State aid — United Kingdom — State aid No C 4/2005 (ex NN 57/2004) — Property Tax on Telecommunications Infrastructure — Invitation to submit comments pursuant to Article 88(2) of the EC TreatyText with EEA relevance
Date: 2005-03-12
Institutions: European Commission
Subjects: State aid, United Kingdom, control of State aid, infringement procedure (EU), property tax, tax relief, telecommunications industry

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Official Journal of the European Union

12.3.2005

STATE AID — UNITED KINGDOM

State aid No C 4/2005 (ex NN 57/2004)

Property Tax on Telecommunications Infrastructure

Invitation to submit comments pursuant to Article 88(2) of the EC Treaty

(2005/C 62/08)

(Text with EEA relevance)

By means of the letter dated 19 January 2005 reproduced in the authentic language on the pages following
this summary, the Commission notified the United Kingdom of its decision to initiate the procedure laid
down in Article 88(2) of the EC Treaty concerning the abovementioned aid.

Interested parties may submit their comments on the measure in respect of which the Commission is initi-
ating the procedure within one month of the date of publication of this summary and the following letter,
to:

European Commission
Directorate-General for Competition
State-Aid Registry
B-1049 Brussels
Fax (32-2) 296 12 42

These comments will be communicated to the United Kingdom. Confidential treatment of the identity of
the interested party submitting the comments may be requested in writing, stating the reasons for the
request.

TEXT OF SUMMARY

Assessment

Procedure

In February 2004 Vtesse Networks Ltd, a UK telecommunica-
tions operator, filed a complaint concerning alleged State aid in
form of a preferential
in favour of British
tax treatment
Telecom Plc (‘BT’), the incumbent telecommunications operator.
Based on this complaint, the Commission requested informa-
tion from the UK authorities and received an answer in April
2004.

Description of
Commission is initiating the procedure

the measure in respect of which the

including telecommunications

The measure concerns a UK property tax levied on business
property,
infrastructure. The
primary regulation governing this tax regime in England and
Wales is the Local Government Finance Act 1988. It foresees a
valuation to determine the value of the assets, which forms the
tax base to which a tax rate is applied to calculate the tax liabi-
lity. The tax rate is set annually and is the same for all telecom-
munication operators. However, the tax base for each operator
is determined by the Valuation Office Agency (‘VOA’), an
the central government, by applying
execution agency of
various valuation methods with a possibility to appeal. The
VOA applies a certain asset valuation method to BT and King-
ston Communication (the incumbent in the region of Hull),
while applies another method to the complainant and other
competitive telecommunications providers. The application of
various methods seems to produce a different and dispropor-
tionate tax burden among companies competing in the tele-
communications market.

According to the Commission's notice on the application of the
State aid rules to measures relating to direct business taxation
(OJ C 384/3-9 of 10.12.1998), tax benefits restricted to certain
types of undertakings, insofar as they favour certain undertak-
ings or the production of certain goods, may constitute State
aid. A reduction in the tax base, and consequently the level of
taxation, that BT and Kingston are liable for, confers a selective
advantage upon these undertakings in that it reduces the costs
that they would normally bear in the course of their business.
The UK telecommunications market has been opened to
competition and hence the advantages granted to BT and King-
ston Communications are capable of distorting competition
and having an effect on trade. It seems that the conditions for
qualifying the measure as State aid under Article 87(1) EC are
met.

Therefore, at the present stage of the procedure the Commis-
sion has come to the conclusion that the UK authorities may
have granted State aid to BT and Kingston Communications
within the meaning of Article 87(1) EC. While the presence of
aid may be ruled out where the differential treatment is justified
by the nature and general scheme of the system, in this case
the Commission doubts that this could be justified based on
the intrinsic features and inherent logic of the tax system.

The derogations provided in Article 87(2) and (3) EC do not
seem to apply. Considering its doubts on the compatibility of
the aid with regards to the EC Treaty, the Commission has
decided to initiate the formal investigation procedure based on
Article 88(2) of the EC Treaty. In accordance with Article 14 of
Council Regulation (EC) No 659/1999, all unlawful aid can be
subject to recovery from the recipient.

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Official Journal of the European Union

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TEXT OF LETTER

(“LGFA”) 1988 (3).
instruments govern the implementation of the system.

In addition, a number of statutory

‘1. The Commission wishes to inform the United Kingdom
that, having examined the information supplied by your
authorities in relation to the measure referred to above, it
has decided to initiate the procedure laid down in Article
88(2) of the EC Treaty.

1. PROCEDURE

2. On 17 February 2004 (A/31115) the Commission regis-
tered a complaint from Vtesse Networks Ltd (“Vtesse”), a
concerning alleged
UK telecommunications operator,
preferential tax treatment in favour of British Telecom plc
(“BT”), the incumbent telecommunications operator. Addi-
tional information was received from the complainant on
23 March 2004, 29 March 2004, 30 March 2004, 30
June 2004, 1 July 2004, 27 July 2004 and 11 October
2004. A meeting with the complainant was held on 30
June 2004 to further clarify the technical details of the
information submitted.

3. The Commission also received on 28 April 2004 (A/
33044) a letter from the UK Competitive Telecommunica-
tions Association (“UKCTA”), a trade association repre-
fixed-line telecommunications
senting the interests of
companies competing with BT, substantiating some of the
issues brought forward by the complaint.

4. On 16 March 2004 (D/51920) the Commission sent a
request for information to the UK, which was answered
on 23 April 2004 (A/32924). The UK authorities
submitted additional
information on 11 October 2004
(A/37753).

5. Finally,

the Commission has received letters dated 19
November 2004 (A/38972) and 30 November 2004 (A/
39285) from BT submitting their views on the issue.

2. BACKGROUND

2.1. Rating system

6. “Business rates” are a UK property tax levied on non-
domestic property (1). Its aim is to contribute towards the
cost of services provided by Local Authorities (2). The
primary regulation on non-domestic rating in England
Finance Act
the Local Government
and Wales

is

(1) Property used for business as opposed to residential purposes.
(2) “Business Rates — An Introduction”, Valuation Office Agency.

7. Most properties are entered on so-called “Local Rating
Lists”, i.e. the rating lists of the authorities in whose terri-
tory the properties are located. However, since properties
such as telecommunications infrastructure extend beyond
the boundaries of a single local authority, their valuations
are typically entered on the so-called “Central Rating List”,
which exists for England and Wales (4). The rate payments
made are then redistributed to the local authorities in
proportion to their populations.

8. The tax rate,

the so called “multiplier”, which applies
equally to all business properties, is determined annually
by the Secretary of State (5) and applies equally to all
operators. It was set at 44,4 % of the rateable heredita-
ment (6) for the fiscal year 2003/4 (7).

9. The base of this tax, the so called “rateable values” in
England and Wales, are determined by the Valuation
Office Agency (“VOA”), an executive agency of the Inland
Revenue, part of central government (8). The VOA is
responsible for valuing the assets and including them on
the “Rating Lists”. Revaluations are held every five years,
so the rateable values determined on 1 April 1998 (so
called “antecedent valuation date”) apply to the current five
year period of 2000-05. Valuations completed on 1 April
2003 will apply for the next period of 2005-10 (9).

10. The property unit as valued for rating purposes is called
the “rateable hereditament” and includes land, buildings and
rateable plant and machinery (10). Liability for the rates
falls on the person in occupation of the rateable heredita-
ment, i.e. the person who is in “paramount control” of the
assets. According to the VOA, there has to be an actual,
exclusive and non transient occupation, which brings
commercial benefits to the occupier (11). According to the
complainant, in relation to rateable occupation of build-
ings, which constitute the majority of UK rateable heredi-
taments, the test is “he who turns on the lights pays the
rates”.

(3) Local government finance in the UK is a devolved matter. The UK
Government is therefore only responsible for the rating system in
England. Rates in Wales, Scotland and Northern Ireland are the
responsibility of the Devolved Administrations. Pre-devolution legis-
lation largely applies in England and Wales, where the system is
very similar. Therefore the description primarily covers the situation
that exists there. However,
the situation in Scotland is broadly
similar.

(4) For telecommunications properties that are entered on Local Rating
Lists, this is done in the area where it is considered by the VOA that
the greatest proportion of rateable value resides.

(5) Except in a revaluation year, the multiplier can not increase by
more than the rate of increase of the Retail Price Index, South
Oxford Council, www.southoxon.gov.uk

(6) The multiplier in percent was 43,2 1995/6, 44,9 1996/97, 45,8
1997/98, 47,4 1998/99, 48,9 1999/00, 41,6 2000/1, 43,0
2001/02, 43,7 2002/03, 44,4 2003/04, 45,6 2004/5.

(7) UK fiscal year 2003/4 covers the period 1 April 2003 — 31 March

2004.

(8) www.voa.gov.uk
(9) Economic circumstances are taken as at the “antecedent valuation
date”, while physical factors are taken as at the date of completing
the rating list.

(10) Schedule 6 of the Local Government Finance Act on valuation of

non-domestic hereditament, www.hmso.gov.uk

(11) Four tests of occupancy as established in John Laing and Son, Ltd.
V. Kingswood Assessment Committee and Others [1948] 2 KB
116.

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2.2. Rating of telecommunications

that

plant

2000 (12)

11. Business rates are also levied on telecommunications
and Machinery Regulation
infrastructure. The Plant
and
stipulates
(“Regulation”)
machinery that are rateable for telecommunications infra-
structure are “cables, fibres, wires, conductors or any system of
such items, or any part of such items or such system, used or
intended to be used in connection with the transmission of
communications signals, and which are considered in the equip-
ment of and are situated within premises” (13). Plants and
machinery not specifically described in the Regulation,
such as for example telecommunications switching and
transmission equipment, are not rateable (14).

12. Telecommunications property has been subject to busi-
ness rates since 1855 when telegraph poles on railways
were deemed to be liable for rates (15), to be followed in
1969 by the telephones belonging to the Post Office
(“PO”) (16). Following the split-up of the PO and the priva-
tisation of BT in 1984, this tax was also levied on the
latter's infrastructure, as well as on that of Mercury
Communications (17), BT's only competitor during the
duopoly situation of the 1980s. Initially, the tax amount
payable was determined by applying a prescribed “stand-
ard formula” (18).

13. When the telecommunications industry was gradually
opened up to competition starting in 1992, the tax was
levied on all telecommunications infrastructure, including
that belonging to cable television companies, public utili-
ties and other competitive providers entering the telecom
market. The LGFA 1988 laid down the legal basis of the
system, which foresaw a valuation of rateable heredita-
ment, with a possibility to appeal, to determine the base
of the business rates tax (19).

14. As new technological solutions appeared, those too were
submitted to the business rates tax regime. For instance,
fibre optic long distance and metropolitan area networks
were added in the late 1990s (20). Fibre optic services
involve three different levels of assets: (i) the duct, (ii) the
is the current
“dark”

fibre and (iii)

the “lit”

fibre.

It

(12) Statutory Instrument 2000/540 , Valuation for Rating (Plant and
(England) Regulations 2000 N.540, Class 3 (4),

Machinery)
www.hmso.gov.uk

(13) The main provisions apply to cables, fibres and wires that are
outside the building, with those inside excluded from rateability.
(14) Brief Overview of the Telecoms Rating System for the purposes of
the Broadband Stakeholders Group, Alan Roy Bradford CEO/VOA,
9 June 2003

(15) Electric Telegraph Co v Salford Overseers, op. cit. footnote 14.
(16) Most of the independent telecom companies were acquired by the
General Post Office around 1912, except what is now Kingston
Communications, which remained in the control of
the local
government in Hull.

(17) Later renamed Cable &Wireless, which since has been divided into

Cable & Wireless UK and ntl. See also supra paragraph 28.

(18) Telecommunications Cable Networks Rating Review, presentation
by Alan Roy Bradford, Valuation Office Agency, 25 June 2004.
(19) The LGFA came into force in 1990, but assets were still valued
using the prescribed formulae during 1990-95 since, allegedly,
given the tight time frame the valuations could not be ready for
this five year valuation period.

(20) Op. cit. footnote 14.

policy of the VOA to only rate fibres from when they are
lit and carry traffic. Ducts are rateable items, but only
when used or intended to be used in connection with
fibres, wires and cables. Consequently, empty ducts and
dark (unlit) fibres are not rated.

2.3. Valuation

15. The LGFA 1988 laid down the legal basis of the system to
be applied in the new market environment. Schedule 6 of
the Act foresees a valuation of rateable hereditament to
determine the base of the business rates tax. The objective
of the valuation is to make a proportionate assessment of
the annual rental value for a property if it is available on
the market (21).
the
objective is to calculate the amount a hypothetical tenant
would pay in rent to a hypothetical landlord for the actual
hereditament.

If rental evidence is not available,

16. Since a specific method for valuing telecommunications
networks is not prescribed, the VOA has a choice of four
methods for calculating the “rateable value” of assets.
According to the VOA, there is an accepted hierarchy
between the possible methods depending on the indivi-
dual circumstances and the evidence available:

(a) First, if there is rental evidence of the property then
i.e. the price at

the “Rental” method is to be used,
which the property is let.

(b) Second,

if direct rental evidence is not available, a
comparison with the rental evidence of other compar-
able properties can be made. This method is called
“Tone of the List”, basically referring to a benchmarking
exercise.

(c) Third, a “Receipts and Expenditure” (“R&E”) method is to
be applied for properties which are seldom let, typi-
cally utilities.
It calculates the hypothetical annual
rental value by examining the receipts and expendi-
tures to arrive at a net profit, the so called “divisible
balance”. The
is determined by
deducting the return required by a tenant on his
capital (“tenant's share”) from the divisible balance to
arrive at the hypothetical rent (“landlord's share”) (22).

rateable

value

(d) Fourth, one can resort

to the “Contractor's Basis”
method. This method arrives at the rental value by
estimating the decapitalised (23) costs of constructing a
similar hereditament adjusted for age and obsoles-
cence, by looking at the cost of the capital which
would need to be raised to finance the build-out, i.e.
the interest that one would need to pay for a loan or
the foregone interest if one's own capital is used (24).

(21) Assuming the tenant undertook to pay the usual tenant's share and
to bear the costs of the repairs and insurance and other expenses
(if any) necessary to maintain the hereditament
in a state to
command rent.

(22) The Receipts and Expenditure Method of Valuation of Non-

Domestic Properties, A Guidance Note, RICS Books.
(23) At the statutory rate of 5,5 % for the 2000 Rating List.
(24) The Contractor's Basis of Valuation for Rating Purposes, a Guidance

Note, RICS Books.

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3. DESCRIPTION OF THE MEASURE

3.1. British Telecommunications

Valuations

17. 1995-2000 period: The VOA applied the “Receipts and
Expenditure” method to BT. Accordingly, BT's tax liability
for the period of 1995-2000 was determined by a valua-
tion based on the “R&E” method undertaken by the VOA,
as subsequently adjusted following a negotiated settlement
with BT who appealed against the original valuation at
the Central London Valuation Tribunal, which is a tech-
nical tribunal. The case was also due to be heard by the
Lands Tribunal, a UK court, when BT and the VOA
reached a settlement.

18. The detailed inputs into the economic model forming the
basis of the original valuation by the VOA using the
“R&E” method and the content of the subsequent adjust-
ments made following the negotiations with BT (who
have constructed their own model based on the “Contrac-
tor's basis” method) are at this stage not available to the
Commission and their transmission necessitates, according
to the UK authorities, BT's consent. The outcome was an
agreement between the VOA and BT, which set the rate-
able value of BT's assets at GBP 470 million for the fiscal
year 1995/96 (25). Applying the 1995/96 multiplier of
43,2 % to this rateable value, BT's tax liability is estimated
to equal about GBP 203 million for this period, which
represented approximately 2 % of BT's relevant annual
revenues (26).

19. 2000-2005 period: For the 2000 revaluation, applicable
for the period of 2000-2005, the VOA settled BT's asset
valuation at GBP 493 million (27). The 2000 value was
based on the principles and values agreed at the same
time the 1995 list agreement was concluded (28).

Revisions

20. In principle, a review of the system only takes place every
five years. According to the UK authorities, when
applying the “R&E” method to BT, economic modelling
was used to estimate the prospects of changes to the level
of receipts over a period of five years, and an “equated”
level of receipts and expenditure was estimated as being
representative of the five year period. This increased the
level of certainty regarding BT's tax liabilities, as high-
lighted by the fact that the 1995 valuation also served as
a basis for determining the 2000 values and as such
conferred a de facto 10 year certainty upon BT.

(25) GBP 445 million for England and GBP 25 million for Wales.
(26) Based on Total Receipts of about GBP 10,199 million as stated in
the 1995 Central Rating List Assessment for BT, CVO Analysis of
Agreed Rateable Value, Equated Figures.

(27) GBP 467 million for England and GBP 26 million for Wales.
(28) Apparently BT's current list valuation, with effect from 1 April
2003, is about GBP 472 million (GBP 447,5 million for England
and GBP 24,9 million for Wales) but appeals are outstanding. It is
unclear to the Commission whether this is the case, and if it is the
case, why there has been a new valuation in April 2003 resulting
in lower rateable values than those determined in the 2000 valua-
tion.

21. Moreover,

subsequent downward revisions have been
made to the 1995 valuation, to reflect the loss of market
share of the company in the UK fixed telecommunications
market resulting from the physical roll-out of competing
telecommunications systems. In practice, these revisions
meant for instance a decrease of an estimated 22 % in the
value of the rateable hereditament in 1999/00 compared
to 1995/96, resulting in a reduction in BT's tax liability
over the same period. According to the authorities, such
revisions are in line with the LGFA 1988 provisions
which allow alterations to reflect changes in the physical
state and enjoyment of the network (29). To the Commis-
sion's knowledge, no similar upward adjustment has been
made to reflect possible extensions or upgrades of the
network.

3.2. Kingston Communications

22. Kingston Communications (Hull) plc is the incumbent
telecommunications operator in the region of Hull (30).
telecommunications
During the privatisation of
networks in the UK in the late 1980s, the network in Hull
remained State owned and the property of the munici-
pality. Part of it was then sold to the public in 1999 with
the Hull City Council remaining the only substantial
single shareholder (31).

the

23. The Commission has at this stage no information about
the results of its valuation and hence the taxes it has been
liable for. However, according to the UK authorities, the
only other operator valued by the full “R&E” method since
1995 is Kingston Communications in Hull.

3.3. Vtesse

Valuations

24. Vtesse is a “fibre to the business” service provider offering
high-capacity retail
leased lines, currently ranging from
25Mbits/s to 32Mbits/s, mainly supplied to large corpo-
rate users.

25. According to Vtesse, these products de facto compete
with BT's 10Mbits/s and above leased line offers. In order
to connect its customers, Vtesse leases “dark” fibre from
other backbone operators and complements this with
their own built infrastructure. The property rented, i.e. the
dark fibre, which is then lit, is included in the “rateable
hereditament” of Vtesse. The VOA has decided to rate
Vtesse based on the “Tone of the List” method which estab-
lishes the “rateable value” of a kilometre of fibre route
(consisting of a fibre pair), which is then applied each
time new fibre is rented and lit. This is the method gener-
ally used for other competitive providers as well.

(29) Paragraph 2(7) of Schedule 6 to the Local Government Finance Act
1988 allows for alterations to be made to a Rateable List still in
force in certain cases, for instance in the case of matters affecting
“the physical state or physical enjoyment of the hereditament” or
“the mode or category of occupation of the hereditament”.

(30) Since 1998 it also provides services to business customers in East
is present on the market as an alternative

Yorkshire where it
provider.

(31) Espicom Business Intelligence: UK Telecommunications Market,

09/2003.

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26. Based on benchmarks of actual rates paid, the VOA has
set the tone rate for one kilometre route of fibre at GBP
1,200/km for the London metropolitan area and GBP
1,000/km in other parts of the country. In addition, in
2001 a so called “oversupply allowance” was granted by
the VOA to fibre providers assessed by the “Tone of the
list” method (32) equalling a 15 % discount on the rateable
value effective as of 1 April 2001 and 25 % as of 1 April
2002 (33). According to the complainant, this was a one-
off measure taking into account the chronic over-invest-
ment in fibre during the telecommunications boom and
the subsequent drastic reduction in value of telecommuni-
cations networks. Accordingly, Vtesse's tax liability was
around 7 % of its recurring revenues in 2003/04, and is
expected to be about 10 % for 2004/05 (34). According to
UKCTA, business rates paid by other competitive provi-
ders represent a similar percentage of their revenues to
that of Vtesse.

Revisions

27. While the tone rate is set at the beginning of the five year
period, the tone of a kilometre route of fibre is applied
each time new fibre is rented and lit. Vtesse has the obli-
gation to regularly inform the VOA of extension to its
network so that the valuation of its hereditament can be
adjusted. As a consequence, whenever it procures fibre to
provide services to its customers, it is liable for rates that
may equal up to 20-30 % of the recurring revenues of a
new contract.

3.4. Other operators

28. Mercury Communications

(later Cable and Wireless,
“C&W”) was the first company to establish a nationwide
telecommunications infrastructure to rival BT in the early
1980s, during the so called duopoly period. In May 2000,
C&W was divided into two businesses: the residential tele-
phony, cable and internet access part was sold to cable TV
operator ntl, while C&W retained the UK corporate
internet access business and was renamed C&W UK. With
the full liberalisation of the market in the 1990s, C&W
UK became an alternative telecoms provider competing
with several other players in the market (35). Originally
C&W was valued just like BT by a prescribed formulae.
However, it is unclear for the Commission which valua-
tion method is currently used for C&W UK.

(32) BT and Kingston Communications in Hull do not benefit from this
allowance, since it is only applied to those assessed by the “Tone of
the List” method.

(33) Letter from VOA to Complainant, 11 March 2004.
(34) Recurring revenues include service revenues but exclude installation
revenues. Given that Vtesse's operations only started in 2002, such
distinction seems reasonable to allow for comparison with BT. Esti-
mate for fiscal year 2004/05 is based on three quarter figures.

(35) Op. cit. footnote 31.

29. Regarding other operators active on the UK market, it is
the Commission's understanding that
they are valued
based on the “Rental” or the “Tone of the List” method (36).
According to UKCTA, alternative telecoms operators typi-
cally pay two or three times the tax, expressed as a
percentage of revenues, than BT. However, the Commis-
sion currently is not
exact data
concerning business
tax liabilities and relevant
revenues of alternative telecommunications operators.

in possession of

rates

4. COMPLAINT AND COMMENTS

30. The complainant has raised the following specific claims

and concerns:

(a) Choice of methods:

If BT was valued using the
“Rental” or “Tone of the List” methods as is used for
Vtesse,
it would end-up with a substantially higher
and more proportionate tax liability. It questions why
the “Rental” or “Tone of the List” methods are not used
for BT.

(b) Adjustments: In any case, the various methods should
in principle yield similar results if appropriate adjust-
ments were made. The complainant doubts whether
such adjustments are made in the process of BT's
valuations, given the different results.

(c) Downward revisions: There is no downward revision
in the valuation of competitors similar to that foreseen
for BT to account for their eventual
loss of market
share or change in network topology.

(d) Upward revisions: There does not seem to be a
systematic upward revision of BT's valuation either,
should the value of its assets increase. At the same
time, Vtesse is charged incrementally, which causes an
increase in the recurring price it can offer to its custo-
mers, whenever it leases new fibre, and lights this
fibre to serve them. The complainant claims to have
lost several contracts to BT by a small margin due to
the incremental tax burden it is obliged to include in
its price bid versus BT who has no such incremental
burden.

(e) Discretionary powers: The rating values and the
valuation methods can be appealed, subject to time
limits. Once an appeal has been made, typically nego-
tiations are held to agree on an appropriate value. If
no agreement is reached, it is referred to the relevant
Valuation Tribunal, and at a second stage to the Lands
Tribunal for determination. However, in most cases a
negotiated settlement
is reached. According to the
complainant, the settlement signed with BT in 1995
gives the incumbent preferential treatment.

(36) Except the cable TV companies, which according to the knowledge
of the Commission, are valued using a different method (based on
“homes passed”) than the four described in this decision to open
the formal investigative procedure.

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31. It should be noted that UKCTA (37), representing various
competitive telecom operators, as well as other operators'
groupings, (38) have also expressed criticism to the UK
authorities concerning, among others:

— the inappropriateness of applying a rating system,
which was originally designed to assess buildings, to
telecommunications infrastructure, including its infre-
quent revisions;

— the asymmetry of

in which different
the valuation,
methods are applied to operators involved in the same
activity,
i.e. delivering telecom services, with special
regard to the distinct treatment of the incumbents;

— the disproportionate results yielded by the use of such
differential methods, i.e. BT is estimated to pay about
2-4 % of revenues (39), while its competitors typically
pay several times this proportion.

32. In response to the concerns of

the industry,

the UK
Department of Trade and Industry, in association with the
Office of the Prime Minister, OFCOM (the sector regu-
lator) and the VOA, has appointed a contractor to review
the rating system as it applies to telecommunications
companies, including possible effects on competition. The
expert was due to report back during the summer of
2004. However, according to the UK authorities, due to
last minute unforeseen circumstances, this report has not
yet been completed and could not be published.

5. ASSESSMENT

5.1. Existence of aid

33. According to Article 87(1) of the EC Treaty any State aid
granted by a Member State or through State resources in
any form whatsoever which distorts competition or threa-
tens to distort competition by favouring certain undertak-
ings or the production of certain goods shall, in so far as
it affects trade between Member States, be incompatible
with the common market. According to the Commission's
notice on the application of
the State aid rules to
measures relating to direct business taxation, tax benefits
restricted to certain types of undertakings, insofar as they
favour certain undertakings or the production of certain
goods, may constitute State aid (40).

(37) UKCTA submission of 23 October 2003 to the Hearing on Broad-
band by the Trade and Industry Sub-Committee appointed by the
House of Commons.

(38) Effect of Property Rating on Competition in the Market for Fixed
Line Telecommunications Services in the UK: Proposed options for
the future, paper drafted by alternative telecommunications provi-
ders, 12 July 2002.

(39) 4 % estimated for England based on 2001 revenues, op. cit. foot-

note 38.

(40) OJ C 384, 10.12.1998, p. 3-9.

State resources

34. In applying Community rules, State resources can be in
“any form whatsoever”, including tax measures such as a
reduction in the tax base. If and when there is a reduction
in a tax burden compared to the general system, State
resources are at stake. The relative reduction of the busi-
ness rates tax burden lowers the tax revenues of local
authorities and hence is equivalent to the use of State
resources in the form of fiscal expenditure.

Selective advantage

35. A reduction in the tax base, and consequently the level of
taxation, that a telecommunications operator is liable for,
confers an advantage upon that undertaking in that it
reduces the costs that that undertaking would normally
bear in the course of its business. This seems to be the
case for BT and Kingston Communications, which benefit
from a reduced tax base compared to other operators.

36. The reasons behind this discriminatory taxation appear to
be the application of a particular asset valuation method
to BT and Kingston Communications, while applying a
different method to other operators. Even if the method
applied, including the corresponding revision mechanism,
is foreseen in the relevant
the
possible approaches, the non-uniformity of the system
and the discretionary powers given to the VOA to apply
the general provisions
to specific operators, while
deciding to treat other operators differently, may lead to a
selective advantage to a certain undertaking, while disad-
vantaging others who compete on the same market.

legislation as one of

37. The justifications given by the UK authorities for applying

the “Receipt and Expenditure” method to BT are:

(a) Asset ownership: BT owns 98 % of its infrastructure
and does not pay rent for it which could serve as a
basis for the “Rental” method.

(b) Size and diversity of infrastructure: There is no
network as large, or nearly as large, and as diverse as
BT's. There are no comparable operators whose rental
values could serve as benchmarks.

(c) The necessity to value “as a whole”: BT's assess-
ment is not made up of valuing many small parts and
adding them together, but it has to be valued as a
whole. Benchmarks on rental values of particular
network elements are irrelevant.

(d) Special obligations: The full value of BT's network is
“depressed” by its onerous licence conditions such as
its universal service obligations (“USO”) and price cap
regulations. Vtesse, on the other hand, does not have
USO (41).

(41) VOA's statement at the Berkshire Valuation Tribunal Hearing, 25

March 2004.

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38. As stated in the Commission's abovementioned notice on
direct business taxation, the presence of aid may be ruled
out where the different nature of the measure is justified
by the nature and general scheme of the system. In line
with the case-law of the Court of Justice (42), the Commis-
sion has continued to take the view that this justification
must be based on the intrinsic features and inherent logic
of the tax system.
the
Commission has doubts about the validity of such argu-
ments, and in particular:

In the case at hand, however,

39. Asset ownership: The UK authorities stated that

the
“Rental” method can only apply to lessees (and not
lessors). However, the rent received by BT when renting
out its own infrastructure could serve as guidance for the
value of the network. Moreover, BT's retail business units
themselves effectively rent infrastructure and buy network
services
that
manages BT's infrastructure. The internal transfer prices
between BT's retail businesses and BT Wholesale could
provide a basis, or at least a benchmark, for estimating
for
the
network services (provided, of course, that those prices
are set at arms length).

rental value, with appropriate

from BT Wholesale,

the business unit

adjustments

40. Size and diversity of infrastructure: Such argumentation
tends to suggest that bigger companies deserve reduced or
digressive rates of taxation. This statement appears to be
incompatible with the Commission's position in previous
fiscal aid cases stipulating that nothing justified preferen-
tial treatment in favour of large companies (43). Moreover,
if the logic of the business rates property tax system is to
assess the value of infrastructure, the size of the company
should not be taken into consideration during the valua-
tion process. In any case, the cable TV companies in the
UK are also active in the telecommunications market,
especially residential and, similarly to BT, have both an
access and a backbone network. Their taxation level could
also serve as a benchmark (44).

41. The necessity to value “as a whole”: The UK was a fore-
runner in telecoms liberalisation, account separation and
tariff regulation based on the cost-orientation of BT's
tariffs. For these purposes, OFCOM, the UK regulatory
authority, and its predecessor OFTEL, have been systema-
tically collecting cost accounting data from BT since the
1980s. BT itself and OFCOM are in possession of detailed
cost accounting data for BT's network. This data could be
used to determine the taxable value of BT's network, at
least to verify the assessment of the tax authorities. More-
over, liberalisation and network element unbundling have
resulted in a variety of wholesale products which could
serve as benchmarks for valuing the rental value of
various infrastructure elements.

42. Special obligations: The Commission is not aware of BT
or Kingston Communications being compensated for the
provision of universal service under the Universal Service

(42) Judgement of the Court of Justice in Case C-308/01 of 29 April
2004 concerning Gil Insurance Ltd and Joint cases T-346/99, T-
347/99, T-348/99 point 58 onwards.

(43) Commission Decision of 17 February 2003 No C15/2002 on
Belgian Coordination Centres (OJ L 282, 30.10.2003) and No C51/
2001 on Dutch international
(OJ L 180,
18.7.2003).
(44) See footnote 36.

financing activities

is

Directive (45). Nor
the Commission aware of any
compensation for universal service, or for any other obli-
gation, which could be regarded as a service of general
specifically being granted through
economic interest,
reduced property taxation. As regards to price regulation,
while it may limit the returns of the incumbent and as
such, the taxation level calculated based on the “R&E”
method, this should not lead to inconsistency between the
results of valuations by different methodologies. Finally,
being an incumbent in a market tends to bring advantages
in terms of asset value, while the arguments brought
forward by the VOA tend to focus on disadvantages.

43. Adjustments: The Commission notes that even if the use
of different methods could be justified by the logic of the
these should deliver comparable results. The
system,
the use of various
Commission's initial assessment of
methods in this particular case is that they seem to lead to
significantly different results based on similar facts. In par-
ticular, the “R&E” method estimates the rent value of the
assets on the basis of revenues from the use of those
assets, while the “Rental” and “Tone of the List” methods
pick up the market values for the rent. Hence, it seems
that the “R&E” method implicitly assumes that assets are
used at capacity and profitably, which however may not
always be the case. To avoid penalising operators whose
assets are valued using a different method, appropriate
adjustments would need to be made. The Commission
does not question the validity of the methods themselves,
but rather has doubts about the way they are applied to
different operators.

44. Revisions: There does not

seem to be any review
mechanism in the system to ensure an equitable and
proportionate tax burden among operators when applying
the different methods. Scope for revisions within the five
year cycle is very limited. While BT does enjoy a down-
wards revision mechanism, there does not seem to be a
similar systematic review of the market conditions faced
by competitors. The effect of such adjustment appears to
move the tax payable by the incumbent closer to one
based on operational performance and revenues, while for
other operators it remains a tax based on rent of assets
irrespective of performance. In addition, the failure to take
into account the increase in the value of BT's infrastruc-
ture between two five-year review periods, while charging
competitors incrementally as the value of their network
increases, seems to further distort competition.

45. Discretionary powers: The valuation process gives discre-
tionary powers to the VOA and seems to leave consider-
able scope for negotiation. According to the UK authori-
ties, while there is an established practice, approved by
the case law of the Courts of England, of applying a
certain hierarchy of methods, there is no requirement in
the LGFA 1988 to use any particular method in order to
arrive at the rateable value and all methods can be consid-
ered (46).
In many cases, negotiated settlements are
reached. At this point, the Commission is unable to deter-
mine whether the reasoning behind adopting a certain
rateable value for BT is well reasoned, justified, and docu-
disadvantage other
mented and does not unduly

(45) Directive 2002/22/EC on Universal Service and Users' Rights

relating to electronic communications networks and services.

(46) Op. cit. footnote 14.

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In any case,

operators (47).
such a settlement should
respect the principle of non-discrimination among opera-
tors and the parameters on which the agreement has been
reached should be objective and opened for all operators.

46. Resulting taxation: The doubts about the justification of
applying different valuation methods are further rein-
forced by the differences in the resulting taxation. Even if
the use of different methods and revision mechanisms
would be based on an objective set of criteria,
the
Commission would expect
these different methods to
ensure equal treatment by yielding comparable results. In
this context, it would be useful to compare the tax levels
to an objective measure of the economic use of the assets
taxed, such as, for instance, revenues. The tax payable by
BT seems to be in the range of 2-4 % of relevant revenues
while that payable by Vtesse and other new entrant
competitors is said to be two or three times as much, and
to reach 20-30 % on an incremental basis. Moreover, the
application of different methods seems to structurally
produce different results when it comes to the frequency
of revisions and adjustments. While some minor discre-
pancy might be justified in the context of a property tax,
it needs to be ensured that such differences are not dispro-
portionate and discriminatory.

Distortion of competition

47. The UK telecommunications market has been opened to
competition since 1992 and today is a highly competitive
market with numerous operators. BT and Kingston
Communications directly compete against Vtesse and
other alternative providers active in the telecommunica-
tions services market. Hence on the assumption that the
difference in business rates taxation among these opera-
tors involved State aid and conferred a selective advantage
upon certain players, it would alter their competitive posi-
tion on the market and hence distort competition.

Effect on trade

48. The mere fact that some firms' position is strengthened by
the resulting lower rate of taxation compared to that of
other firms which are competitors in intra-Community
trade demonstrates that Community trade is affected. BT
is a company active on a global scale, competing on
several community markets in electronic communications
services. Hence any advantage conferred upon it affects
trade between Member States. This criterion also appears
to be fulfilled to the extent that the telecoms companies
affected by the measure at stake are able, actually or
potentially,
to trade with companies located in other
Member States.

Conclusion

49. In conclusion,

it would appear that the measure under
consideration involves State aid within the meaning of

(47) According to the UK authorities, the VOA needs to obtain BT's
consent to release to the Commission the relevant documentation
which served for BT's valuation. In addition, it is said that BT itself
arrived at its own valuation by the “Contractor's Basis”method but
the VOA is not in possession of this valuation.

Article 87(1) EC. The Commission would like to empha-
size, however, that this conclusion should not be seen as
an attempt on its part to impose on the UK authorities
the use of a particular valuation method. It is, in fact, for
the UK authorities to choose the method they consider
most appropriate to value the “rateable hereditament”,
provided that any differences between individual under-
takings or economic sectors are justified by the intrinsic
features and inherent logic of the tax system and that,
eventually, all taxable persons are subject to the same
objective and non-discriminatory treatment,
leading to
comparable levels of taxation.

5.2. Nature and amount of the possible aid

50. On the basis of the information provided so far,

the
Commission tends to believe that the measures constitute
new aid and not existing aid. Despite the fact that commu-
nications systems have been rated since the middle of the
19th century,
it is the Local Government Finance Act
(LGFA) 1988 which largely governs the current non-
domestic rates system in England and Wales. Prior to the
1988 Act, BT (and most other utilities) were rated by a
mandated statutory formula. The LGFA put utilities on the
same commercial basis as other enterprises by introducing
an independent valuation by various methods and
allowing for appeal. The provisions of the Act were imple-
the 1995 valuation when the “Receipt and
mented at
Expenditure” method was first applied to BT and Kingston
Communications.

51. Assuming that the measure qualifies as aid, within the
meaning of Article 87(1) EC,
the aid amount must,
according to § 35 of the Commission's abovementioned
notice on direct business taxation, be calculated on the
basis of a comparison between the tax actually paid and
the amount which should have been paid if the generally
applicable rule had been applied. However, since, at this
point in time the Commission cannot pronounce itself on
which method, if any, and, which level of taxation, if any,
is deemed to be the standard one in the present case, the
amount of aid cannot be determined at this stage, either.

5.3. Compatibility

52. At this stage and in view of the above, the Commission
cannot exclude that BT, to whom the “Receipt and Expendi-
ture” method is applied, may benefit from a specific and
more favourable tax treatment amounting to State aid as
defined under Article 87(1) EC. In addition, the Commis-
sion notes that Kingston Communication is likely to
benefit from a similar tax treatment than BT.

53. It is therefore necessary to determine if such an aid could
be considered compatible with the common market under
Article 87(2) or (3) of the EC Treaty. It appears that none
of the exceptions under Article 87(2) EC Treaty apply in
this case, as the measure is not aimed at the objectives
listed in these provisions.

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54. Under Article 87(3)(a), an aid measure is considered
compatible with the common market when it is designed
to promote the economic development of areas where the
standard of living is abnormally low or where there is
serious underemployment. Such areas are defined by the
United Kingdom's regional aid map. Since the measures
are not limited to such areas, this provision does not
apply.

55. As regards the exceptions laid down in Article 87(3)(b)
and (d), the aid in question is not intended to promote the
execution of an important project of common European
interest or
to remedy a serious disturbance in the
economy of the United Kingdom, nor is it intended to
promote culture or heritage conservation.

56. Finally, it is necessary to examine if the aid can qualify for
the exception laid down in Article 87(3)(c) which states
that an aid may be considered compatible with the
common market where it facilitates the development of
certain economic activities or of certain economic areas
and does not adversely affect trading conditions to an
extent contrary to the common interest.

57. The preferential tax treatment does not seem to be related
to investment or to job creation and constitutes a perma-
nent relief from charges that should be normally met by
these companies in the course of
their business. The
measure could, at this stage, be considered as an operating
aid scheme, the benefits of which will cease as soon as it
is withdrawn. According to the constant practice of the
Commission, such aid cannot be considered to facilitate
the development of certain economic activities or of
certain economic areas.

58. Since, assuming that the measure qualifies as State aid, it
would not seem to qualify for any of the exceptions
provided for in the Treaty, the Commission doubts that it

could be
market.

considered compatible with the

common

6. CONCLUSION

under

acting

the procedure

59. In the light of the foregoing considerations, the Commis-
sion,
down in
Article 88(2) of the EC Treaty, requests that the United
Kingdom submit its comments and provide all such infor-
mation as may help to assess the aid/measures to BT and
Kingston Communications, within one month of the date
of receipt of this letter.

laid

60. The Commission is in particular interested to receive the
conclusions of the review of the system undertaken by the
Department of Trade and Industry or details of
the
ongoing discussions and any working papers on this
matter. In addition, it would like to receive the details of
the agreement between the VOA and BT, the VOA and
Kingston, concluded in 1995, applicable for the 1995-
2000 period and especially the economic modelling
behind the valuation and the justifications (including data
on relevant revenues etc.) for any subsequent concessions
made during the settlement. Similarly, the Commission
would like to receive the details of BT's and King-
ston's 2000 valuation, applicable for the 2000-05 period.
Furthermore, the Commission is interested in tax levels
and relevant revenue data for Vtesse and other alternative
operators, including Cable and Wireless. It also requests
that your authorities forward a copy of this letter to the
potential recipients of the aid.

61. The Commission wishes to remind the United Kingdom
that Article 88(3) of the EC Treaty has a suspensory
effect, and, that Article 14 of Council Regulation (EC)
No 659/1999 provides that all unlawful aid may be recov-
ered from the recipient.’