Thousands of firms are to be refused business rates discounts claimed due to the pandemic in what has been described as a “catastrophic blow”.

The Treasury said that it would legislate to throw out the claims – which it has been estimated could have cost it £5bn – and will instead set up a £1.5bn fund to help the worst affected companies.

Supply chain firms which have seen trade collapse, but have missed out on £16bn in business rates relief for retail, hospitality and leisure sector operators, should be among those to receive the aid.

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However taxpayer help will be denied to others, with the government giving the example of a city centre office-based firm which may have seen many staff working from home and property values hit but otherwise not suffered a big impact.

The government said 170,000 firms had applied for discounts on their business rates bills arguing that the COVID-19 crisis represented a “material change of circumstances”.

But it said these appeals could have meant “significant amounts” of taxpayer cash going to companies that have been able to operate normally.

They would also disproportionately benefit certain regions such as London if they had been allowed to go ahead, the government said.

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Instead, the Treasury is allocating a £1.5bn pot to local authorities “based on the stock of properties in the area whose sectors have been affected by COVID-19”.

Real estate adviser Altus cited one estimate suggesting rates appeals could have cost the government up to £5bn.

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Chancellor Rishi Sunak said: Our priority throughout this crisis has been to protect jobs and livelihoods.

By providing more targeted support than the business rates appeals system, our approach will help protect and support jobs in businesses across the country.”

But Robert Hayton, UK president of property tax at Altus, said: “This will be a catastrophic blow for businesses.”

He said firms had “spent the last year lawfully pursuing business rate adjustments only to have their statutory legal right ripped from them to allow the government to roll out a wholly inadequate scheme which won’t deliver enough business rates support”.

CBI chief economist Rain Newton-Smith said the new £1.5bn fund would help “forgotten supply chain businesses” that had been hit indirectly by restrictions.

But she added: “Other firms whose revenues have been hard hit by the crisis will certainly be highly frustrated that their appeals for discounts will be null and void now.”

The government said councils would “use their knowledge of local business and the local economy” to distribute the new pot of money.

It argued that relief should be provided to sectors that have suffered most economically rather than on the basis of falls in property values.

The Federation of Small Businesses welcomed the new money to help the likes of wholesalers, suppliers and brewers but said it was “crucial” that it should reach those that need it most.