Agenda Index City of Vancouver

ADMINISTRATIVE REPORT

TO: Standing Committee on Transportation and Traffic

FROM: City Manager, in consultation with Director of Legal Services, Manager of Real Estate, and the Director of Finance

SUBJECT: Provincial Government Discussion Paper Concerning the Property Classification Regulation under the Assessment Act

RECOMMENDATION

THAT Council advise the Provincial Government that:

COUNCIL POLICY

The Assessment Act and Vancouver Charter give Council the authority to levy a general purpose property tax in the City, including the authority to differentiate among classes in the establishment of property tax rates.

The British Columbia Assessment Authority is authorized to classify and to establish the actual and taxable values for all property in the Province.

PURPOSE

On January 21, 1999, the Ministry of Municipal Affairs circulated a Discussion Paper entitled "Classification of Vacant Land Zoned for Mixed-Use Developments". The purpose of this report is to provide Council with an analysis of the issues raised in the Discussion Paper and to recommend how Council might respond to it.

A copy of the Discussion Paper is attached as Appendix "A".

BACKGROUND

In 1983, the Province conferred on municipalities the power to set variable tax rates--different tax rates for different types or classes of property. In essence, local Councils were given the authority to establish how their requirements for tax revenue would be distributed among various classes of property.

Under the Assessment Act, Cabinet is given the power to create and define these classes of property. It is within the classes defined in the Prescribed Classes of Property Regulation (the "Classification Regulation") that municipalities have the power to set variable tax rates, thereby varying the property tax burden differentially based on local needs and taxation policies.

It is the current Classification Regulation that is under consideration in the Discussion Paper. The Regulation creates and defines nine classes of property based on use:

A copy of the Classification Regulation is attached as Appendix "B".

DISCUSSION

The Provincial government has circulated the Discussion Paper as part of a process to consider whether changes should be made to the Classification Regulation. This process was initiated by the government in response to recent requests made by members of the development industry.

The changes the development industry seeks would result in certain vacant land owned by developers and held for future residential development being classified as Class 1, "Residential" property rather than as Class 6 "Business & Other" property, thereby entitling it to receive more favourable tax treatment than it receives under the current classification scheme.

The main issue raised in the Discussion Paper is quite straight-forward, although the underlying issues are complex. It revolves around the following question:

More specifically the question is asked with reference to vacant land intended for mixed-use (residential and commercial) development, although the question raises issues with respect to all vacant land held for residential development.

For owners of vacant land being held for future residential development, the question is very important because in most municipalities there is a significant difference between the taxes to be paid on land classified Class 1 Residential as compared to land in other classes. For example, owners of land classified Class 6 Business & Other in Vancouver pay taxes at about 5.3 times the rate of owners of land classified Class 1 Residential. A limited survey in the Discussion Paper indicates that, in other municipalities, the differential ranges from 1.98 times (Kelowna) to 4.61 times (Coquitlam).

Class 1 Residential includes land and improvements used for residential purposes. As the Discussion Paper notes, Class 1 is ". . . essentially a class for ordinary homeowners. This class was established under the assumption that taxing authorities would impose lower tax rates on property used for the basic shelter requirements of their citizens. Properties in the business and industrial classes, on the other hand, have generally been subject to higher rates of taxation. Business has a greater ability to pay tax than households, and the nominal rate of taxation is effectively reduced because businesses can deduct property taxes from corporate income taxes." Class 1 was created to provide municipalities the ability to treat property used for basic human shelter differently for tax purposes than property in other classes. The fact that residential property tax rates throughout the province are generallylower than the rates in other classes indicates Councils generally support the preferential tax treatment of these properties.

The other class that is relevant to this issue is Class 6, Business & Other. The definition of Class 6 provides that this class ". . . shall include all land and improvements not included in Classes 1 to 5 and 7 to 9". Accordingly, Class 6 acts as a "catch-all" class. As well as including office and retail business property, it also includes all other property that does not fall within any of the other specified classes.

Another principle of classification that is important to this discussion is "split classification". The Classification Regulation provides for a "split classification" when the use to which a property is put falls within two or more classes. In these circumstances the classification is split between or among those classes proportionally in relation to the value attributed to each class. Consequently, the taxes that apply to this property are also split by class.

Although the classification system works well for property for which a use can clearly be identified, the treatment of vacant land is often problematic. As vacant land has no present use, it does not fit naturally into any of the classes and, therefore, would fall into Class 6 by default. However, as the Discussion Paper notes, this would have resulted in many small, non-commercial holdings of vacant land being taxed as business property. As the government did not intend this to happen, it enacted Section 1(c) of the Classification Regulation. Section 1(c) provides that "land having no present use and which is neither specifically zoned nor held for business, commercial, forestry or industrial purposes" is to be included in Class 1. As this provision has been interpreted by the Assessment Authority, vacant land that is zoned exclusively residential falls into Class 1 and the owner gets the benefit of Class 1 tax rates.

We are uncertain as to the rationale underlying section 1(c) of the Classification Regulation; however, it was likely to reflect the notion that vacant land, and especially small parcels intended for residential development, should also be given some preferential treatment in the tax system. The comparison with Class 1 Residential properties was, at least, convenient in that residential tax rates were expected to be the lowest among the classes.

If this was the rationale, there is now some question as to whether that is an appropriate treatment. It is unlikely, for example, that when section 1(c) of the Classification Regulation was enacted decades ago, the scale of the current major redevelopment projects underway in the City was contemplated.

While Section 1(c), as interpreted by the Assessment Authority, results in vacant land held for future residential development which is zoned exclusively residential being classified Class 1 Residential, it creates an anomaly with respect to vacant land zoned for mixed-use (residential and commercial) purposes. As noted above, unless vacant properties being heldfor residential purposes meet the requirements of Class 1, the Classification Regulation would, by default, require them to be classified Class 6. This means that vacant land zoned for more than one purpose (e.g., mixed residential and commercial) will be classified as Class 6 and taxed at a higher tax rate. In these circumstances, developers holding vacant land zoned for mixed-use pay taxes at the higher Class 6 rate on the entire development parcel while those holding land zoned exclusively for residential use pay lower Class 1 tax rates.

As a result of this classification anomaly, it is in the financial interest of developers holding vacant land for future mixed-use development to have the anticipated residential portion of the value classified in Class 1 as early as possible in the development process. Over the past two decades this issue has spawned numerous Court cases concerning the interpretation of the language used in the Classification Regulation to define Class 1. In a series of decisions, the B.C. Supreme Court and the B.C. Court of Appeal have consistently rejected arguments advanced by developers that, under the current Classification Regulation, vacant land that is held for future residential development but is not zoned exclusively for residential use, and on which no construction work has commenced, should be classified in Class 1.

In each of these cases, the Court has attempted to interpret the Classification Regulation in an effort to establish the appropriate "triggering event" in the development process that should cause the shift from Class 6 to Class 1. In the most recent decision (December 1998), the Court rejected the argument that the commencement of excavation work on such property should trigger a Class 1 classification. The judge in this case held that, before this type of property should be classified in Class 1, ". . . a tangible improvement to the land must have been made by the landowner which is most likely to be far beyond any advantage that might be gained from short-term tax sheltering of the land under s.1(a) Residential Classification".

At the present time, the Assessment Authority (based on its interpretation of the judicial decisions interpreting the Classification Regulation) treats the construction of an assessable improvement (e.g., a poured foundation) as the "triggering event" to move the residential portion of the land with mixed-use zoning from Class 6 to Class 1.

The Discussion Paper indicates that members of the development industry argue that the "triggering event" should be much earlier in the development process. With respect to future mixed-use developments, developers argue that as soon as there is some type of "commitment" (e.g., an ODP or zoning) to develop land with a certain mix of uses, classification should be based on that anticipated future mix (by application of the "split classification" provision in the Classification Regulation).

In support of their position, developers advance a number of arguments. In particular, they argue that the current Classification Regulation discourages mixed-use development by forcing property owners of land zoned for mixed-use to pay property taxes at the Class 6 rateon the entire development. The Assessment Authority classifies vacant land held for future residential development which is zoned exclusively residential in Class 1. However, vacant land with mixed-use zoning is classified in Class 6 until there is an assessable improvement on the property. The higher tax rate imposed on Class 6 property results in higher holding costs in relation to land held for mixed-use (as opposed to exclusively residential) development, which could discourage this type of development.

There has been much debate about the impact of holding costs, including property tax, on the ultimate cost of housing. Developers argue that if taxes are kept low, the consumer benefits from lower housing costs. However, there is no proof of this argument. Developers are in business to maximize their profits--not to provide reasonably priced housing. They will take advantage of lower input costs to increase that profit in the final price if the market will allow it. In an up market where demand exceeds supply, all costs including taxes can usually be passed through to the purchaser by raising the residential sale price. In a flat or a down market where supply exceeds demand and the end price cannot be raised for competitive reasons, the developer or the original land owner will absorb the additional cost in reduced profit or lower land cost. In the long run, additional holding costs will be reflected in the vacant land value because the amount a developer will pay for land is a residual after all costs and profit are calculated. A good example is Downtown South, where the introduction of the $6.00 DCL immediately reduced the vacant land price by $6.00 a buildable square foot.

It is also noted in the Discussion Paper that arguments can be made for moving the "triggering event" for reclassifying land from Class 6 to Class 1 to a point much later in the development process. In the most recent Court case considering this issue, one municipality took the position that the residential portion of property zoned for future mixed-use development should not move from Class 6 to Class 1 until there is actual residential occupancy. The underlying rationale for this position is that the justification for the beneficial tax treatment accorded to property in Class 1 is that this property is used for basic shelter requirements. To give the same beneficial tax treatment to land held by developers for their business purposes (i.e., to profit from its future development) would be inconsistent with this underlying rationale.

It is difficult, however, to argue with the point made by developers of mixed-use developments with a residential component. Compared to those developing an exclusively residential development on residentially zoned land, they do pay higher taxes under the current Classification Regulation. The issue is whether the solution they propose -- a change to the Classification Regulation to provide that the residential component of their mixed-used developments be classified Class 1 Residential very early in the development process--makes sense from a policy perspective. This is really the issue that the Discussion Paper seeks input on.

THE VANCOUVER SITUATION

This issue is important in relation to the tax rate imposed on land held for mixed-use development and in relation to the overall allocation of the tax burden among all property owners in Vancouver. This is because there are a variety of properties in Vancouver that are caught in this situation, including, but not restricted to, most of the major redevelopment projects now underway in the City. This would include vacant parcels in:

In addition there are various single and assembled lots throughout the City and many potential sites that could fall into this category in the future. In every case, the developer is holding vacant land that is zoned for mixed-use (residential and commercial) that is classified in Class 6. In some cases, this property may even be adjacent to vacant property zoned exclusively for residential use which is classified and taxed in Class 1. Under the Assessment Authority's interpretation of the current Classification Regulation, this disparity will continue until the developer of the mixed-use property develops an "assessable improvement" on the site at which time the residential portion will be reclassified and taxed as Class 1.

For much of the property identified above, the shift of residential value to Class 1 is inevitable. Once there is an assessable improvement on the property, the shift occurs. For example, the 1999 Assessment Roll, includes a shift of $32.0 million in land value in the Concord and Collingwood Village developments from Class 6 to Class 1 as a result of the developer meeting the assessable improvement test. The impact of that shift is demonstrated below:

Shift of $32.0 million in Land Value from Class 1 to Class 6:

   

Municipal Levy

Other Levies

Total

1998 Taxes in Class 6

  

$464,214

$388,220

$852,434

1998 Taxes in Class 1

  

$86,309

$100,670

$186,979

Change in the Tax Levy

  

$(377,905)

$(278,550)

($656,455)

This "loss" of tax revenue does not reduce overall taxation requirements of the City, so it must be made up by increasing tax rates for all property classes. Staff have not attempted to determine the impact if all of the property currently caught up in this situation was to be reclassified, but it is clear that there would be a significant one-time shift of assessed value from Class 6 to Class 1 that would impact on taxation levels in the City. However, while the change requested by the developers would have a financial impact on the City, this is not the basis on which Council should make a decision that involves equity in the taxation system.

THE DISCUSSION PAPER OPTIONS

There are several possible options available to deal with the anomaly in the classification system. The Discussion Paper introduces three possibilities and staff propose to introduce a fourth.

1. Maintain the Status Quo
2. Move the "triggering event" for the class change earlier in the development process (the developers' proposal).
3. Move the "triggering event" for the class change later it the development process (the position argued by a municipality in a recent Court case).

The issue of when vacant land held for future residential development should be classified as Class 1 Residential really hinges on the purpose for the creation of the class itself. As noted above, the Discussion Paper suggests that the reason for creating the Residential class was to provide a way for municipal Councils to deal differently with ordinary homeowners providing basic human shelter and paying property with after tax dollars. And as taxes on rental properties are paid by tenants through rents with after tax dollars, the argument is easily extended to multi-unit residential buildings and suites.

As noted in the Discussions Paper, a fundamental principle of the classification system is that properties alike in terms of ownership and attributes should be assessed and ultimately taxed in a similar manner. With this in mind, we asked the question:

As developers do not "occupy" the land for the purposes of human shelter and as they are able to write off all of the costs of holding the land including property taxes, it could easily be argued that the answer to this question is "Never". On that basis, it is difficult torationalize the inclusion in Class 1 at any point in the development process of land held by developers for residential development. And this conclusion applies not only to mixed-use developments but also to any residential development.

This conclusion may not be inconsistent with the wording of Section 1(c) of the Classification Regulation which specifies that Class 1 includes "land having no present use and which is neither specifically zoned nor held for business, commercial, forestry or industrial purposes." Comments made in a recent Court decision suggest that no vacant land, whatever its zoning, that is held for future residential development should be classified in Class 1. It could be argued that, whatever its current zoning, such land is held for a business purpose (i.e., the business of developing residential property for profit) and therefore does not come within section 1(c) of the existing Classification Regulation.

As a result of these considerations, it is recommended that Council take the following position on the question raised in the Discussion Paper:

· No change should be made to the Classification Regulation that would result in the reclassification of the residential portion of land held for future mixed-use development from Class 6 to Class 1 at any point in the development process.

· The City would support changes to the existing classification scheme that would ensure that all vacant land being held for future residential development, whatever its current zoning, be treated the same. Under the existing Classification Regulation, all such land should be classified in Class 6.

Although this recommendation will not fulfill the hopes of the development industry it does have the advantage of creating a level playing field between developers of mixed-use developments and those developing land zoned exclusively for residential uses. It also maintains an appropriate distinction between residential property owners and those in the business of developing property for profit.

Such a change could also have significant impacts on the taxation of vacant residential land since it would, by definition, extend to all vacant residential land, including land owned by many smaller companies which buy residential property and build residential accommodation for sale. However, the only difference between small and large developers is one of scale. Each has the same ability to write off the holding costs of property against the profit on the ultimate sale to an ordinary homeowner. Moreover, even the owner of a vacant single family lot not used as their principle residence can claim all taxes paid as an expense when calculating capital gains payable on sale of the lot.

The implementation of this approach to classification might also impact on how and when residentially zoned land is developed. The ability to "shelter" vacant residentially zoned land held for future development in Class 1 may, in some circumstances, actually discourage its development. For example, faced with classification (and taxation) as a Class 6 property, the owner of the large vacant lot at 8th and Sasamat might have been encouraged to develop the property more quickly rather than leaving it vacant for close to a century.

TAXATION OF VACANT LAND: A POSSIBLE ALTERNATIVE

There is one further comment that might be made on the classification of vacant land that follows from the arguments of developers. That relates to the equity issue of having vacant land taxed at rates that are the same as improved property. In its simplest form, the argument is that vacant land does not attract the same level of service from the municipality as does improved property. As there are no occupants, there is less demand on fire or police service and on sewer, water or streets infrastructure and no one to utilize parks and recreation services. Developers of large properties might also argue that they are often required to provide basic infrastructure and amenities in addition to paying property taxes.

Although this issue is not addressed in the current Discussion Paper, should there be a desire to treat vacant land differently than the treatment it now receives in Class 6, one option would be to create a separate class of property for vacant land. This would leave municipal Councils to determine the level of taxation that should apply based on local needs. However, we would expect that the result of those considerations would be a higher level of taxation on this property than residential property used for basic shelter on which taxes are paid with after tax dollars.

While this step would provide a possible alternative to the treatment of vacant land recommended in this report, no changes to the Classification Regulations should be made in this direction without further study involving municipalities. Accordingly, it is recommended that Council take this further position in relation the question raised in the Discussion Paper:

· Should the Provincial government wish to pursue a change in the Classification Regulation by the creation of a new class for all vacant land, whatever its zoning, held for future residential or mixed-use development, it should initiate discussion with municipalities about this issue.

CONCLUSION

The development industry has requested that the Provincial Government amend the Classification Regulation to move the "triggering event" which causes the anticipated residential portion of vacant land held for future mixed-use development to shift from Class6 to Class 1 for taxation purposes. Currently that "event" is the development of an assessable improvement on the site. Developers propose that the "event" be moved to the point at which an elected Council declares its intentions for the land--likely the Official Development Plan or zoning stage of the development.

Staff have reviewed this proposal and recommend that Council oppose this change on the basis that property developers holding land for the business of development for profit should not be classified with ordinary occupiers using the residential improvements for basic shelter and paying property taxes with after tax dollars.

At the same time, staff acknowledge that there is a disparity between the treatment of developers of mixed-use developments and developers of wholly residential parcels in that the latter receive the benefit of the Class 1 Residential classification with its lower tax rates. However, the solution to that disparity is not to classify the anticipated residential portion of vacant land held for future mixed-use development in Class 1, but to classify all vacant land held for future residential development, whatever its zoning, in Class 6.

NOTE FROM CLERK: ELECTRONIC COPIES OF APPENDICES A-B NOT AVAILABLE - ON FILE IN THE OFFICE OF THE CITY CLERK.

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