Rating Manual section 6 part 3: valuation of all property classes

Section 1118: water supply hereditaments

This publication is intended for Valuation Officers. It may contain links to internal resources that are not available through this version.

1. Co-ordination

Water supply hereditaments comprise the catchment reservoirs, water treatment works, pumping stations, storage reservoirs, water mains, etc. that make up water supply networks. The hereditaments, therefore, comprise land, buildings and rateable plant & machinery related only to the water supply functions of water companies. The ten largest companies also have sewerage functions and Rating Manual - Section 6 part 3: Section 900 deals with the valuation of hereditaments used for those purposes.

The Utilities Rating Team deal with water supply hereditaments. Hereditaments in this class are entered in the Central Rating List and therefore do not have a special category code.

For further information on coordination for this class see the practice note to this section for the appropriate Revaluation.

There are a number of water suppliers to single or small groups of users that do not form part of the main structure of the industry as described below. Reference should be made to Rating Manual Section 6 part 3 – Section 725: Non-Statutory Water Undertakings for these hereditaments.

2. History and context of present water supply structure

2.1 Up to 1989

The water and sewerage industry was highly fragmented before 1973. Ownership lay for the most part in public hands but there were approximately 1,300 sewerage and sewage disposal authorities, 200 water undertakers and 27 river authorities.

The Water Act 1973 reorganised the water industry in England and Wales into ten publicly owned water and sewerage authorities and 29 privately owned statutory water companies. The profits and dividends of the statutory water companies were subject to control.

The ten publicly owned water and sewerage authorities were given geographical areas defined by particular rivers and their tributaries. This enabled them to perform wide functions under a policy of integrated river basin management. Functions carried out were water supply (except where there were statutory water companies operating in the area), sewerage, sewage treatment, pollution control, land and highway drainage, flood defence and fisheries management.

The government announced in 1985 that it was considering a measure of privatisation in the water industry. The eventual outcome was the sale of the industry in 1989.

2.2 1989 onwards – the current structure

The Water Act 1989 set the present pattern of the water industry. The National Rivers Authority (NRA) was set up to deal with river management functions such as pollution control and flood defence. At the same time the Office of Water Services (OFWAT) was set up to oversee the economic regulation of the industry. Ten water and sewerage companies (WASC’s) were to be privatised. They were to carry out the functions of provision of water supply and sewerage and sewage disposal. The 29 water only companies (WOCs) were able to opt for public limited company status.

The 10 water and sewerage companies (WASCs) were floated on the stock exchange in 1989. Today (2005), all 10 WASCs remain but the number of WOCs has reduced to 13.

The Water Industry Act 1991 deals with the appointment of undertakers, their functions regarding water supply and sewerage services and the regulation of these companies. The Act gave the Secretary of State the power to appoint water and sewerage undertakers and to impose conditions of appointment as he sees fit, to allow him to carry out the duties ascribed to him in the Act. The Instrument of Appointment, or licence, sets out these conditions and specifies in greater detail than the Act the duties by which the undertakers are bound and the formal regulatory environment in which they operate.

Water companies were subject to the windfall tax of 1997 imposed by the Chancellor of the Exchequer on many privatised former publicly owned industries.

The structure of the industry together with the nature of its infrastructure has given the water companies a large measure of monopoly in the geographical areas of their operation. However, a new competition regime came into force on 1st December 2005 which allows large business customers to move from their existing water service providers to competitors. In order to facilitate this, water companies must allow competitors (for whom there is a licensing system) access to their supply systems.

3. Regulation of the industry

The economic regulator for the water industry is the Director General of Water Services (presently Philip Fletcher) who heads the Office of Water Services (OFWAT). The Director General regulates prices that the companies are permitted to charge customers for the provision of their regulated services. From 1st April 2006 the Director General’s functions transfer to the Water Services Regulation Authority.

There is also regulation by the Environment Agency. This area of regulation is aimed at maintaining and improving the quality of freshwater – underground and surface – so that it is fit for human and eco-system use. Additionally, the Drinking Water Inspectorate deals with the quality of drinking water. The functions of the NRA were transferred to the Environment Agency in 1996.

The water industry has regularly had interest shown in it by the Office of Fair Trading and the Competition Commission, notably in respect of takeovers and mergers.

The Competition Commission have, in the past, been influenced by OFWAT’s preference for no reduction in the number of companies (which they use as comparators in the price review process) when considering takeovers and mergers. It remains to be seen whether following the recent regulatory price review for the period 2005-2010 OFWAT will relax their preference on maintaining the present number of comparators. The impact of the Enterprise Act 2002 in this area has also yet to be established.

The Government Legal Service www.gls.gov.uk/competition-commission-rep.htm

says in relation to the Enterprise Act,

“The Enterprise Act 2002 introduces a new regime for the assessment of mergers and markets in the UK. In most mergers and market references the Commission is responsible for making decisions on the competition questions and for making and implementing decisions on appropriate remedies. Under the legislation which the Act replaces, the Commission had to determine whether matters were against the public interest. The public interest test is replaced by tests focused specifically on the question of whether there has or could be a substantial lessening of competition in a market in the UK in the case of mergers; and in the case of market investigations whether there are features of a market which restrict or distort competition. The new regime also differs from the previous regime where the Commission’s power in relation to remedies was only to make recommendations to the Secretary of State, it is now determinative.”

4. How price regulation works

There are different ways of regulating prices but the one used by OFWAT in the water industry is price cap regulation. Prices limits are set in advance for periods of 5 years. The prices are set at levels that give a return on the value of the company (as measured by its Regulated Capital Value or RCV) and cover expected operating and maintenance costs. The price limits that are set impose an upper limit on the average prices that companies can charge customers throughout a price control period. OFWAT expresses the price limits on water companies as RPI+/-K. This means that the water company is allowed to increase its average price each year by the level of inflation (RPI) +/- a percentage (K). K may be positive or negative depending on the circumstances of the company. The regulator determines K separately for each company. The charges to which the price limits apply are known as the tariff basket and comprise charges for measured and unmeasured water supply. The K relates to the average of these charges. For water and sewerage companies there are separate K’s for the water and sewerage sides of the business.

There is incentive for the companies to make efficiency savings as they can keep the benefit from them for 5 years. After 5 years, prices are brought back into line with underlying costs.

Five-yearly periodic reviews (1995-2000, 2000-2005, 2005-2010) are the present pattern. There is, however, some likelihood that they will be lengthened in the future. There are some limited grounds on which companies may seek an interim determination to increase prices during price control periods.

The Price Review 1999 for period 2000-2005 (referred to as PR99) determined significant price cuts whilst simultaneously imposing a large capital programme on companies. The companies responded by achieving large efficiency savings within a short space of time.

The Final Determinations for Price Review 2004 (for period 2005-2010 - referred to as PR04) were well received by the City. They show a general increase in prices to allow greater allowances in operating expenditure, higher maintenance spending and more investment in quality enhancements. The companies must still however make efficiency gains if they are to achieve the outputs that OFWAT requires of them.

5. Treatment of drinking water

Treatment is the term used to describe a series of processes raw water is subjected to in order to make it safe for human consumption. The degree of treatment needed depends on the source of the water – river, impounding reservoir or underground aquifer – and the nature of the area from which it comes. For example, in areas of intensive agriculture, some pesticides will have been washed off fields by rain into rivers and reservoirs whereas water from underground sources will have been naturally filtered by the rock formations through which it has percolated.

The process for converting raw water into potable water is described below in the order in which it takes place. It should be noted, however, that there is significant variation in the type of plant and the detail of the processes found in water treatment works.

a) Raw water

Raw or untreated water may be from surface or underground sources. Surface water is collected and stored in upland areas by damming watercourses to make impounding reservoirs. There are also pumped storage reservoirs where the raw water may be pumped from a river rather than relying on natural inflows from the catchment. Boreholes are used to abstract underground water, which having been naturally filtered by percolating through the ground generally requires less treatment than surface sources.

There will be a series of screens to remove debris such as branches and leaves at river intake works and on inflows to impounding reservoirs. In the case of river intakes there will be pumps to pump the water to the reservoir. Water in reservoirs is managed, for example, so that water is turned over from the top to the bottom to help control algae and other problems.

b) At the water treatment works

At the water treatment works, impurities too fine to be screened out are removed. The water is first mixed with chemicals such as ferric-sulphate that act as coagulants and with lime or sulphuric acid to adjust the pH level (the pH effects the ease with which solids may be removed). The mixing may take place in inlet channels to the works or the water may be put into flocculation tanks and slowly agitated. Particles that were too small to be removed by the screens bind together to form larger particles.

The water next passes into clarifiers where the solid matter that has formed is removed. There are a number of different methods of clarification. One method relies on sedimentation for the coagulated particles to collect in the cone-shaped bottoms of tanks from where the solid matter is drawn off. An alternative process is dissolved air flotation which injects tiny bubbles of air into the bottom of the tank. This causes the solid matter to float to the surface from where it is scraped off whilst the water is drawn off from the bottom. Another variation uses coagulant to form a sludge blanket part way up the tanks. Impurities stick together as the water passes up through the blanket. The water is then run off from the top and the blanket periodically removed.

The clarified water passes into filters where it flows through sand and gravel in order to remove any remaining particles. The sand and gravel filters are regularly back-washed. Back-washing is forcing air and clean water back through the filter to remove any build up of particles. There will usually be a 2-stage filtration process. The pH value of the water will be adjusted between each stage of the process to ensure ease of treatment.

Ozone treatment for disinfection might follow. There may also be Granular Activated Carbon (GAC) filters for removing minute traces of pesticides.

Chemicals will be added where necessary to correct the pH value of the water to minimise corrosion of pipes and fittings in the distribution system and on customers premises. Phosphate may be added in soft water areas to prevent lead from old pipes dissolving into the water.

The water will then pass into contact tanks to be disinfected with chlorine. Most of the chlorine is then removed and the water passes into treated water tanks. The small amount of chlorine remaining will protect the water on its subsequent journey to the customer. Outgoing pumps introduce the water into the mains. Treated water is often stored in service reservoirs or towers as part of the distribution system.

There will be sludge treatment for the solid matter removed from the water during the treatment process.

Water treatment works have sophisticated computerised control and monitoring systems and require only a handful of on-site operators.

6. Unit of assessment

Section 64(3) of the Local Government Finance Act 1988 (LGFA 1988) gives the Secretary of State powers to make regulations prescribing as a single hereditament properties which would otherwise be more than one hereditament.

The Central Rating List (England) Regulations 2005 (2005/551) and The Central Rating List (Wales) Regulations 2005 (2005/422 (W.63)) prescribe the hereditament for water supply companies so that there is a single entry for the network of each company in the Central List for England or Wales as appropriate. Four companies have cross-border networks and, therefore, have an entry in both English and Welsh Central Lists. The following designation is from the English regulations; the Welsh are similar in effect.

“15 — (1) Where a company which is a designated person by virtue of regulation 3(1) and Part 10 of the Schedule occupies or, if it is unoccupied, owns what would, apart from these Regulations, be more than one hereditament and each of those separate hereditaments satisfies the conditions set out in paragraph (2), those hereditaments will be treated as one hereditament.

(2) The conditions are that each of the hereditaments is –

(a) used wholly or mainly for the purposes of a water undertaker or for ancillary purposes; and

(b) is not an excepted hereditament.

In paragraph (2) —

“excepted hereditament“ means a hereditament consisting of or comprising one or both of the following –

premises used wholly or mainly for the manufacture, storage, sale, display or demonstration of apparatus or accessories for use by consumers of water (any use for the receipt of payments for the use of water or sewerage services being disregarded);

premises used wholly or mainly as office premises, where those premises are not situated on operational land of the designated person; and

“water undertaker” has the same meaning as in Part 2 of the Water Industry Act 1991.

The hereditament described in paragraph (1) will be treated as occupied by the designated person.”

“Office purposes” and “operational land” are defined as,

“1-(2) “office purposes” includes the purposes of administration and clerical work and handling money; and “clerical work” includes writing, book-keeping, typing, filing, duplicating, sorting papers or information, calculating (whether by manual, mechanical or electronic means), drawing, and the editorial preparation of matter for publication; and

“operational land”, in relation to a designated person, means land which is used for the purposes of carrying on that person’s undertaking, not being land which, in respect of its nature and situation, is comparable rather with land in general than with land which is used for the purposes of carrying on of statutory undertakings (within the meaning of the Town and Country Planning Act 1990(2)).”

Water companies sometimes engage in activities that are not within the meaning of “water undertaker” in Part 2 of the Water Industry Act 1991. They may also have subsidiary or related companies sharing their premises. Occupations for these other activities and businesses are not included in the central rating list entries for the water companies and any hereditaments so used should be entered in local lists.

In deciding whether particular premises are part of the central rating list entry or should be the subject of a local list entry, it is necessary to decide who is the rateable occupier and to identify the hereditament in accordance with normal rating principles. The rateable occupier must be a designated person and the hereditament must be used wholly or mainly for the purposes of a water undertaker (as defined above) and must not be an excepted hereditament. Where all these conditions are satisfied then the hereditament will be part of the central rating list entry for the designated person. Where, however, part is an excepted hereditament, then that part should be the subject of a local list entry whilst the remainder will be part of the central rating list entry.

Reference should be made to Rating Manual – section 2 part 2 for further instructions and advice on the various classes of prescribed hereditaments (including water companies) valued by the Central Valuation Officer.

7. Designated persons

Water undertakers included within the 2005 central rating list regulations as designated persons are:

  • Anglian Water Services Limited

  • Bournemouth and West Hampshire Water plc

  • Bristol Water plc

  • Cambridge Water plc

  • Cholderton and District Water Company Limited

  • Dee Valley Water plc

  • Dwr Cymru Cyfyngedig

  • Folkestone & Dover Water Services Limited

  • Mid Kent Water plc

  • United Utilities Water plc

  • Northumbrian Water Limited

  • Portsmouth Water Limited

  • Severn Trent Water Limited

  • South East Water Limited

  • South Staffordshire Water plc

  • South West Water Limited

  • Southern Water Services Limited

  • Sutton and East Surrey Water plc

  • Tendring Hundred Water Services Limited

  • Thames Water Utilities Limited

  • Three Valleys Water PLC

  • Wessex Water Services Limited

  • Yorkshire Water Services Limited

8. Plant and machinery

Plant and machinery is rateable in accordance with The Valuation for Rating (Plant and Machinery) (England) Regulations 2000 as amended (SI 2000/540) and The Valuation for Rating (Plant and Machinery) (Wales) Regulations 2000 as amended (SI 2000/1097 (W.75)) and the principles described in Rating Manual - section 6 part 5.

The principal items of rateable plant and machinery for water supply hereditaments are:

Reservoirs - Class 4 Table 4

valve towers - Class 4 Table 3

borehole linings - Class 4 Table 3 well casings and liners

tanks, chambers and vessels (e.g. for flocculation, clarification, ozone treatment, contact tanks, surge tanks, treated water tanks). Many of these will be of reinforced concrete construction and not capable of being moved from one site and re-erected in their original state on another. Class 4 Table 4

filters Class 4 Table 4

walkways, stairways, handrails and catwalks associated with the items named above Class 4 Table 3

water mains and booster pumps Class 3(g). Water treatment works are considered to be factories within the meaning of the Factories Act 1961 and the pipework within them is not, therefore, rateable under Class 3 (g)

electrical equipment Class 1 Table 1

9. Basis of valuation

Before the 2005 Revaluation, the Secretary of State prescribed rateable Values for water supply hereditaments. From 1st April 2005, however, these herediaments are subject to conventional valuation although the extent of the hereditaments is prescribed as described in section 6 above.

The water supply companies are profit-making enterprises operating within a regulated market. The regulatory regime aims to assure them of profits in order to reward them for their investments and thereby enable them to maintain a high credit rating and attract necessary funds to maintain and improve their networks.

There are no rents paid for water supply networks. Other classes of property are too dissimilar for rental evidence to be taken from them and reliably adjusted to guide valuation of water supply networks.

The revenue & expenditure (R & E) valuation method is appropriate in the above circumstances. Its rationale reflects the profit motivation of the companies. Reference should be made to Rating Manual - section 4 part 2 and the practice note to this section for further information.

Practice note 1 : 2005 : Water supply hereditaments

1. Co-ordination

Water supply hereditaments are dealt with by the Utilities Rating Team.

Where advice is needed as to whether particular premises should be included in the central rating list entry for water supply companies or should be the subject of a local list entry this should be sought from the Technical Adviser who will, if necessary, liaise with CEO and the Utilities Rating Team. If there are no Technical Advisers available then advice may be sought directly from the Utilities Rating Team where this is felt necessary or expedient.

In the event of it being concluded that a hereditament shown in a local list should actually be included in the central rating list entry, the Utilities Rating Team should be advised (email is sufficient) of the address including postcode, description and the RV deleted from the local list (where appropriate).

2. Industry consultation

The valuations for Revaluation 2005 were made following consultation with individual water supply companies, their trade body Water UK and OFWAT. As part of the consultation process, draft valuations were issued to the companies in order that representations could be made. A number of points made by companies were adopted for the final valuations.

3. Valuation

3.1 Receipts & expenditure method of valuation

The receipts & expenditure (R & E) method of valuation is used to value this class of hereditaments. The method is described in detail in Rating Manual - section 4 part 2. It is outlined in “The Receipts and Expenditure Method of Valuation for Non-Domestic Rating – A Guidance Note” by the Joint Professional Institutions Rating Valuation Forum 1997 as:

“Gross Receipts should be determined by taking into account all income reasonably able to be derived from occupation of the property

The proper Cost of Purchases made in order to produce those receipts should be deducted to determine the Gross Profit.

From the Gross Profit the Working Expenses should be deducted to determine the Divisible Balance.

The Divisible Balance is the sum available to be shared between the landlord and the tenant. It comprises two main elements:

(i) the Tenant’s Share – to provide a return on any tenant’s capital employed and a reward to the tenant for his venture reflecting the extent of the risk and the need for profit. This is deducted from the Divisible Balance to leave:

(ii) the Landlord’s Share i.e. the rent payable (which becomes the rateable value).”

The valuations of the water companies for Revaluation 2005 were made following consultation with the industry. Most of the information used in the valuations was publicly available but there was some additional information supplied by the companies. The principal sources of information were as follows:

regulatory information relating to the price control period (2000-2005) current at the AVD (1st April 2003) including June returns for the years 2000/01, 2001/02, 2002/03 and interim determinations;

regulatory information relating to the price review for 2005-2010 including Asset Stock and Condition Profile for data on assets.

There are ten water and sewerage companies (WASC’s) and 13 water only companies (WOC’s). The WASC’s are required by OFWAT to provide separate regulatory accounts for the two sides of their businesses. There was, therefore, separate regulatory information for the water supply businesses.

3.2 Receipts

Water company (WASC’s and WOC’s) receipts are from:

  • Measured charges. These charges are where customers are metered. There will be a standing charge and a volumetric charge for the amount of water used.

  • Unmeasured charges. These charges are where customers are not metered and pay based on the rateable value of their properties. For domestic properties the rateable values used are those that were produced for the purposes of local authority rates until 1990.

  • Large Business Users. These charges are not within the tariff basket and inset appointments can be granted to sites using 100 megalitres or more per year in England or 250 megalitres or more per year in Wales. Inset appointments are the mechanism whereby one company can replace another to supply water.

  • Revenue grants, provision of water services to third parties and other sources (such as non-tariff basket charges).

The approach to the valuation considers the hypothetical tenant to be standing looking forward at the antecedent valuation day (AVD) of 1st April 2003. The forward look is important because both rent and tenant’s share will have to be taken out of earnings to come rather than past profits. Expected receipts from price increases/decreases arising from PR99 for 2003/4 and 2004/5 (the final two years of the price review for 2000-2005) are, therefore, taken account of in the valuations. Receipts arising from any interim determinations are spread across the whole price control period rather than treated as income for the years in which it is actually received.

3.3 Expenditure

Water company (WASC’s and WOC’s) expenditure in respect of the purchases and working expenses referred to in paragraph 3.1 above is classified as:

  • Direct costs. These include employment costs, electricity, purchase of materials and consumables.

  • General and Support Activities. These include centrally provided services such as administration, personnel, financial, data processing and property maintenance.

  • Operating expenditure for Business Activities. These include customer accounting, meter reading, scientific and laboratory services and the cost of complying with regulatory requirements.

  • Uniform Business Rates.

  • Doubtful debts. This is the charge to the profit and loss account for bad and doubtful debts. Bad debts are a particular concern in the water industry as companies are not allowed to cut off supplies for non-payment.

  • Operating expenditure for third party services. This includes the bulk supply of raw or treated water to other water companies.

  • Depreciation for non-rateable (i.e. tenant’s) assets.

The non-rateable assets of water companies are identified on the basis of their asset lives. This information is shown in the asset stock and condition profile data produced by the companies as part of the price review process for the period 2005-2010. As the range of years used by companies for the different life categories varies from one company to another, a standard life for each life category is adopted to ensure consistency of treatment between companies. The rateability of assets and the standard life adopted is as follows-

Life Rateability Standard life adopted
very short life assets all non-rateable 5 years
Short life assets all non-rateable 10 years (excluding vehicles) 7 years (vehicles)
Medium life assets all non-rateable except booster pumps 25 years
Medium / long life assets 25% taken as non-rateable in order to exclude steel storage tanks < 400m3 40 years
Long life assets all rateable except 5% of water treatment works to represent value of inter-process pipe-work. 60 years

Depreciation is calculated using gross modern equivalent asset values since this is what it would cost to replace an old asset with a technically up to date new asset with the same service capability, allowing for any difference both in quality of output and operating costs.

Straight-line depreciation over the standard life of both rateable and non-rateable assets is calculated and the proportion of total depreciation attributable to non-rateable assets calculated. This proportion is applied to the annual depreciation charge as stated in the June returns to give a sum representing the annual depreciation of tenant’s non-rateable assets.

  • Infrastructure renewal expenditure (this is mainly spent on renewal of mains pipework in order to maintain existing operating capability) and maintenance non-infrastucture. It is only expenditure under these headings that is spent on repair that is allowable.

  • Expenditure on enhancement. Enhancement is sub-divided into quality, enhanced service level and supply/demand balance. This expenditure results in a permanent increase in the current level of serviceability and is not allowable as expenditure of the hypothetical tenant.

Levels of expenditure are estimated by reference to figures from earlier years and by reference to the regulatory material named above. Infrastructure renewal expenditure may be more or less in any year than the level of spending required by OFWAT and there is, therefore, an infrastructure renewal charge charged to the profit and loss account in order to even out these variations. It is the infrastructure renewal charge that needs to be considered for the rating valuation because repair expenditure is allowed on the basis of the average annual amount that it is necessary to spend.

3.4 Allowing for inflation

Revenue and expenditure from before the AVD (1st April 2003) is adjusted for inflation using the RPI measure. Inflation from the November prior to the start of each financial year to November 2002 is applied to receipts to bring them into terms of AVD prices. The use of November follows industry practice in setting prices in November for the forthcoming year. Expenses have been adjusted using full year inflation figures to AVD.

3.5 Tenant’s share

Tenant’s share is calculated as a percentage of divisible balance. The percentage is 35% for large companies and 40% for small companies with four companies at an intermediate level.

3.6 Landlord’s share and excepted hereditaments

The resultant landlord’s share may need to be reduced for any “excepted hereditaments” (see sub-section 6 of the main part of this rating manual section). A common example of an excepted hereditament is where the head offices of a company are not on operational land and are assessed and entered in the local rating list. The R & E valuation of the water supply hereditament calculates a landlord’s share that includes all rateable property used for the water supply business. It is, therefore, necessary to deduct the rateable values of any excepted hereditaments from the R & E valuation at the landlord’s share stage. Where excepted hereditament(s) are only part used for the water supply business (part may, for instance, be used for the sewerage side of a company’s business or for unregulated businesses), the local list rateable value will need apportioning so that only the rateable value attributable to the water supply business is deducted.