In a move widely welcomed by local governments and the infrastructure sector, the Deputy Prime Minister, Nick Clegg, recently announced that local authorities in England are finally to be granted new powers to undertake Tax Increment Financing ("TIF"). To read the Treasury press release, please click here.

What is TIF?

TIF is a mechanism enabling local authorities to finance infrastructure and regeneration projects in the bond or bank debt markets today off the back of anticipated future increases in local tax revenues. TIF works on the assumption that the projects once completed will lead to increased property values and further development in the relevant area, in turn generating increased tax revenues which the local authority can then use to repay its borrowing over time (often a 20 - 30 year period). In the USA, where TIF has been used for over 50 years, investors in TIF-backed municipal bonds are further incentivised to lend by a tax exemption on the interest they receive.

TIF - a long time coming

Since the beginning of the credit crunch, there has been renewed focus in the UK on new ways of funding infrastructure and regeneration in a new era of public spending constraints. Reports published in 2008 by the British Property Federation (Tax Increment Financing: a new tool for funding regeneration in the UK? (November 2008), and PriceWaterhouseCoopers and the Core Cities Group (Unlocking City Growth: Interim Findings on New Funding Mechanisms (2008)) both discussed the possibility of using TIF schemes to accelerate regeneration projects in England.

In 2009, the previous Labour government invited expressions of interest in TIF from local authorities, but the schemes which came forward have not got beyond the drawing board. Then in the March 2010 budget, the Chancellor set aside £120m to kick-start a series of pilot projects where local authorities could access this fund to start paying off the early-years' debt associated with TIF schemes. It is unclear whether this fund will survive the Coalition Government's Spending Review due on 20 October, notwithstanding Mr Clegg's announcement to give local authorities the requisite borrowing powers to undertake TIF.

What is the timetable for introducing TIF?

In England, new enabling legislation will be required to allow local authorities to borrow against predicted growth in business rates (they can already borrow against their overall revenue stream, but this does not include business rates because such revenue is not guaranteed).

In Scotland, the devolved government believes that it already has sufficient legal powers to give the go-ahead to TIF schemes. Edinburgh City Council is working with Forth Ports on a pilot TIF scheme to boost development on a 400-acre brownfield site around Leith Docks. North Lanarkshire and Glasgow are also considering TIF schemes.

More details on TIF and the timeline for introducing legislation in England will be set out in the Coalition government's White Paper on sub-national growth due around the time of the Spending Review.

What is the potential?

At present, it remains unclear how broad TIF's potential application is or what size of project TIF could potentially support. This will become clearer when the Coalition Government provides answers to the following questions:

  • What cap (if any) will apply to the level of TIF borrowing which local authorities may undertake?
  • Will other tax streams, such as stamp duty, be included within overall TIF schemes? Mr Clegg only referred to business rates in his announcement. Note that the inclusion of stamp duty would require changes to be made centrally to the allocation of tax revenue, as stamp duty is currently collected by HMRC.
  • How will TIF interact with other funding routes, such as such as PFI or prudential borrowing: Will TIF be a "last resort"?
  • How attractive an investment opportunity will TIF combined with the relevant local authority's credit rating be to bond and bank debt markets?
  • What tax incentives (if any) will there be for investors to buy bonds / make loans to TIF schemes?
  • Will there be any central government support in the event of a TIF failure by a local authority?
  • What safeguards will be imposed to minimise the risk of a TIF failure by a local authority?

Challenges

Experience in the USA shows that TIF is not without its challenges. Forecasts of tax revenue growth may be overly optimistic and lead to financial problems for local authorities if growth does not match projections. One solution, where feasible, would be for local authorities to seek developer finance and pass the risk associated with realising tax revenue growth to the developer (who may be in a better position to assess growth potential in the area).

Unsurprisingly, Treasury has stressed the need for a carefully designed framework of rules, and although the experience of the US shows that such strategic national oversight is vital, this may effectively limit the extent of local authorities' powers to use TIF.

Once plans for TIF are clearer, the infrastructure market will be able to prepare to make the most of this funding mechanism and the new projects that will improve local communities.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 30/09/2010.