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An introduction to tax incremental financing

This guide was last updated in August 2011.

Tax incremental financing (TIF) was introduced as part of the Chancellor's four-year spending review in October 2010 as a way of allowing local authorities to fund key regeneration projects in deprived areas. In a TIF arrangement, the money will be borrowed against the increase in locally-collected business taxes anticipated by the new development being created. TIF schemes have been successfully used in other countries, particularly the US, over the past 50 years to encourage investment in deprived areas.

What is tax incremental financing?

The idea of local authorities borrowing money against future improvements is not new. In the UK, authorities were able to raise money by trading local authority bond issues on the stock market. Although technically still legal, these arrangements fell out of favour in the 1980s as local authority credit became more tightly controlled and funding more centralised.

A TIF arrangement is designed to encourage more businesses to move into an area, by allowing local authorities to fund improvement and regeneration projects from the increase in locally-charged businesses taxes that will be generated by these improvements. Currently, locally generated business rate income is collected by authorities on behalf of the Treasury, which then reallocates this money to individual authorities. If a TIF arrangement is used, the local authority can instead assign this anticipated money to a specific local project that requires significant investment.

There are two specific areas of activity that a local authority wishing to use TIF will be involved in, with two different types of risk factor:

  • in activities that are 'downstream' of the local authority, it will designate a specific 'TIF Zone' and pay for the projects being created. Here, the risks that must be considered are those associated with the completion of the development;
  • In 'upstream' activities, the local authority will raise and repay finance for the developers to borrow from. Here, the risks that must be considered are those associated with cash flow from future business rates.

TIF Zones will need to be specifically designated as such. This will likely depend on the area satisfying two criteria: a demonstrable need for regeneration, and an economic test to prove that there is no suitable alternative means of raising capital or obtaining funding.  This latter test is referred to in the US as the 'but for' test.

How is TIF funded?

There are a number of different ways that funding could be provided, including:

  • the local authority borrowing against its anticipated income, to assist cash flow;
  • a developer borrowing against its anticipated income, which is then reimbursed by the local authority;
  • local people investing in the scheme through a local authority bond issue serviced by the anticipated uplift in business rates, potentially with tax relief if specific laws are passed in this area.

What are the benefits of a TIF arrangement?

TIF arrangements kickstart regeneration in a specific area when no alternative source of funding is available, making them a useful way of raising capital for public projects and improvements that may otherwise be unaffordable in times of austerity. As new businesses move into the regenerated areas they will start paying business rates and make money for the authority.

Regeneration also often has a knock-on effect on existing properties, increasing the value of surrounding real estate and perhaps encouraging more investment in new or rehabilitated buildings.

What are the risks?

Since TIF arrangements hinge on anticipated cash flow in the form of business rates that will have been ringfenced for the development project, certainty that the development will be completed and then occupied will be critical.

Issues around project risk must be covered in a Funding Agreement between the local authority and developer or project sponsor. These risks include occupancy rates, uninsurable risks, changes in the law and changes in business rates.

What are the next steps?

So that local authorities can benefit from TIF arrangements, the Government will have to pass new laws allowing them to borrow for this purpose. These laws will probably also include rules on the circumstances where this could be done, including how to designate a TIF Zone.

Local authorities will also have to be given the power to retain and divert business rates into specific local projects as these funds are currently collected centrally, pooled and then redistributed.

Summary

Tax Incremental Financing arrangements have been successfully used in other countries, particularly the US, for over 50 years to successfully drive investment into deprived areas. If the long-awaited legislation, promised in the Chancellor's four-year spending review, is brought forward in the UK then this smarter use of public money where it is really needed will have the potential to drive regeneration in deprived areas across the country.

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