Welcome to the first in a series of articles providing an overview of the foundational legal principles of business rates. In this first article, we explore the concept of the 'rating hypothesis'.
The rating hypothesis underpins the concept of rateable value ("RV"). Paragraph 2(1) of Schedule 6 to the Local Government Finance Act 1988 ("the 1988 Act") defines rateable value as: "the rateable value of a non-domestic hereditament none of which consists of domestic property and none of which is exempt from local non-domestic rating shall be taken to be an amount equal to the rent at which it is estimated the hereditament might reasonably be expected to let from year to year…" on three key assumptions.
We explore these assumptions further below. However, it is first crucial to understand the concept of a 'hereditament' as this is a fundamental concept in rating law.
The hereditament
A hereditament is a unit of property to which a rateable value can be applied.
Under the 1988 Act, a hereditament is defined at s.64(1) by reference to the definition contained in s.115 of the General Rate Act 1967, which refers to a unit of property which may become liable to a rate and is shown as a separate item in the valuation list.
In establishing the existence of a hereditament, it is important to consider the occupational arrangements that determine the extent of the occupier's control of the property along with the obligations placed on the occupier.
Whilst a freehold or leasehold property might be the most obvious example of a hereditament, other interests may also constitute hereditaments. For example, an occupational right under a licence. A hereditament may comprise no physical property at all but rather consist of rights over other physical property, such as the right to display an advertisement.
The three statutory assumptions
Valuation and the hypothetical tenant
When considering the statutory assumptions, it is first important to note that the rating hypothesis envisages valuation based on a hypothetical tenancy, made between a hypothetical landlord and tenant. The valuer should assume that the hypothetical parties will reach an agreement to let the property, being made between a willing landlord and a willing tenant at a reasonable rent that the property would be expected to achieve on a year-to-year basis, which is then applied to the relevant hereditament.
First assumption
The first assumption provides that the hypothetical tenancy begins on the day two years prior to the compilation of the current rating list (pursuant to para 2(3)(b) of Schedule 6 of the 1988 Act, being a date specified by the Secretary of State).
For the current rating list, which commenced on 1 April 2023, the valuation date is 1 April 2021. This date is known as the 'antecedent valuation date' ("the AVD"). The AVD is fixed for the duration of the list and applies both to the compiled list valuations and valuations for any list alterations. Therefore, the valuer must consider the nature of the market that existed at the AVD to determine the RV of a hereditament.
The significance of this is that the AVD may be a date when the market is either particularly strong, or particularly weak, which may lead to RVs that are then not reflective of the economic conditions for the period during which they have to be paid. This could lead to ratepayers suffering from high RVs if the market drops after the AVD or conversely leave local authorities with low RVs if the market then picks up after the AVD.
Second assumption
The second assumption requires the valuer to assume that the hereditament is in a state of reasonable repair at the commencement of the hypothetical tenancy (even if it is physically run down), unless a reasonable landlord would consider the cost of such repairs to be uneconomic.
This assumption has led to a considerable amount of litigation in recent years, culminating in the decision of Newbigin (VO) v Monk [2017] UKSC 14, in which the Supreme Court decided that the second assumption can be displaced if, assessed objectively on the material day, the property is undergoing redevelopment that renders it incapable of beneficial use or occupation. The effect of the application of this 'reality principle' is that the assumption of repair will not apply and, instead, the rateable value of the hereditament will be reduced to nil or a nominal figure. Precisely what constitutes a scheme of development is a contentious question that we will visit in a later article in this series.
Third assumption
The third assumption imposes a number of covenants on the hypothetical tenant, such that it is required to bear most of the costs associated with occupying the property, including all rates and taxes, insurance and costs of repair.
This assumption is relevant where a premises might be let on favourable terms, such as where a landlord agrees to reimburse a tenant for its non-domestic rates.
In such circumstances, the reimbursement provision is discounted for the purposes of the rating hypothesis, and can thus be used as evidence of a lower RV.
Next time
In our next article, we will be exploring valuation in more detail.
If you wish to continue the discussion, or have any ratings queries we could help with, please do not hesitate to contact Emma Macintyre, Charlotte Nayler or James Myers.