly, maximises potential revenue. These advantages appear to outweigh concerns regarding the extension in the scope of PGS. We welcome the proposed broadening in the scope of development gain capture and endorse the proposal that liability should be based on the land value uplift achieved rather than on the nature of the development.

The PGS rate

23. The Government has not proposed a specific rate at which PGS would be applied. In its consultation document, it indicated that "PGS would be set at a modest rate to capture a portion of the land value uplift created by the planning process".[53] As the Government told us, the rate at which PGS needs to be set will be affected by decisions on the scope of the tax and any exemptions or discounts in respect of particular types of development.[54] Moreover, PGS is intended as just one part of a package of measures designed to promote growth in the housing supply and support the provision of infrastructure, including the current cross-cutting review of infrastructure being undertaken ahead of the Comprehensive Spending Review. The Government will also need to establish the impact of PGS on the markets for housing and land before determining a precise rate. The Minister assured us that this work was in hand.[55] We recommend that the Government provide us with regular updates on the progress of its research into the impact of PGS on the markets for housing and land.

24. A rate somewhere between the VAT rate of 17.5 per cent and 20 per cent has been widely considered.[56] South East England Regional Assembly (SEERA) told us that "research recently undertaken for the Assembly suggests that even at a rate of less than 20 per cent [PGS] could be expected to raise significantly more resources than present section 106 arrangements".[57] It told us, for instance, that its research indicated that a PGS system in the South East would raise about £4 billion over the 20 year period covered by the South East Plan whereas Section 106 arrangements, even if operated more efficiently, would generate only about £1 billion.[58] Similarly, modelling undertaken by English Partnerships, based on greenfield sites, indicates that with PGS set at 15 per cent, the resources raised would be less than under current arrangements but that with a rate of "20 per cent the take from PGS and section 106 under the new system is greater than the existing section 106 take", although it also noted that, depending on the nature of the site, the actual rate required for PGS take to equate to the current take even for greenfield sites ranged from 7 to 22.5 per cent.[59] Certainly a rate within this range would be in keeping with the Government's commitment to modesty in comparison with previous attempts to capture development gain, where the rate ranged from 52 to 110 per cent.[60]

25. The Government's primary purpose in proposing the introduction of PGS is to increase the resources available for investment in infrastructure overall, above and beyond those produced within the existing planning regime. The rate at which the tax is set will be a key factor in determining whether, and how much, additional revenue is generated. Some witnesses—National Grid Property Holdings and Northamptonshire Chief Planning Officers Group for instance—questioned whether PGS would result in any increase in overall resources.[61] Even so, several factors make this a difficult hypothesis to prove or disprove conclusively: not knowing the rate at which it will be set is one factor but the dearth of robust statistical information on the current level of planning obligations and the capital value of the infrastructure that is delivered is another (we discuss this point further at para 65). We set out here some of the issues that the Government will need to consider when determining the rate at which to set PGS.

26. There are already instances where developers claim that the burden imposed upon them by Section 106 agreements threatens the viability of a particular development. The implication is that the profit in such developments is so slim that there is no additional margin which PGS can lever into the public sector without forcing either the landowner or the developer to pull out of the project and consequently that PGS will not generate any additional capital and may indeed generate less (even though Section 106 agreements were never designed to be revenue raising). No doubt this argument has been used by developers and others as a bargaining position but nevertheless there are instances where it holds true (see para 30 for example). If Section 106 agreements were exploited to their full potential nationwide, as the recent Audit Commission report advocates, this circumstance would arise more often. Thus, while we accept that in some specific instances PGS may generate less revenue than the current regime would, the important question is whether PGS can generate additional revenue overall.

27. If local authorities, however, followed Government policy rigidly, only using Section 106 agreements to meet site specific needs, it would be less likely that there would be many cases in which the viability of the scheme was threatened by infrastructure requirements, though there will always be some specific marginal cases. Difficulties are therefore more likely to arise where local authorities stretch the scope of Section 106 agreements beyond the Government's intentions. On this basis, we believe that PGS could represent a fairer and more even-handed approach than the arbitrary, sporadic and unpredictable imposition of broad planning obligations.

28. The fact that in a minority of cases PGS would generate less revenue than current arrangements has to be balanced against the broadening in the tax base that is inherent within the proposals (see para 22). That so many more developments would be subject to PGS than are currently captured by planning obligations provides a prima facie case that PGS must raise additional revenue, and in many instances this would be raised in addition to Section 106 requirements. Despite the lack of data to form a basis of comparison between PGS and current arrangements, the scale of the extension of scope (from the current 6.9 per cent of planning permission grants to encompass all but home improvements) means that those who believe that PGS will raise less revenue will need to present far more convincing evidence than they have done to date to persuade us to their point of view.

29. There are a number of approaches that the Government could take to quantifying these assumptions to form a basis for determining the optimal PGS rate. The Sheffield University and Halcrow Group study for the Department for Communities and Local Government (DCLG) suggests that some five per cent of gross development value is typically absorbed by affordable housing and that, taken together with other planning obligations, some 10 per cent of development value typically is captured.[62] Figures from the Audit Commission are similar to these estimates: it states that at most some 10 per cent of development value is applied in this way.[63] This implies that land value increases arising from the granting of planning permission must be at least and probably much more than 10 per cent if a development is to proceed. If land purchase costs account for 50 per cent of all development costs—not an unreasonable assumption for the South and East of the country—then PGS would have to be levied at 20 per cent to raise exactly the same amount as existing arrangements. This analysis suggests that PGS could be levied at a rate a little higher than 20 per cent without stifling development but where the land value was modest only, PGS at 20 per cent would struggle to match Section 106 results.

30. Rather than using development value, PGS could be compared with the current regime on the basis of cash value but here the complexities go beyond a dearth of statistical data: those figures which do exist do not appear to be consistent. Research commissioned by SEERA suggests that PGS at 20 per cent would raise £4 billion over 20 years in the South East, whereas Section 106 agreements would capture just a quarter of that over the same time period and geographic area. Sheffield University and the Halcrow Group reported that in 2003-04 Section 106 agreements raised a cash equivalent of £1.2 billion nationwide. This figure is some 25 times higher than that implied by the SEERA research which, unless we accept that the South East accounts for only one twenty-fifth of the national total, is hard to reconcile with the national pattern of development. Both studies make numerous assumptions and are based on small samples which may account for such a difference: both make a valuable contribution to the debate but do not provide an adequate basis for robust tax revenue projections or comparisons. As Knight Frank noted in its Planning-gain Supplement Audit: Final Report, published in September 2006, "there is little empirical evidence of how PGS would impact on the actual viability of different types of developments".[64] Nor is there any data available upon which to appraise the potential for Section 106 to be extended and improved and thus to compare the benefits of PGS against those of a reformed system of planning obligations. It is clear that extensive further research and statistical analysis is required to enable the Government to determine the rate at which PGS should be set.

31. Several witnesses argued that the strength of the Government's commitment to recycle PGS receipts into infrastructure investment should be a key factor in determining the rate at which the tax is levied. The TCPA, for example, told us that

One of the key things for the development industry is whether whatever level of tax is put in place does deliver the investment that they see on occasion holding up development, whether it is from additional money for the housing corporation to allow their affordable housing to come forward or whether it is funding for the infrastructure, […] rather than the money being immediately available to free up the development. I think those are going to be some of the key tests, that if some of those barriers are removed then that will be one of the implications on which the development industry will judge whether or not it is worth bringing forward their sites.[65]

The implication is that the development industry is prepared to pay PGS provided that the funds raised are used to support development through the provision of infrastructure and that the better the additional provision of infrastructure, the higher the rate of PGS that could be imposed without representing a disincentive to bring land forward for development.

32. In making its determination of the PGS rate, the Government will need to strike a balance between setting the rate too high, which could discourage development and encourage avoidance, and setting it a rate which will cover the additional costs of administering the tax, generate a surplus over current arrangements and provide a contribution to investment in strategic infrastructure. It will need to make a strong case to support its determination if the rate does not fall within the anticipated range if the proposals are to retain credibility. In any case, we would expect the analysis and statistical modelling supporting the Government's determination to be made publicly available and open to widespread scrutiny.

Changing the PGS rate

33. Certainty over PGS liability would be a valuable asset for the development industry. That certainty may be undermined, particularly for long-term development projects, if the PGS rate were to change frequently.[66] We asked the Financial Secretary to the Treasury how frequently he expected the PGS rate to be changed. He told us that, while in principle the Government kept the operation of every tax under annual review, the Government wanted "to ensure a degree of stability and certainty" because it too recognised PGS's "potential impact in some long-term planning business investment decisions and markets".[67] We welcome the Government's understanding that it would be impractical to vary the PGS rate frequently. The need to keep revisions to a minimum makes it all the more important to establish a workable rate at the outset.

19 Planning-gain supplement consultation, para 2.2 Back

20 Q 82 Back

21 See, for example, Q 84 Back

22 Planning-gain consultation, Box 2.2: Definitions of planning value and current use value, p. 12. Back

23 Planning-gain supplement, para 2.8 Back

24 Planning-gain supplement, para 2.11 Back

25 Q 231 Back

26 See, for example, Q 236 Back

27 Planning-gain supplement, para 2.13 Back

28 On actual valuations, see, for example, Ev 107, 124. On concerns over administrative practicalities, see for example, Ev 29, 111, 124; QQ 231-7 Back

29 See, for example, QQ 52, 63; Ev 2 Back

30 Ev 110 Back