How the government taxes UK’s broadband future

In 2003, Vtesse Networks, a small UK fibre network operator, challenged the Valuation Office Agency’s assessment of BT for business rates in British and European courts. It argued that the VOA’s assessment amounted to an unfair subsidy to BT

In 2003, Vtesse Networks, a small UK fibre network operator, challenged the Valuation Office Agency’s assessment of BT for business rates in British and European courts. It argued that the VOA’s assessment amounted to an unfair subsidy to BT.

Vtesse won the first case at the Valuation Tribunal on a technicality, but has lost all the ensuing court battles so far. Its appeals are due to be heard in mid-December. A win for Vtesse could unleash an investment boom in next-generation networks that would shorten the government's timetable to give effect to its Digital Britain policy.

Vtesse CEO Aidan Paul says the grounds for its case would have disappeared if Treasury minister Stephen Timms had accepted an independent recommendation prepared for the then Department of Trade & Industry (now the Department for Business, Innovation & Skills) not to tax fibre networks.

The Valuation Office Agency (VOA) uses a complex formula to work out the rateable value of communications networks. The valuation is subject to negotiation and appeal, which adds uncertainty to the outcome.

Spokesmen for network operators Virgin Media and TalkTalk say that anything to lower the tax rate would be helpful, but it is uncertainty, more than anything, that holds up their investment plans.

Taxing fibre networks

The business rates tax is a UK property tax on non-domestic property or "rateable hereditament" and includes land, buildings and rateable plant and machinery. Its aim is to contribute towards the costs of services provided by local authorities.

The rateable value is the hypothetical annual rent at which the hereditament might reasonably be expected to be let from year to year in an open market transaction at a certain valuation date.

Radio equipment, such as masts, has always attracted business rates tax. The VOA is now exploring whether wi-fi hotspots and Wimax wireless networks are also liable. If so, the tax liability may be backdated five years, putting many non-profit community networks at risk.

When rating fibre networks, the length of fibre, whether the fibre is lit, how many homes the fibre "passes", and other factors are taken into consideration.

The clearest explanation of how the VOA calculates rateable values is contained in the European Commission's 26-page decision (2006/951/EC, Official Journal of the European Union 28.12.2006) where Vtesse Networks claimed, unsuccessfully, that BT was receiving state aid unlawfully. The appeal is due in British and European courts in December.

The VOA rates BT on its "receipt and expenditure", but other network operators are rated on the actual or deemed rental value of their fibres. The VOA also considers the length of the fibre between the local exchange and the customer's premises. The longer the link, the more tax it attracts.

This makes it financially more attractive to use fibre over short distances, such as within cities and suburbs. Customers who live any distance from an exchange or roadside cabinet have to pay the higher tax burden or do without. This can amount to £2,000 a year for a 3.5km link, says one operator, "virtually 100% of what I can charge". Some remote communities cannot afford this, so they require financial support to get connected.

Discounted taxes

BT's fibre network stretches more than 17 million kilometres - 9,867,205km in the core or backbone network, and 7,685,103km in the access or "last mile" network.

The VOA also operates a steep discount policy on lit fibres per route. The more fibres that are lit on any one route, the less the fibre owner pays per lit fibre. In addition, owners of networks whose total length is less than 3,000km pay 11% more to light the first fibre on a route. Together, these make it harder for smaller network owners to compete with BT.

Instead of paying a per kilometre rate for its fibre network, BT pays tax on what the VOA assesses as the hypothetical rental value of BT's entire network.

This peaked at £533m in 2006. The VOA has since cut BT's rateable value each year. According to its central rating list for England, BT's rateable value dropped from £415m on 1 April 2008 to £386m on 1 October 2008. The proposed valuation for 2010 is £255m. Given the new tax rate of 48.5%, 2p up on last year, BT's business rates bill will therefore be £124m.

In a neat symmetry, the amount of tax revenue lost as a result of BT's reduced rateable value, around £190m, would be matched almost exactly by the proposed levy of 50p per month per fixed telephone line. Had the VOA not cut BT's rateable value, there would be no need for the controversial levy.

In addition, if BT's fibre network were taxed per kilometre, it would have to pay more than £1bn just for its local access network in England.

The VOA has not responded to requests for an explanation for the decline in BT's rateable value, but the European Commission says material factors that could affect it include the expansion of BT's network and the roll-out of competitors' networks.

According to BT's annual report to 31 March 2009, it had property, plant and equipment worth £15.41bn, and spent more than £3bn on capital goods. BT's Openreach subsidiary, which is largely responsible for the UK's local access network (the links from the subscriber to local exchanges), returned operating profits of £1.22bn on sales of £5.23bn.

Unfair advantage

The VOA also treats BT differently in other ways. Non-BT network operators (except Virgin Media, which is subject to yet another different regime) are liable for business rates as soon as they light their fibres. This cost is fixed by the VOA's formula (see graphs below). BT pays on the projected profit or loss on "rent" it could make on both its lit and dark fibre. This is averaged over a five-year rating period and adjusted yearly for material changes in market conditions.

It must therefore include this cost in its prices. BT's tax bill is an annual adjusted average. Other fibre network operators must pay as soon as they light their fibres. Non-BT operators say this gives it great flexibility in pricing, especially in specific circumstances such as a competitive tender.

BT is therefore in a win-win position in bidding for contracts. If it wins the business, great; if it loses the business, its rateable value drops and it pays less in business rates tax.

Non-BT operators say the time difference between when the liability arises and when it is paid means BT can afford to sell at or below its break-even cost. This is because BT collects its money well before it pays the tax, while other operators have to pay whether the customer pays them or not. Also, the amount BT has to pay is subject to adjustment.

BT and Virgin Media benefit in another way. BT pays tax on all its fibre, dark or lit, and Virgin Media on the basis of the number of houses that its network "passes" (i.e. could have access if they wanted). They incur no extra tax liability for speeding up their networks, but they would have to pay tax to reach more premises.

So it pays them to "sweat their assets". Rationally, they should increase both the speed and the number of people on the existing networks rather than increase their geographic coverage.

As Computer Weekly reports in the past year have shown, BT and Virgin Media are both increasing the headline speeds of their existing networks, but have sought public money to extend their reach. Only very recently have they revealed plans to grow their networks into presently unserviced areas.

Graph 1 shows the 11% discount given to network owners as they light more fibres. Graph 2 shows how the amount of tax due rises the longer the link from the exchange to the subscriber’s premises. In both cases, the regime favours network owners who have lit more than 3,000km of fibre.

Source: Valuation Office Agency

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