Commercial and Industrial Property

- Tax Policy Options

 The Strategic Policies and Priorities Committee recommends the adoption of the recommendations in the following transmittal letter (July 12, 1998) from the Assessment and Tax Policy Task Force:

 Recommendations:

 The Assessment and Tax Policy Task Force on July, 6, 7, 11, and 13, 1998, recommended to the Strategic Policies and Priorities Committee and City Council that:

 (1)because of the concerns in the valuation of commercial and industrial properties and for the need to provide protection to business tenants and to charities and similar organizations, and in order to limit the tax changes created by current value assessment, all commercial and industrial assessment-related property tax increases be capped at 2.5 percent of existing 1997 taxes (both realty and business occupancy taxes) per year for three years (1998-2000), and that these caps be funded by withholding a proportionate amount of tax decreases from properties with tax decreases;

 (2)the other tax policy measures available for the commercial and industrial property classes, including graduated tax rates, separate classes and tax rebates, not be implemented at this time;

 (3)prior to the full implementation of three-year averaging in 2006, the Province be requested to use a longer period of time (e.g., ten years) to average assessed values, especially for commercial properties; and

 (4)a work plan be developed to formulate comprehensive tax policies in advance of the return of 1999 current value assessment, including the establishment of a Business Reference Group to assist in the process.

 The Task Force reports having requested the Chief Financial Officer and Treasurer to report directly to City Council on July 21, 1998, on the following:

 (1)any decisions of other major municipalities in Ontario on phase-ins, capping, etc.;

 (2)background information on the average tax burden and average income of tenants versus homeowners; and

 (3)an amendment to Table 7, attached to the report (June 26, 1998) from the Chief Financial Officer and Treasurer, to analyse the following proposal of Councillor Walker:

 That City Council:

 (i)create a separate tax class for office buildings;

 (ii)create a separate class for shopping centres;

 (iii)adopt graduated tax rates for the residual commercial class being:

 (a)4.12 percent for the first $400,000.00 of a property's assessed value

(b)7.75 percent for the remainder of the property's assessed value;

 (iv)provide tax rebates for properties receiving tax increases over 150 percent, to be financed by a 3.3 percent mill rate increase for all commercial properties; and

 (v)adopt an eight year phase-in of all commercial tax changes.

 Background:

 The Assessment and Tax Policy Task Force had before it a report (June 26, 1998) from the Chief Financial Officer and Treasurer outlining the various tax reform options available with respect to commercial and industrial property.

 The Task Force also had before it the following communications respecting the Current Value Assessment and the commercial and industrial property class:

 (a)(July 2, 1998) from Ms. Mary Rose Ward, President, Mary-Rose Fashions;

 (b)(July 7, 1998) from Mr. Peter Menzel, Toronto Automobile Dealers' Association (T.A.D.A.);

 (c)(July 7, 1998) from Ms. Angela Robertson, Community Social Planning Council;

 (d)(July 7, 1998) from Mr. John Campbell, President, Brookfield Management Services Ltd., Toronto Office Tower Coalition;

 (e)(July 6, 1998) from Mr. James H. Oestreicher, Assistant Professor, University of Toronto;

 (f)(July 7, 1998) from Mr. John Barnoski, Ontario Specialty Tenants' Coalition;

 (g)(July 8, 1998) from Ms. Lea Pyykkonnen, Executive Director, Toronto Finnish-Canadian Seniors Centre;

 (h)(July 8, 1998 from Mr. Bruce McKelvey, President & Chief Executive Officer, CDI Education Corporation; and

 (i)Mr. Terry Mundell, President, Ontario Restaurant Association.

 The Task Force held public hearings on July 7, 1998, to hear deputations from citizens on the reports from the Chief Financial Officer and Treasurer respecting Commercial and Industrial Property: Tax Policy Options, Property Tax Rebates for Charitable and Similar Organizations, and Tax Shifts -- Effect of Changes to Transition Ratios.

The following persons addressed the Task Force on July 7, 1998:

 -Mr. John Doherty, obo Planned Parenthood Toronto;

-Mr. George Springle

-Mr. David G. Fleet, Poole Milligan, Barristers & Solicitors, obo Toronto Office Tower Coalition

-Mr. David McAlpine

-Mr. Wayne Amundson, obo Canadian Society of Association Executives

-Mr. Terry Mundell, President, Ontario Restaurant Association

-Ms. Maggie Pettet

-Ms. Angela Robertson, obo Community Social Planning Council

-Mr. Walker Kwok, Co-Chair, Toronto Fair Tax Chinatown Committee & Toronto Chinatown Community Development Association

-Mr. Dan Clement, obo United Way of Greater Toronto

-Ms. Midge Day, York Mills Heights Ratepayers' Association

-Mr. Peter Menzel, Toronto Automobile Dealers Association

-Mr. Richard D'Iorio, obo Toronto Arts Tax Alliance

-Ms. Asha Crogan, obo Professional Art Dealers Association of Canada

-Mr. John Barnoski, obo Ontario Specialty Tenants Coalition

-Mr. Kelly McCray, obo Toronto Arts Tax Alliance

-Mr. Loukas Stathokostas

 (Copies of the communications referred to in the transmittal letter of the Assessment and Tax Policy Task Force have previously been distributed to all Members of Council with the agenda of the Assessment and Tax Policy Task Force and copies thereof are on file in the office of the City Clerk.)

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 (Report dated June 26, 1998, addressed to the

Assessment and Tax Policy Task Force

from the Chief Financial Officer and Treasurer)

 Purpose:

 To outline the various tax reform options available with respect to commercial and industrial property.

 Financial Implication and Impact Statement:

 The recommended capping of business properties will protect businesses from significant CVA-related tax increases. However, if Council adopts the cap, budgetary tax increases, if any, in 1999 and 2000 would have to be funded from uncapped properties. For every one-percent increase in the City's levy during the next two years, this could result in a 2.8 percent increase in the City's municipal portion of the residential/farm tax rate or a 1.8 percent increase in the total residential/farm tax rate.

 Recommendations:

 It is recommended that:

 (1)because of the concerns in the valuation of commercial and industrial properties and for the need to provide protection to business tenants and to charities and similar organizations, and in order to limit the tax changes created by current value assessment, all commercial and industrial assessment-related property tax increases be capped at 2.5 percent of existing 1997 taxes (both realty and business occupancy taxes) per year for three years (1998-2000), and that these caps be funded by withholding a proportionate amount of tax decreases from properties with tax decreases;

 (2)the Province be requested to rescind any provisions in Bill 16 which prevent a municipal council from funding a budgetary tax increase from all property classes, should the capping provisions be adopted;

 (3)the other tax policy measures available for the commercial and industrial property classes, including graduated tax rates, separate classes and tax rebates, not be implemented at this time;

 (4)prior to the full implementation of three-year averaging in 2006, the Province be requested to use a longer period of time (e.g., ten years) to average assessed values, especially for commercial properties; and

 (5)a work plan be developed to formulate comprehensive tax policies in advance of the return of 1999 current value assessments, including the establishment of a Business Reference Group to assist in the process.

 Reference/Background:

 Bill 106 and Bill 149, the Fair Municipal Finance Act (Nos. 1 and 2), provided Council with some flexibility in setting tax policy for commercial property (e.g., graduated tax rates and a maximum eight-year phase-in period). Bill 16 - "Small Business and Charities Protection Act, 1998" includes a municipal option to limit the tax increases resulting from tax reform to no more than 2.5 percent per year for the next three years. These caps can be applied to commercial, industrial and multi-residential properties and would be funded by limiting the amount of tax decreases resulting from Current Value Assessment (CVA). The legislation also provides municipalities the option of requesting the following new property classes: office buildings, shopping centres, parking lots and vacant land and large industrial properties. The graduated tax rate option is also now extended to the industrial class. Furthermore, tax rebates can provide additional protection to businesses.

 The recent 1998 Ontario budget will provide funding to those communities, like Toronto, with business education taxes above the provincial average in order to reduce education tax rates for commercial and industrial properties. This equalization plan will be phased-in over the 1998 - 2005 period. When complete, the plan will reduce business education taxes in Toronto by an estimated $400 million. Legislation will be introduced to implement this plan.

 Comments:

 Introduction:

 This report deals only with an implementation plan for CVA for the commercial and industrial property classes, within the context of the existing provincial legislation. Other tax policy issues dealing with narrowing the gap between the municipal tax rates for industrial and commercial property are addressed in a separate report. This report summarizes the analysis and findings regarding the tax policy options for commercial and industrial properties, including graduated tax rates, separate classes, tax rebates, phase-ins and capping provisions pertaining to commercial and industrial properties.

 The summary financial information contained in the Appendix does not reflect the impact of the plan to reduce business education tax rates announced in the 1998 Ontario budget. Further provincial details affecting the calculation of reduced education tax rates are pending. Once completed, the education tax rate reduction plan in Toronto will have reduced the preliminary estimated total commercial and industrial tax rates as follows:

 These are preliminary estimates based on the final assessment roll and will be revised as part of the final tax calculations.

 Current Value Assessment - 1998:

 The preliminary work done by City staff (in February and early March) was based on a single tax rate for all commercial property. Based on the final assessment roll received on June 15, 25 percent of commercial assessment portions (i.e. properties) experience tax decreases and 75 percent face increases. The average decrease amounts to $56,192.00 or 31.7 percent and the average increase is $18,372.00 or 251.6 percent. The median or mid-point of decreases is $7,022.00 or 28.9 percent and the median increase is $5,979.00 or 120.9 percent. The analysis clearly shows that a significant number of businesses in Toronto would face substantial tax increases. For example, almost half of the approximately 33,800 commercial properties face tax increases over 100 percent and almost 4,600 commercial properties face tax increases over 300 percent. The impact of CVA with one tax rate on commercial property is shown in the Table 1 in the Appendix.

 The June 1996 values for commercial property were estimated by the Ministry of Finance using the income and sales comparison approaches. Office buildings and shopping malls were generally assessed using the income method. However, the assessed values for some smaller, older office buildings were determined using the sales comparison (or market) approach. Most strip retail properties were also valued using the sales comparison approach. The CVA findings showed that the office building sector in Toronto, which currently pays half the amount of total commercial taxes, would receive a total reduction of $418 million. On the other hand, most strip retail type properties would experience increases totaling $175 million.

 Within the commercial class different types of commercial property have different effective tax rates, which are expressed as 1997 taxes as a percentage of 1996 values. Groups within the commercial property class are at diverse starting positions - some as low as 1.25 percent (e.g., vacant commercial land) and others as high as 12.06 percent (e.g., office buildings). As a result, property types with current effective tax rates below 7.75 percent experience increases. Property types with current effective tax rates above 7.75 percent (e.g. hotels, motels/taverns and department and discount stores, etc) on average, see tax decreases.

 Furthermore, the existing effective tax rates of properties within property types vary. For example, some strip retail properties are taxed at 1.0 percent, while others are taxed at 5.0 percent, compared to the average of 2.83 percent. This additional level of discrepancy within types of property further exacerbates the problems associated with reform.

 A number of tax policy options provided in both the Fair Municipal Finance Act (Nos. 1 and 2) and Bill 16 are available to make the CVA impacts on commercial and industrial classes manageable. It would appear that municipalities could implement change using either one of two approaches. A municipality could implement the assessment-related tax increases for commercial and industrial properties using a combination of tax policy tools - graduated tax rates, separate classes and tax rebates. Under one option a municipality could phase-in the impacts of the plan over a period of up to eight years. Alternatively, under a second option a municipality could cap the assessment-related tax increases with or without the tax policy tools. As discussed later in the report, capping without any other tax policy options is recommended.

 Tax Policy Options - Commercial Property:

 This section provides a summary of the tax policy options available in the legislation to help municipalities implement tax changes.

 1.Graduated Tax Rates:

 Graduated tax rates are provided to mitigate the impacts of both reassessment and the elimination of the business occupancy tax on lower-value commercial properties. The Fair Municipal Finance Act allows a municipality to pass a by-law creating two or three bands of assessed commercial value in order to apply lower tax rates to lower valued commercial property. A different tax rate would apply to each band. The impact of using only graduated tax rates as a tax policy tool has been examined using two and three-tier tax rate scenarios. The tax rates selected were based on reducing tax shifts by recreating existing tax burdens by property value range The ranges of assessment value and tax rates under the two and three tier tax rate models studied are presented below (see Table 2 in the Appendix for more details). Under the two tier rate model, for example, the first $300,000.00 of current value could be taxed at a rate between 2.0 to 6.0 per cent depending on the model selected. The amount of current value above $300,000.00, if any, would be taxed at a rate between 7.9 to 11.0 percent, again depending on the option chosen.

 Summary of Graduated Tax Rate Models

 Both the above exhibit and Table 2 in the Appendix were prepared using the preliminary assessment data from February. Extensive analysis conducted on the preliminary data (24 different models which are summarized in Table 3) was not repeated to the same degree using the June 15 assessment information. Instead the analysis was more focussed on the selected graduated tax rate models that provided the greatest benefits based on the previous review of the preliminary data. See "Model M2 GTR" section for this discussion.

The graduated tax rate options examined were only able to limit increases for most strip retail properties to no more than 100 percent. This was achieved by substantially increasing taxes on larger commercial properties particularly on office buildings. Even then, about 2,800 strip retail properties would face tax increases over 100 percent. Although graduated tax rates help to lessen the impact of CVA, they alone are not sufficiently flexible to reduce tax increases on commercial property to acceptable levels.

 2.Separate Classes of Property:

 Bill 16 allows a municipality to adopt optional property classes, namely - office buildings, shopping centres, vacant land and parking lots, and large industrial properties. The municipality has up to 30 days after the return of the assessment roll to adopt any of the optional classes. The Minister of Finance may extend this period of time up to, but not exceeding 60 days after the roll return, if requested by the municipality. The City has requested such an extension. The review of the office buildings constituted an important part of the examination of separate classes.

 Separate Class for Office Buildings:

 As noted, one of the reasons for the huge tax shifts within the commercial class is the valuation date (June 30, 1996) in the current reassessment program. In 1996, office buildings (which currently pay half of all commercial property taxes in Toronto) had values far below their replacement cost, because rents and vacancy rates were only beginning to recover from their levels in the early 1990's. For example, Royal LePage reports that in 1996 the average net rent for "Class A" office space in Toronto was in the $4.00 per square foot range.

 While CVA, based on 1996 values, with one tax rate would have shifted over $400 million in taxes away from office buildings and on to other commercial properties, this phenomenon is expected to be short-lived. Recent sales of office buildings suggest that the value of office buildings in the downtown may have already doubled from their level in June 1996.

 The next reassessment in 2001 will be based on 1999 values. By that time, it is reasonable to expect that the value of office buildings will have substantially recovered and that the tax shift off office buildings and on to other commercial property may be either eliminated or significantly moderated. For example, if the value of office buildings were to double by 1999 and the value of other commercial property were to remain at its June 1996 levels, the tax shift away from office buildings would be only $80 million compared to a $418 million shift based on 1996 values. In the example above, the total tax rate for all commercial property would be 5.9 percent instead of 7.75 percent. But even with a 5.9 percent tax rate for all commercial property, there would still be large tax increases for many strip retail properties.

 Data from the proposed reassessment in Metro Toronto in 1992, based on 1988 market values did not show a significant shift of taxes away from office buildings. Therefore, it seems that the values of office buildings fluctuate much more than the values of retail properties, and that these office market cycles of about eight to ten years will create future tax shifts off and on to office buildings. The three-year averaging proposal, which is to be incorporated into the assessment system after 2005, will not be able to moderate these shifts, because it appears that the office market cycle is much longer than three years. Accordingly, prior to the full implementation of three-year average in 2006, the Province should review whether three years is an adequate period of time to average the current values of commercial properties.

 In order to eliminate these large tax shifts within the commercial class, one could place office buildings in a separate class. The difficult question is at what relative tax level? Bill 16 enables a municipality to adjust the existing tax burdens of a separate office building class (i.e., a 12.06 percent tax rate) towards the average commercial class tax burden (i.e., a 7.75 percent tax rate). The analysis based on separate classes in this report assumes that existing tax rates for the optional classes are not moved toward the commercial average.

 Not all office buildings would have received the same magnitude of tax decreases based on CVA with one tax rate. While attention has, to date, focussed on the large absolute dollar tax decreases that the "bank" towers would have received, the smaller, older Class B and Class C office buildings would have received much larger percentage tax decreases. Therefore, if office buildings were in a separate class, those buildings (mostly bank towers) that would have received small tax decreases under CVA with one tax rate would receive tax increases under a tax system with office buildings in a separate class. It is recommended, as part of a more comprehensive review for a long-term strategy, that office building valuation scenarios be developed and tested against the available tax policy tools before separating them into a separate class.

 Further analysis of the office building sector should also be accompanied by examining how small business, particularly strip retail properties, can be protected. The Province has not created a separate class for strip retail properties apparently because it would be very difficult to define this class, particularly if a comprehensive definition were desired. At its meeting on April 28, 29, and 30 and May 1, 1998, Council recommended that the Province be requested to provide municipalities with the authority to create a separate class for retail, restaurant, retail with residential above and retail with office categories. Any definitional problem(s) associated with this new class of property should be reviewed along with other initiatives discussed in the section "Comprehensive Tax Policies" prior to the next reassessment.

 The option of separate classes on its own still results in significant tax increases for properties in the residual commercial class, particularly for small or strip retailers. However, graduated tax rates can provide tax relief to some properties within the residual commercial class. The creation of a separate class also locks-in properties at a tax rate that could be significantly higher than the residual commercial class and as a result may be seen to be inequitable.

3.Tax Rebates to Business:

 Bill 16 also enables municipalities to provide tax rebates to businesses with significantly high increases that need further protection. The rebate program is primarily intended to provide assistance to the 'outliers' with large increases after other tax policy options have been exhausted. It is not intended to emulate the capping option for tax increases for commercial and industrial properties. The rebate would be funded by increasing the overall commercial tax rate by a sufficient amount to offset the amount of the tax rebate. The amount by which tax rates are increased to fund the tax rebate is equivalent to a budgetary increase for the year and is not eligible to be phased-in. This additional tax amount can be recouped from all properties within the property class eligible for the rebate or from all uncapped property classes. The rebate cannot be funded by withholding or clawing back a portion of the tax decreases within the commercial or industrial property classes.

 The Minister shall determine within 30 days of receiving a municipality's rebate by-law whether education taxes would also be eligible for any tax rebate program (i.e., whether the Province will fund the education portion of the rebate program). This could be problematic if a municipality adopts a rebate program and approves its tax rates and the Minister does not agree to fund the Province's share.

Table 3 in the Appendix compares a tax rebate program with the cap and claw back option for properties experiencing tax decreases and increases under CVA. Most significantly, as a result of funding a tax rebate to cap increases at 2.5 percent, properties experiencing tax decreases under CVA would receive reduced decreases and some properties with decreases would end up with tax increases. A property with no tax change under CVA would experience a 35 percent increase if the tax rebate program were funded within the class. Properties with more than a 2.5 percent increase under CVA would receive a 38 percent increase under a rebate plan. Because the overall tax rate must be increased to finance the tax rebate, properties with increases end up with a greater increase than the intended capped amount (i.e., 38 percent instead of 2.5 percent).

 The number of business properties that benefit from a tax rebate program depends on the eligibility criteria. The number of commercial properties benefiting, for example, under the 2.5 percent capping level shown in Table 3, would be 26,000. Under a more restrictive scenario, for example properties with increases greater than 100 percent, the number of eligible properties could conceivably range between 4,370 (under selected graduated tax rate models) to 15,250 (under CVA in Table 1). The tax rebate option is not recommended in this report because the capping provision provides better protection to businesses facing significant increases while at the same time, ensuring that no business with a tax decrease under CVA experiences a tax increase.

4.Phase-in:

 The legislation allows for the phase-in of assessment-related tax increases up to a maximum of eight years. Any phase-in program must be self-financing so that the amount of the phased-in tax increases is offset by tax decreases within the class. The phase-in program must begin in 1998 and the annual amount to be phased-in must be the same or less than the amount phased-in the previous year. The phase-in provision for assessment-related tax changes for commercial and industrial property on its own is not recommended because even with an eight-year phase-in period there are too many large tax increases. The annual amount of average tax change that would be phased-in under CVA with one tax rate is shown in Table 4. It is evident that some commercial types of property would experience over 20 percent annual tax increases. By the third year of an eight-year phase-in period, almost 1,600 commercial properties would have received tax increases greater than 100 percent.

 As a result, a phase-in period longer than eight years would be required to mitigate the impact to a manageable and sustainable level. A phase-in program will likely be considered as part of implementing the next reassessment. Depending on the impacts arising from the next reassessment, a longer phase-in period (e.g., 10 to 20 years) may need to be considered. Otherwise additional tax policy tools would be required to mitigate these increases.

 Combinations of Tax Policy Tools:

 This section summarizes the major findings from the analysis of tax options for the commercial class. The impact on tax rates that result in each class of commercial property, if Council adopts the option to create separate classes, is shown in Table 5. More detail about the impact of CVA with one tax rate on commercial properties in Toronto is provided in Table 1.

 Model 1, in Table 5, examines a separate class for office buildings. Since office buildings are currently taxed at an average tax rate that is considerably higher than the average for all commercial property, separating office buildings reduces the tax rate on the residual or remaining commercial class to 6.09 percent. Although this helps the strip retail properties, it does not provide as much assistance as would be expected if strip retail properties were in a separate class.

 Model 2 looks at both a separate class for office and a separate class for the shopping malls. Since shopping malls have an existing tax rate lower than the rest of commercial, the residual commercial tax rate is pushed up to 6.19 percent, from 6.09 percent in Model 1. Similarly, Model 3, which adds a separate class for vacant land and parking lots, raises the tax rate on the residual commercial class to 6.44 percent.

 Model M2 GTR is based on a separate class for office and a separate class for shopping malls, with the graduated tax rate option used for the residual commercial properties. A tax rate of 4.12 percent on the first $400,000.00 of current value, was used which allows the top rate to remain at 7.75 percent, so that the hotels and other large properties in the residual commercial class would be no worse off than they would have been under CVA with one tax rate.

 Implementation Options - Commercial Property:

 Option 1: 8 Year Phase-in, Graduated Tax Rates, Separate Classes and Tax Rebate - Model M2 GTR:

 Model M2 GTR represents the most potentially viable option of the detailed models studied to date that can be considered as an alternative to capping. In order to provide additional assistance to businesses experiencing significant increases under Model M2 GTR, an eight-year phase-in and a tax rebate plan were also applied. A range of capped tax increases for the first and third years of the phase-in period and the corresponding tax rate impact (to fund the rebated tax amounts) are shown in Table 6. For example, in the first year of the phase-in period, commercial tax rates would increase by 1.7 percent in order to rebate commercial property with tax increases greater than 2.5 percent, and increases to 5.7 percent by the third year as summarized in the following:

 Tables 7 and 8 show the benefit that a Model M2 GTR phase-in plan combined with a tax rebate provides when compared to a Model M2 GTR phase-in without a tax rebate. The reduced tax increases under the tax rebate option in Table 7 are funded by an overall increase in the commercial tax rates. Therefore, some property types will experience, on average, smaller decreases or even tax increases (e.g. office buildings, hotels, medical/dental offices and other commercial). Accordingly, the impact of funding the tax rebate tends to cancel some of the benefits of the other features of Model M2 GTR for some properties. However, without a tax rebate there would be 1,595 properties with tax increases greater than 100 percent by the third year of the phase-in, as shown in Table 8.

 The Model M2 GTR should be studied as part of the comprehensive review of tax options prior to the next reassessment. The model creates separate classes for office buildings and regional shopping malls. The creation of separate classes, as pointed out earlier, raises questions about the appropriate level of taxation for these new classes over the long term. Bill 16 allows for the shifting of taxes between the commercial and optional classes. Any downward adjustment to the office building tax burden, for example, towards the average tax burden for the commercial class would require shifting taxes either on to commercial properties below the class average or on to the residential/farm class or both. The creation of separate classes should not be undertaken without a long-term strategy of the relative tax levels for new property classes.

 Option 2: 2.5 Percent Cap on Tax Increases:

 Bill 16 provides Council with the option to cap all commercial, industrial and multi-residential tax increases resulting from tax reform at 2.5 percent per year for three years. If Council adopts this provision, it will be locked-in until the next reassessment in 2001. Municipalities cannot opt out of the cap once imposed. Conversely, Council may not opt into the cap after 1998. Most significantly, the cap limits any tax increase in those property classes that are capped to 2.5 percent of their 1997 taxes. Any budgetary increases cannot be imposed on capped property classes. Council would have to fund budgetary increases from uncapped property classes. This is a new development since the Minister of Finance's March 27 announcement of new tax tools, which made no reference to any such condition.

 The tax reform legislation to date has either referred to assessment-related or tax policy changes (i.e., a tax shift between classes) without any special rules relating to budgetary increases. Council should not be restricted in how it funds budgetary increases from the property tax base. It should have the choice of funding a part of or all budgetary increases from either an uncapped class (i.e., residential/farm class) or from all classes proportionately. It is recommended that the Province be requested to rescind any restriction in Bill 16 that hinders Council's ability to fund budgetary increases from all property classes should the capping provisions be adopted. However, the implementation of the 2.5 percent cap could conceivably act as an incentive to freeze taxes over the next two years. If there were budget-related tax increases, effectively resulting in a tax shift to the residential/farm class, this would not be inconsistent with the long-term tax reform goal of reducing business property taxation levels in Toronto as discussed in an accompanying report.

 A municipality has 30 days after the return of the assessment roll to adopt the capping provision. However, the Minister of Finance may extend this deadline up to, but not exceeding 60 days following the roll return. The 2.5 percent cap on tax increases would limit the tax decreases, by clawing back the amount of tax decreases to some sufficient level to fully offset the cap on increases. Table 9 shows the impact of the caps on the tax decreases for each of the separate class options discussed above. If Council chooses to proceed with CVA with one tax rate for commercial property and cap increases, only 4.97 percent of the amount of tax decreases could be allowed (i.e., 95 percent of the tax decreases under CVA would have to be clawed back) in the first year. For example, a business property with a $5,000.00 decrease would receive a $248.50 decrease. The amount of the allowed decrease goes up to an estimated 10.16 percent in the third year, resulting in a $508.00 decrease in the above example.

 Many tenants in shopping centres have suggested that they would be facing increases well beyond the 2.5 percent cap as a result of the building owner's allocation of the tax changes, including the elimination of the business occupancy tax, among small and large stores in the building. Bill 16 protects tenants and ensures that the tenant pays only the tax amount required under the lease in 1997. However, the legislation also provides for landlords to recoup more than the 1997 taxes actually paid by tenants if this tax amount was less than the amount allowed under the lease.

 It is important to appreciate that Model M2 GTR cannot provide the same protection to individual tenants, such as small commercial tenants in shopping malls, that the 2.5 percent capping provision ensures. The capping option ensures that tax reform does not result in additional tax shifts within a property caused by the elimination of the business occupancy tax.

 The protection provided to tenants also makes the tax rebate program for charities and similar organizations redundant. The cap ensures that tenants do not pay more than 2.5 percent more than in 1997, where tax increases are applicable, thereby eliminating the need to rebate charities and similar organizations. By adopting the cap for commercial and industrial property, Council avoids the administrative costs associated with tax rebates. The cap on commercial property also ensures that the property of the Toronto Transit Commission and the Toronto Hydro Electric Commission, which is classified as commercial and pays taxes, would also be limited to an increase, where applicable, of 2.5 percent each year in the 1998-2000 period.

 Analysis of Option 1 vs. Option 2:

 Despite the mitigating effect of graduated tax rates and separate classes, there would still remain a large number of businesses with significantly high tax increases. Additional tax tools such as tax rebates and phase-ins would be necessary. However, with the expected change in office building values by the next reassessment, as discussed previously, it is not considered advisable to phase-in CVA tax impacts which are anticipated to be quite different from those in 2001. The 2.5 percent cap also ensures that no business is significantly impacted, and in the interim allows for a limited amount of tax change. The impact of CVA with one tax rate, the impact of a 2.5 percent cap on increases (for both the first and third years of the capping option), and the impact in the first and third years of an eight-year phase-in are shown for each separate class option. The results of these options are summarized in Tables 10 - 12 in the Appendix.

 Table 10 shows the impact of CVA applied without any caps or phase-in. Table 11 shows the impact of the 2.5 percent cap in the first and third years for each of the selected separate class options. Table 12 shows the impact in year 1 and year 3 of an eight-year phase-in for each of the selected separate class options. If Council wishes to cap the tax increases, it does not make much difference which underlying tax policy option(s) is chosen. For example, by the third year under capping (i.e., 2000), retail properties with residential uses above would have increased by 7.2 percent under CVA with one tax rate, compared to 4.6 percent under Model M2 GTR.

 Although Model M2 GTR is a promising model and is recommended for further study, it should be noted that it contains a separate class for office buildings. As mentioned earlier, a separate office building class locks-in these properties at an effective tax rate that continues their uncompetitive tax status among North American cities. This dampens the competitive position of this sector, which constitutes about half of the employment base plays a crucial role in the Toronto economy.

 The benefit of capping vs. phase-in is that it provides Council with the ability to limit the impact of the effects of CVA while still proceeding with some measure of tax reform, albeit on a limited scale. The cap is an interim step towards a more detailed plan to be prepared in time for the next reassessment. In addition, the capped three-year period (1998-2000) also allows for the updating of commercial assessments, particularly for office buildings, to more accurately reflect recent rental activity in this sector. As well, the definitional problems in creating a separate strip retail class may also be resolved.

 Together the capping provisions along with the availability of all the current tax policy tools in 2001, effectively allows for the deferral of comprehensive reform of business property taxation in Toronto until the next reassessment. Consequently, Council is not locked into any long-term reform package that has not had the benefit of in-depth analysis and review. An inappropriate tax reform plan, even if phased-in over a long period, could create serious impacts and require significant remedial action(s). It is recommended that the capping provisions under Bill 16 be implemented and the other tax policy measures available for commercial and industrial property, including graduated tax rates, separate classes of property, tax rebates and phase-ins not be implemented at this time. This essentially endorses an Option 2 approach as discussed above.

 It is important to note that although the capping provisions provide Council time to prepare for the next reassessment, the cap itself reduces Council's flexibility in funding any budgetary tax increases. If this arises, capping commercial and industrial properties provides Council with an incentive over the next two years to meet zero tax increases in those years. During these three years, Council will only be permitted to fund budgetary tax increases from uncapped property classes. For example, a one percent increase in the net levy funded exclusively by the residential/farm class amounts to a 2.8 percent increase in the municipal residential/farm tax rate or a 1.8 percent increase in the total residential/farm tax rate. Budgetary tax increases could begin to reduce the comparatively higher taxes on business, and for multi-residential properties for that matter, and make business taxes in Toronto more competitive. Capping requires substantial administrative maintenance of the 1997 assessment data in order to calculate revised capped amounts. The administrative requirements of a phase-in plan are somewhat less onerous. Phase-ins require that any physical changes to the property to be updated, whereas capping requires that changes in commercial and industrial vacancies be maintained in addition to physical changes.

 Underlying Tax System:

 If Council adopts the 2.5 percent cap, the impact of the decisions involving separate classes for office buildings and graduated tax rate options becomes less significant. However, the direction of the tax changes can be influenced by any choices that Council makes, if it elects to, around separate classes and graduated tax rates. For example, a strip retail property currently taxed at a level well above most strip retail properties, but below the commercial average, might be paying 1997 taxes at six or seven percent of its 1996 value. Under capping, this property would face a tax increase of 7.5 percent over three years, if all commercial property were taxed at one tax rate. On the other hand, if a separate office building class was created and some form of graduated tax rates were implemented, this same strip retail property would experience a tax decrease over the next three years. Different tax policy options will generally yield different results from one another.

 The choices made about the underlying tax system will also send a strong signal to markets about how Council intends to set relative tax rates for each type of commercial property in the long-term. For example, should strip retail properties pay taxes in the long run at the same level as other commercial properties? While certainty in the treatment of property over the long-term is desirable, there is not sufficient time in which to completely identify or analyze the implications of the multitude of possible options. Additional time to fully examine the results of using the new provincial separate class definitions and the different tax rates applied to these types of property is necessary to implement these classes in a way that is both fair and defensible. Input from the business community on these matters can play a valuable role and is further discussed later in this report. There is also a very real risk that any hurried decisions made by Council over the next few weeks may not be sustainable in the long run, and that yet another set of changes would be necessary in the future.

 Industrial Class Tax Impacts:

 The estimated tax impacts for industrial properties based on the final assessment roll shows that there are 30 percent industrial assessment portions experiencing a decrease and 70 percent with an increase. The average tax decrease amounts to $28,675.00 or 18.9 percent while the median decrease amount is $7,696.00 or 15.1 percent. In terms of increases, the average increase is $11,527.00 or over 3,000 percent (largely due to vacant lands) and the median increase is $4,936.00 or 50.6 percent.

This section outlines the results of applying the tax policy options to industrial properties. Bill 16 introduced the option of creating additional classes within the industrial class for large industrial properties. The graduated tax rate option was extended to the industrial property class and the option of capping all tax increases at 2.5 percent per year for three years was also introduced. Details about the impact of CVA with one tax rate on industrial properties in Toronto are provided in Table 13.

 Tax Policy Options - Industrial Property:

1.Graduated Tax Rates:

 Similar to commercial property, Council can also consider using graduated tax rates to decrease the tax rate on lower valued industrial properties. The application of graduated tax rates as the only tax policy option to industrial property was tested under Model I-2 in Table 14. This model provides for the first $200,000.00 of CVA to be taxed at 7.0 percent, the next $300,000.00 (i.e., $200,000.00 to $500,000.00) taxes at 11.0 percent and any CVA over $500,000.00 taxed at 12.52 percent. However, as shown in Table 14, overall there is not a significant difference on average between the graduated tax rate option and CVA with a single tax rate. It appears that industry in residential property, industrial condominiums, industrial property valued less than $1 million and small warehouses, in particular benefit from this model.

2.Separate Classes:

 The "large industrial properties" class includes all industrial properties with gross floor area greater than 125,000 square feet. Those buildings less than this threshold remain in the residual industrial class. Model I-1 in Table 13 shows the impact of creating a separate class for large industrial properties. Since large industrial properties are taxed at an average rate that is slightly higher than the average for all industrial property, separating them into their own class reduces the tax rate on the balance of industrial properties. The tax rate on the residual industrial class does not change very much as a result of separating the large industrial properties, because the large industrial properties are a small part of the industrial tax base.

 Council can choose to maintain the full differences in tax rates among any industrial classes that it creates. For estimate purposes it has been assumed that Council will choose to maintain the differences in the tax rates among any new industrial classes. Bill 16 allows Council the option of moving the tax rate for a new separate class towards the average rate for the entire industrial class.

3.Tax Rebates:

 The results of a tax rebate program on its own are shown in Table 15. Similar to the example for commercial properties, the increase in the industrial tax rate to fund the rebate is significant. To provide assistance in the first year similar to the 2.5 percent capping option, the industrial tax rate would increase by 13.2 percent. The cost of funding the rebate and consequently the impact on the industrial tax rate decreases as the threshold for the rebate declines. It would be more appropriate to consider the rebate in conjunction with other tax tools, as is discussed below.

Implementation Options - Industrial Property:

 The impacts of the tax policy options examined for industrial property are shown in Table 16. In addition to CVA with one tax rate, Table 16 presents average tax changes for the first year of an eight-year phase-in; graduated tax rates and graduated tax rates combined with a phase-in plan; a phase-in and tax rebate plan; and the 2.5 percent capping option. The tax impacts in the third year of each of these options is presented in Table 17.

 Option 1: Phase-in of Graduated Tax Rates and Tax Rebates:

 The average tax impacts of the various options for industrial property as shown in Table 16 generally do not reflect the range of diversity demonstrated by commercial property. This would suggest that the industrial property class might not need many tax policy options to make the tax changes manageable, if a tax cap is not adopted.

 Graduated tax rates for industrial property were combined with a phase-in plan. The impact of the first year of an eight-year phase-in for the Model I-2 is shown in Table 14. A comparison of the first year of CVA with one tax rate and the first year of the graduated tax rate model overall does not show a significant difference except for industrial condominiums. Consequently, graduated tax rates combined with a phase-in plan are not recommended.

 Alternatively, tax changes could be phased-in combined with a tax rebate to industries with significant increases. The impact of funding a tax rebate program with an eight-year phase-in is not significant as shown in Table 15. The program results in a 0.6 percent increase in the industrial tax rate in the first year of the phase-in, if tax increases are capped at, for example, the 7.5 percent level. By the third year the impact would be 3.0 percent.

 However, excluding vacant land can reduce the cost of the rebate program. For example, the cost of the rebate in the third year ($10.2 million) can be cut by almost 50 percent and reduced to $5.4 million. From an economic development perspective, tax assistance to vacant industrial land, in the form of a tax rebate program has some advantages as well as some obvious disadvantages. Lowering the taxes on a vacant parcel would lower its carrying cost, make it more likely that the owner continues to hold the land. It is then more likely that, in the case of an existing firm, on-site expansion will occur rather than searching for another location, should its space requirements expand in the future.

 On the other hand, lowering taxes on vacant land will create an incentive to demolish existing industrial buildings, at times when demand for these buildings is low, as was the case only a few years ago. The former assessment system provided a similar incentive because land was effectively taxed at a much lower percent of value than were buildings, and several older industrial and in some cases office buildings were demolished primarily for tax reasons. On balance, a lower tax rate on land than on buildings should not be implemented.

 Option 2: 2.5 Percent Cap on Tax Increases:

 The mitigating impact of the 2.5 percent cap is shown in Table 14 for the first year of the three-year period. When compared with CVA, the cap ensures that tax increases are manageable. In consultation with the Economic Development Division, it is considered appropriate that the implementation of comprehensive tax reform should apply to both commercial and industrial property classes simultaneously and not to one class only, while the other is capped. Furthermore, commercial and industrial uses are inter-linked, particularly where both uses occupy the same property. Therefore, it is recommended that industrial properties be treated in the same fashion as commercial properties, and that all tax increases be capped at 2.5 percent per year for three years. As a result, it will be necessary to claw back a significant portion of the tax decreases that would have resulted from CVA. In the first year, it will be necessary to claw back 87 percent of the amount of tax decreases under CVA (i.e., 12.84 percent of decreases can be allowed), and in the third year it will be possible to allow 23.47 percent of the amount of tax decreases otherwise permitted.

 The underlying tax system for which the caps have been proposed is CVA with one tax rate. More detailed analysis is required to determine whether or not the graduated tax rate system is more equitable or better from an economic development perspective than taxing all industrial property at the same tax rate.

 The tax rate on industrial properties is much higher than on commercial properties and creates a serious equity question, which needs to be addressed. The industrial class has the highest tax rates of any property class in Toronto. The difference in tax rates between industrial uses and commercial uses (11.06 percent and 7.75 percent respectively) is of particular concern because many industrial properties contain both industrial and commercial tenants. In fact, the value of commercial uses in industrial properties is almost as large as the value of industrial uses in industrial properties. The difference in tax levels creates a powerful incentive for the owner of an industrial park or a multi-storey industrial building to lease space to commercial users rather than industrial users, because the tax advantage helps commercial uses out-bid manufacturers for industrial space. This situation creates potentially substantial negative employment and investment impacts and further hinders the competitiveness of industry in Toronto.

 This issue is further reviewed in an accompanying report which identifies the tax impacts of moving towards equity in terms of relief for the industrial class, and for that matter, the commercial class as well. The resulting tax shifts in the analysis identify the impacts on the residential/farm class which the new taxation system clearly shows is paying at a lower rate of taxation. Changes to the comparative taxation levels among the property classes are needed to ensure that Toronto remains as a competitive place for business.

Comprehensive Tax Policies:

It is difficult to attempt to make all of the complex decisions about the relative tax rates for each sub-class of commercial and industrial property in the next few weeks. Bill 16 for the 1998 taxation year, requires a municipality to decide whether it will opt any of the separate classes within 30 days following the return of the assessment roll (with a possible 30 day extension). This timeframe provides Council little time to explore the impact of all possible new classes in addition to all the other tax reform decisions required.

 Review of Model M2 GTR for the commercial property class indicates the level of detail required making the CVA tax impacts manageable. This model consists of a full package of tax options - graduated tax rates, separate classes, a phase-in and a tax rebate. Prior to the implementation of this option with all its details, additional time would be required to study the full range of its impacts. As such, its implementation is not recommended at this time.

 It is evident that the proposed 2.5 percent cap on increases is viewed as an interim solution, so that the City and the Province have time to address all of the complex tax policy issues before the next reassessment. The Province has indicated that all tax options including the ability to phase-in tax increases and decreases, create separate commercial and industrial classes and impose graduated tax rates will be available to municipalities in the next reassessment. It is proposed that a work plan be developed that would allow these tax policy options to be reviewed over the next two to three years, including the establishment of a Business Reference Group to assist in the process.

 This solution may not give as much comfort to commercial and industrial taxpayers facing large tax increases under CVA, such as strip retailers, in the short-term, as a plan that clearly sets out where Council would prefer relative taxes to be for the various sub-classes of commercial property. However, these taxpayers would at least have the comfort that the tax increases under CVA with one rate are not intended to be a long run goal of Council. The cap ensures that businesses will not be significantly impacted over the next three-years. Furthermore, tenants in commercial and industrial properties will be protected from tax increases beyond 2.5 percent. Council's adoption of the 2.5 percent cap will also make unnecessary the tax rebate mechanism for charities and similar organizations and will considerably decrease the administration and cash flow issues for these organizations.

 The 2.5 percent cap provision enables Council to begin providing relief to commercial and industrial properties by shifting budgetary tax increases on to the residential/farm class. This is consistent with the long-term goal of reducing the level of business property taxation that Council should consider as part of tax reform. The shift in taxes on to the residential/farm class will begin moving towards property class tax equity and improve the competitive position of business in Toronto, which is critical to maintaining the economic vibrancy of the Toronto economy.

 Conclusions:

 Council can implement tax reform for commercial and industrial property using either a detailed plan including some combination of graduated tax rates, separate classes, phase-ins and a tax rebate. Alternatively, Council may cap tax increases. It is recommended that all commercial and industrial property tax increases be capped, pursuant to Bill 16, at 2.5 percent of existing taxes per year for the 1998-2000 period and be funded by limiting the amount of tax decreases resulting from reassessment. No other tax policy measures are recommended for commercial and industrial property at this time, because there is not sufficient time to fully consider and make all of the necessary tax policy decisions.

 The 1998-2000 period should be viewed as an interim step for commercial and industrial properties in terms of assessment and taxation reform. It is recommended that a work plan be developed to address all of the tax policy issues that need to be considered before the next reassessment in the 2001 taxation year. The issues that need to be addressed over the next two to three years include the relative tax rates for different types of business property, consideration of separate property classes for types of commercial and industrial property, and a further review of the tax policy tools available to the City.

 Contacts:

 Peter Viducis392-1005

Ed Zamparo 392-8641

Bill Wong392-9148