Online tax: a simplistic rather than simple solution to business rates?
COVID-19 Market Update – 19/02/2021
15 minutes to read
Introduction
This is the 32nd of a series of weekly notes analysing the state of the UK retail market in the light of the COVID-19 pandemic. This note explores two key themes:
- Business rates: what we hope for vs what we expect
- What we learned from the latest ONS retail sales figures
Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.
Key Messages
• Major business rate reform unlikely in 3 Mar budget
• Holiday likely to be extended for 12 months
• Possible raising of RV bandings
• Tinkering rather than necessary wholesale change
• Next proposes a 35% rates reduction for shops
• Offset by a 50% rates increase in warehousing
• Resettlement between property asset classes a credible alternative
• Tesco proposes 1% online tax for pure-plays
• Introduction of an online tax far from straightforward
• A green tax a more viable (long term) alternative
• Retail sales feel full force of lockdown in Jan
• Y-o-y retail sales values (exc fuel) down -4.3%
• Food sales +4.6%, non-food -27.6% (clothing – 48.2%)
• Huge pent up demand of ca. £125bn
• Greater clarity on roadmap out of lockdown to come on Mon
1. Business rates; what we hope for vs what we expect
With the end of the holiday looming large at the end of March and the Chancellor’s budget before that (on 3 March), the thorny issue of business rates has again rapidly risen up the agenda. What does the retail market want from the budget and what might we actually get? Sadly, two very different questions, with two very different answers.
Very tellingly, it is perhaps easier to answer the second of these questions than the first. The fact that it is more simple to second-guess the machinations of central government than set out a clear agenda of what the retail market wants is damning on both sides. Central government is unlikely to be sufficiently visionary to implement drastic but necessary change. The retail market, on the other hand, is happy to hide behind the fact that the current system is broken, without necessarily proposing concrete, fully quantified alternatives. In last night’s breaking news, Next is perhaps the one exception – my thoughts on that to follow.
The Chancellor basically has four generic options: 1. Do nothing. 2. Further deferral. 3. Tinkering around the edges. 4. Wholesale reform. Doing nothing is not an option – the fact that warring parties such retailers and landlords are united in agreement that the current system is not fit for purpose speaks volumes as to the need for change. Something has to happen and the Chancellor is at least likely to acknowledge this.
But further deferral and possibly a degree of tinkering is probably all we can realistically expect on 3 March. In all likelihood, we would expect the business rates holiday to be extended beyond 31 March, probably for a further 12 months (following a precedent recently set in Scotland). With the retail and hospitality sector still in lockdown and in such a precarious state, I’m not sure he has any alternative. But as we said last year, this will only provide temporary relief rather than long-term resolution.
There may be some tinkering around the edges. On the basis of recent history, the focus is more likely to be on revising the bandings for rate relief and raising the rateable value (RV) threshold from its current level of £51,000. All well and good, but hardly the game changer that the high street so desperately needs.
As I’ve argued before, this is addressing the problem from the wrong end of the equation. Put bluntly, what proportion of the high street as we know it has a rateable value of less than £50k - £60k? Very little. Yes, raising the threshold may benefit some small independent traders, but it is not going to move the needle for the vast majority.
And the bigger, more implicit picture here is perhaps even more worrying – the way central government continues to view the high street as the domain of small operators, butchers, bakers and candlestick makers. Absolutely nothing against independents and local operators, but the mainstay of most of our town centres and high streets is actually national multiples. And the implicit perception that because they are chain stores, they are ‘big businesses’ and therefore without need of support and external intervention. That completely misses the point.
A wholesale root and branch reform of the business rate system is unlikely to be forthcoming, much as it is needed. On the one hand, it would be unrealistic to expect such a complicated process of reform to be prioritized at a time when the UK government is fighting a global pandemic. But even putting COVID-19 to one side, there has never been much motivation to change what is a stable, steady, easy-to-collect income stream for councils and local authorities. More cynically still, business rates is an ‘electorate neutral’ issue in a way that other taxation metrics (e.g. income tax, council tax) aren’t. If it’s not a votes winner either way, there’s limited impetus for change.
Wholesale reform of business rates is needed, but what should that look like? No end of lobbying, including a letter to Rishi Sunak just last week from 18 retail CEOs including Tesco, Asda, Morrisons, Waterstones and Kingfisher demanding a “fundamental reform of business rates”, but little by way of quantified alternatives, other than the multiplier used should be “significantly reduced”.
One (of the many) criticisms of business rates is that they are anachronistic and no longer reflect the realities of modern day retailing. And, of course, the key difference between now and when business rates were conceived is the rise of online and the mechanics / economics of multi-channel retailing. Put simply, retail markets have evolved massively, but business rates remain steadfast.
All this suggests some sort of online tax as an alternative to business rates. Particularly when Amazon’s tax position is placed under scrutiny, as it recently has been (again). Figures from Altus Group suggest that Amazon's overall business rates bill for 2020-2021 will be £71.5m - just 0.37% of its retail sales. Compare this with the 2.9% that would have been paid by physical store operators (£8.25bn of £285.8bn). By way of real example, now defunct Arcadia would have had to pay £91m. And former CEO of Sainsbury’s Mike Coupe pointedly revealed that despite the rates holiday on its stores (which saved it ca. £500m, which it has since repaid), it was still paying more than Amazon.
But a blanket online tax is probably not the answer, for a host of reasons. Despite all commentary to the contrary, the dividing line between online and physical retail is now blurred to the point of no longer existing. Introducing a blanket online tax would effectively harm those that it is designed to help – high street operators who are in fact multi-channel. Not to mention the huge complexities of recognizing what constitutes an online sale these days (instore order, click & collect, returns etc etc). And above all else, the retail sector is already over-taxed, the last thing it needs is a new drain on its resources.
Tesco has broken rank and actually called for an online tax levy of 1% on pure-play operators. A more concrete proposal at least, but not without its own nuances and potential loopholes. Amazon could argue it’s not a pureplay in that it operates Go stores in the US (and probably will at some point in the UK), plus it also owns Wholefoods. Likewise, ASOS could retain the newly-acquired TopShop Oxford Circus flagship and argue the same. Equally, Boohoo could open a token outlet or two, just to prove a point. Too much complexity around something that any government wants to be simple and easy to collect.
Rather than a blanket online tax, a tax based on deliveries (or a green tax) may ultimately be a more workable solution and would certainly bring consistency with wider ESG agendas. It potentially irons out nuances of what constitutes an online sale (if it’s delivered to your home it is and if it’s not, it isn’t) but it clearly needs considerable investigation before it is implemented. A move in this direction is unlikely to be announced in the forthcoming budget, but ultimately is probably where we should be headed longer-term.
Sharp intake of breath - should the burden of business rates be redistributed across other property sectors? It certainly ticks a number of boxes: simplicity relative to other online tax alternatives, retention of the burden within the parameters of real estate and a process that is quick to implement. And yes, a fairer reflection of modern day retailing. My esteemed industrial colleagues and clients in the shed space may, however, not wholeheartedly agree.
But this approach is garnering support amongst retailers. Interestingly, this has to date largely been driven by leading multi-channel operators rather than single-channel high street operators. To quote Alex Baldock, CEO of Dixons Carphone in a recent Retail Week interview: “[…] the only part of the commercial property market where rents are growing – and they are growing dramatically – is distribution warehouses. Yet rates bills for sheds are proportionately a fraction of those for stores. We need much faster resettlement of rates to reflect changing rental values. This would be fairer, rebalancing the bill away from the struggling high street towards those better able to pay. It would largely be self-funding: the bill would go down for stores, but up for sheds.”
Enter stage left Next’s highly-esteemed CEO Lord Wolfson. His views largely echo those of his counterpart at Dixons Carphone, albeit with quantified proposals: “In-store sales at Next have gone down 25% since 2015 but our rates on those properties have gone up 9%. They have become unfair because they no longer reflect the value property against which they’re charged. Rents on shops have been coming down, rents on warehouses have been going up and the rates don’t fairly reflect the value of warehouse property either.” Lord Wolfson is calling for business rates on physical stores to be cut by a third, offset by an increase on warehouses of around 50%.
Lord Wolfson’s proposals pack a powerful punch and, in my opinion, should be heeded for a number of reasons. Firstly, he is a rightly regarded as one of the captains of the retail industry and Next is one of the best retail business we have. Secondly, Next is one of the leading practitioners of multi-channel retailing and therefore has full visibility of the true mechanics and economics of both store-based and online retailing. Thirdly, his proposals appear a genuine attempt to establish an equitable and fair industry-wide solution, rather than to just achieve cost savings for the business that he represents.
Of course, his proposals will be contentious. Non-retail occupiers of warehouses certainly won’t appreciate a 50% hike in business rates and may resent being caught up in what they may regard as mere retail channel politics. But from a purely retail standpoint - a fairer approach to levelling the playing field and the basis of a more equitable business rates system? Certainly easier and less disruptive to implement. Fairer? A retail opinion will probably differ radically from an industrial one.
Business rates in summary: we hope for radical reform, but we’re unlikely to get it in the forthcoming budget. Holiday likely to be extended for another 12 months, rateable value threshold possibly raised from £51k. Short term solutions: resettlement of shops to sheds by adjusting multipliers, and annual reassessment of rateable values (rather than every 5 years). Longer term: a measured move towards a green/delivery tax. External quantification of any of these measures more than welcome…
2. What we learned from the latest ONS retail sales figures
Predictably, very little to cheer in the January retail sales figures, which reflected a full month of national lockdown. The month-on-month figures were even less meaningful than usual (guess what? We spend more over Christmas than we ever do in January) but are nevertheless being widely reported. As ever, fuel sales were another major distorting factor in understanding what is actually playing out on the high street.
Year-on-year retail sales values excluding fuel (the purest and most meaningful metric) declined by -4.3% in January. Equivalent volumes (goods sold, net of inflation) were down -3.8%. The ‘headline’ y-o-y numbers (including fuel) were considerably worse (values -7.2%, volumes -5.9%) as were the totally meaningless (but widely reported) month-on-month ones (values -7.8%, volumes -8.2%).
The headline read on the January figures? In very broad terms, Lockdown V3 has been worse than Lockdown V2, but not as bad as Lockdown V1. But however you dress up the comparisons, the figures are in no way good. January was the fourth worst month for growth since ONS records began, surpassed only by the three months of Lockdown V1 last year (March -4.6%, April -18.2%, May -9.6%).
The polarity between grocery and non-food performance has been a recurrent theme for much of last year and, if anything, has intensified during Lockdown V3. In January, food sales were up +4.6%, a slight acceleration on the rate of growth in December (+3.9%). In stark contrast, non-food sales slumped by -27.6% in January, a sharp descent from the far-from-stellar decline of -3.2% reported in December.
Clothing had an absolutely miserable month, with y-o-y sales down by -48.2%. This marked the third worst month since ONS records began, eclipsed only by the nadir months during Lockdown V1 (April -69.7%, May -61.5%). Soft demand is just one challenge facing fashion operators – product is highly seasonal and with no clarity on when lockdown will be lifted, they can but second-guess which stock to be buying in. And in what volume. Many may already be focusing on Autumn/Winter, even though we are not even in Spring.
Even non-food categories that staged something of a recovery between lockdowns in Q3/Q4 struggled in January. Household goods sales were down -6.9%, with furniture (-13.3%), carpets (-9.3%) and electricals (-20.3%) all heavily in negative growth territory – significant as January is a key month for many operators in those sectors. By virtue of being classified as “essential”, DIY sales remained in positive territory, although sales growth in January (+7.5%) was a marked deceleration on the average of the previous three months (+32.9%).
There were also weird polarities in traditionally complementary categories. Books (-63.9%) had their worst month on record, while Recorded Music & DVDs saw year-on-year growth (yes, growth) of +16.1%. Chemists sales surged by +49.6%, but cosmetics/toiletries sales slumped -37.3%. This will have negative margin implications for health & beauty operators who straddle both categories and is perhaps why it is tenuous to classify them as “winners” from the pandemic.
Predictably, online penetration again reached record highs in January at 35.2% (food 12.3%, non-food 39.4%). But in terms of growth, multi-channel again outperformed pure-play. Y-o-y growth of non-store operators (+46.9%) lagged that of overall online growth (+72.7%). The narrative remains that during times of lockdown, some trade transfers to online, usually to tried-and-tested brands that consumers usually shop with in “normal times”. Online’s share of spending rises, but the overall spending pie is actually much smaller.
Depressing as January’s figures are, there a few surprises. Where do we go from here? We should gain much more clarity on the path out of Lockdown V3 in the eagerly-anticipated Prime Minister’s address this coming Monday. We can but speculate as to when “non-essential” retail will be allowed to re-open, but it seems safe to assume that it won’t be until well into March, at the very earliest. February will therefore represent another full month of lockdown and the retail sales figures will reflect that and be little better than we have seen in January.
Regardless of when Lockdown V3 is lifted, trying to derive an accurate read of the market from retail sales numbers will be a nightmare from March, indeed for the rest of the year. By the time we reach March, the comp base becomes massively distorted as we lap the effects of outbreak of the pandemic a year ago. For example, y-o-y food growth (the one consistently positive feature of retail sales over the past year) will be far more challenged when the comp from March 2020 is +10.4%. Equally, online growth will look decidedly subdued versus triple-digit increases at certain time last year.
Conversely, y-o-y non-food growth is likely to show huge y-o-y gains from April onwards, assuming that lockdown is lifted by then and no further restrictions are in place. Again, it would be wrong to get too seduced by what may be more mathematical quirks than a Lazarus-style resurrection.
Going forward, it is much more about the bigger picture than the vagaries of monthly retail sales figures. On the consumer side, there are reasons to be optimistic: pent up demand is palpable and the UK shopper is chomping at the bit. Most metrics support this view. To pick out just two: recent research from CACI suggests that 74% of consumers’ finances have improved or stayed the same during the pandemic. The Bank of England estimates that UK consumers have £125bn in pent-up savings.
The money is there. So too is the inclination to spend it. It just needs an outlet. And the tax playing field needs to be a level one. Over to you Messrs Johnson and Sunak…