Tax Management
Weekly State Tax Report™
Reproduced with permission from Tax Management Weekly State Tax Report, Perspective, 09/19/2014.
Copyright 姝 2014 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com
Ta x B a s e
San Francisco’s new gross receipts tax will be phased in over five years, beginning Jan.
1, 2014. The authors provide a historical background and overview of the tax. They explain
who is subject to tax, what constitutes a ‘‘gross receipt,’’ the rates applicable to the different types of businesses, apportionment and the combined filing requirement.
San Francisco: The City That Knows How . . . to Tax?
BY ALEX THACHER, ALLAN HOLZER
WILLIAMS
AND
MICHAEL
Alex Thacher (Executive Director), Allan Holzer (Manager) and Michael Williams (Senior)
are members of Ernst & Young LLP’s Indirect,
State and Local Tax Services practice. The
views expressed in this article are those of the
authors , who can be contacted at The views
expressed are those of the authors, who can
be contacted at [email protected];
[email protected]; and Michael.Williams@
ey.com; and do not necessarily reflect the
views of, and should not be attributed to,
Ernst & Young LLP. The authors gratefully
acknowledge helpful exchanges and comments from Kimberly Bott and Sean Lynch.
Adam Leibowitz and Alan Witlen provided
excellent research assistance.
ince the earthquake and fire of 1906, San Francisco (‘‘the City’’) has been known as ‘‘the city that
knows how’’ due to its ability to rebuild and rebrand in the wake of the devastation caused by that disaster. In the 100 years since, the City has rebuilt and
rebranded itself many times over in a variety of different ways. In a similar fashion, in the wake of citizen
concern over how its payroll expense tax regime was
affecting job creation and growth, the City redefined its
tax code, shifting the tax base from payroll expense to
business gross receipts.1
In November 2012, City voters approved Proposition
E, which amended the San Francisco Bus. and Tax
Regs. to include a new Gross Receipts Tax (‘‘GRT’’).
S
1
Victoria Barrett, Payroll Tax Be Gone: Angel Investor Ron
Conway Discusses Election Victory in San Francisco (Nov. 7,
2012), http://www.forbes.com/sites/victoriabarret/2012/11/07/
payroll-tax-be-gone-angel-investor-ron-conways-discusseselection-victory-in-san-francisco/ (quoting Ron Conway, technology investor, on Proposition E).
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2
Prior to this shift, the City was the only major city in
California to levy its entire business tax on payroll expense.2 The Findings and Purpose included in Proposition E declares the payroll expense tax discourages job
creation and economic growth, lowers wages and provides an unstable revenue stream.3
The GRT will be phased in over five years beginning
Jan. 1, 2014,4 and the existing payroll expense tax will
be phased out during the same period.5 During the fiveyear phase-in/phase-out period, taxpayers will be required to pay both the payroll expense tax and the
GRT.6 After 2018, most businesses7 will be liable only
for the GRT, which generally will be imposed on ‘‘persons’’ engaged in business in the City measured by
gross receipts from business activities attributable to
the City.8 The GRT is similar to tax structures found in
other California municipalities, such as Los Angeles,
with one key difference being that the City’s GRT references a taxpayer’s California state reporting group and
is based on the gross receipts of all members of the
California state reporting group rather than on a
separate-entity basis.9
History of the Payroll Expense and Gross Receipts Taxes
Until 1999, the City imposed a dual business tax system
consisting of a 1.5 percent payroll expense tax and a
varying rate gross receipts tax.10 Under this hybrid tax
2
See, San Francisco Controller’s Office of Economic Analysis, Enacting a Gross Receipts Tax, and Phasing-Out the Payroll Expense Tax: Economic Impact Report, (Aug. 24, 2012),
http://sfcontroller.org/Modules/
ShowDocument.aspx?documentid=3426.
3
San Francisco Bus. and Tax Regs. §950.1.
4
Id. §§903.1(d), 950.6.
5
The five-year phase-in is based on estimates by the City to
attain revenue neutrality during the transition from the payroll
tax to the GRT. For each year beginning in 2015, the treasurer,
controller and chief economist will jointly prepare an annual
report to the Mayor and Board of Supervisors on the implementation of the GRT and its impacts on the City’s economy
and business community. If the GRT revenues meet projections, the City plans to adopt in full the GRT as its sole business tax, fully eliminating the payroll tax but for a levy on administrative offices. If GRT revenues do not meet projections,
the City retains the right to adjust the rates accordingly or retain usage of the payroll tax. For fiscal year 2013, the payroll
expense tax had $410 million in receipts. Per Proposition E,
the anticipated business tax revenue for each year is an
amount equal to the product of the actual revenue for the fiscal year immediately preceding such fiscal year, multiplied by
107.5 percent. See, Id. §903.1(d)(3).
6
The five-year phase-in is based on estimates by the City to
attain revenue neutrality during the transition from the payroll
tax to the GRT. If the City does not remain revenue neutral by
using the GRT rather than the payroll tax, the GRT provides
for a reversion to the payroll tax or an adjustment to the GRT
rates. See, Id.
7
Businesses defined as ‘‘administrative offices’’ will continue to be subject to a tax based on payroll expense. See, Id.
§953.8.
8
Id. §953(a) (providing that, ‘‘except as otherwise provided
under this Article, the City imposes and every person engaging
in business within the City shall pay an annual gross receipts
tax measured by the person’s gross receipts from all taxable
business activities attributable to the City’’).
9
Los Angeles imposes its gross receipts tax on a separate,
rather than combined, company basis. See, Los Angeles Municipal Code §21.06(a).
10
See, San Francisco Controller’s Office of Economic
Analysis, Enacting a Gross Receipts Tax, and Phasing-Out the
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structure, businesses calculated both a gross receiptsbased tax liability and payroll expense-based tax liability and then paid the greater of the two calculated tax
amounts.11 By requiring business taxes and fees be paid
to conduct business within its borders, the City was able
to raise revenue that became a component of its annual
budget.
This type of non-income-based tax structure was
implemented by the City and other California municipalities due to restrictions on levying an income tax under state law.12 Despite the prohibition on municipalities imposing an income tax, the same statute authorizes municipalities to levy taxes based on payroll
expense and business license taxes measured by gross
receipts.13 Although the statute authorizes municipalities to levy such taxes, under both the U.S. Constitution
and California Constitution, any such local tax must
still meet a variety of tests in order to pass constitutional muster.14
In that vein, the constitutionality of the City’s dual
tax scheme was eventually questioned. In 1999, a California appeals court ruled that the hybrid system as administered violated the commerce clause of the U.S.
Constitution and California Constitution.15 In response
Payroll Expense Tax: Economic Impact Report, (Aug. 24,
2012),
http://sfcontroller.org/Modules/
ShowDocument.aspx?documentid=3426.
11
Id.
12
Cal. Rev. & Tax. Code §17041.5 (stating, ‘‘notwithstanding any statute, ordinance, regulation, rule, or decision to the
contrary, no city [. . .] whether chartered or not, shall levy or
collect or cause to be levied or collected any tax upon the income, or any part thereof, of any person, resident, or nonresident.’’).
13
Id. (providing that the code shall not be construed so as
to prohibit the levy or collection of any otherwise authorized
license tax upon a business measured by or according to gross
receipts).
14
General Motors v. Los Angeles, 35 Cal. App. 4th 1736,
1742 (Cal. Ct. App. 1995) (citing Complete Auto Transit Inc. v.
Brady, 430 U.S. 274, 279 (1977) ) (providing the efficacy of local taxing regulations is tested under the same principles applied to state taxes. These principles, derived from the commerce clause of the U.S. Constitution, are that ‘‘ ‘the tax [1] is
applied to an activity with a substantial nexus with the taxing
state, [2] is fairly apportioned, [3] does not discriminate
against interstate commerce, and [4] is fairly related to the services provided by the state.’ If a local taxing scheme fails any
one of the four requirements to comply with the commerce
clause, we are required to invalidate it.’’). See also, id. (citing
General Motors v. Los Angeles, 5 Cal. 3d 229, 238 (Cal. Ct.
App. 1971)) (holding that, ‘‘[i]n spite of the absence of a specific ‘commerce clause’ in our state Constitution, other provisions in that Constitution – notably those provisions forbidding
extraterritorial application of laws and guaranteeing equal
protection of the laws . . . — combine with the equal protection
clause of the federal Constitution to proscribe local taxes
which operate to unfairly discriminate against intercity businesses by subjecting such businesses to a measure of taxation
which is not fairly apportioned to the quantum of business actually done in the taxing jurisdiction.’’).
15
See, Macy’s Dept. Stores Inc. v. San Francisco, 143 Cal.
App. 4th 1444 (Cal. App. 1st Dist. 2006). In this case, the taxpayer alleged, and the trial court found, that the city’s business
tax scheme failed the internal consistency test and therefore
violated the dormant commerce clause because the tax scheme
could discriminate against intercity taxpayers. Macy’s brief,
citing Oklahoma Tax Commission v. Jefferson Lines Inc.
(1995) 514 U.S. 175, 185, stated that ‘‘Internal consistency is
preserved when the imposition of a tax identical to the one in
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to this decision, the City eliminated the gross receipts
tax component of their dual tax scheme and required all
entities engaged in business in the City to pay a 1.5 percent payroll tax on all compensation paid to employees
for services performed in the City.16
From the implementation of this separate payroll expense tax regime, the City observed that the revenue
stream provided by the payroll tax was uncertain and
fluctuated greatly depending on economic conditions.17
Over the past several years, City officials have made unsuccessful efforts to amend the payroll expense tax at
the ballot.18 Additionally, the City Council adopted several exclusions to the payroll expense tax, including exemptions for the biotech and clean tech industries.19
Recently, in an effort to attract technology startups to
the area and improve certain neighborhoods, the City
Council adopted an additional exclusion covering the
Central Market area and the stock-based compensation
of pre-IPO companies.20 Due to these exclusions, the
City’s payroll expense tax only captured about 10 percent of businesses in the City.21
With many citizens and government officials determined to change the City’s business tax structure,
question by every other State would add no burden to interstate commerce that intrastate commerce would not also bear.
This test asks nothing about the degree of economic reality reflected by the tax, but simply looks to the structure of the tax
at issue to see whether its identical application by every State
in the Union would place interstate commerce at a disadvantage as compared with commerce intrastate. A failure of internal consistency shows as a matter of law that a State is attempting to take more than its fair share of taxes from the interstate transaction, since allowing such a tax in one State
would place interstate commerce at the mercy of those remaining States that might impose an identical tax.’’ Macy’s argued
that the City’s dual tax could potentially discriminate against
intercity taxpayers who could be subject to tax under a payroll
expense measure in one jurisdiction and under a gross receipts
tax in another, unlike an intra-city taxpayer who would pay tax
only to the City under only one measure. Macy’s made no
claim that it paid any actual excess taxes to the City, only that
the tax regime could be applied inconsistently. The internal
consistency test required that the application of a tax be identical for every taxpayer, regardless of the economic reality of
that tax. The trial court awarded a full refund of all business
taxes paid during the period at issue. See also, Macy’s Dept.
Stores Inc. v. San Francisco, 143 Cal. App. 4th 1444 (Cal. Ct.
App. 2006).
16
Los Angeles had a similar tax structure to that challenged
in the Macy’s case. The Los Angeles tax structure also was
struck down as unconstitutional because it exempted in-city
businesses paying the payroll tax from paying the gross receipts tax. However, businesses located outside the city and
doing business in Los Angeles were subject to the gross receipts tax. This created a discriminatory situation whereby two
businesses performing the same activities in Los Angeles were
not subject to the same tax due to their location inside or outside the city. Los Angeles amended its regime to eliminate the
payroll tax in favor of a single gross receipts tax. See, Id.
17
Id.
18
See, San Francisco Controller’s Office of Economic
Analysis, Enacting a Gross Receipts Tax, and Phasing-Out the
Payroll Expense Tax: Economic Impact Report, (Aug. 24,
2012),
http://sfcontroller.org/Modules/
ShowDocument.aspx?documentid=3426.
19
Id. (in addition to the statutory exclusions, the City has
allowed negotiated exceptions on a company-by-company basis).
20
Id.
21
Id.
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Proposition E was proposed in 2012 and passed with
approval of 71 percent of the popular vote.22 The GRT
implemented by Proposition E applies to any entity engaged in business within the City, unless otherwise exempt.23 The GRT rate varies depending on the amount
of annual gross receipts an entity allocates to the City
and the type of business activity in which it engages.24
Are You Subject to the Gross Receipts Tax? The new
GRT is considered a privilege tax imposed on entities
engaged in business in San Francisco.25 Entities are
considered to be engaged in business, and subject to the
GRT, if they (or their employees, representatives or
agents) participate in any of the following nexuscreating activities:26
s Maintaining a fixed place of business in the City;
s Owning, renting or leasing real or personal property located in the City for a business purpose;
s Employing or loaning capital on property located
within the City for a business purpose;
s Performing work or services within the City or
utilizing the streets in connection with a business activity for at least seven days in a year;
s Exercising corporate or franchise powers within
the City; or
s
Liquidating a business when the liquidator
thereof holds themselves out to the public as conducting business.27
On the other hand, a taxpayer will not be deemed to
be engaged in business, and thus will not be required to
register or file for GRT purposes if that taxpayer’s activities consist solely of one or more of the following:
s Using the services of any unrelated investment
advisor;
s Maintaining documents of formation, incorporation or registration within the City;
s Being an owner, member or other participant in a
pass-through entity engaging in business within the
City; or
s Having trustees or directors who meet or reside
within the City.28
Definition of Gross Receipts The City’s GRT ordinance
broadly defines ‘‘gross receipts’’ to include all
‘‘amounts derived from sales, services, dealings in
property, interest, rent, royalties, dividends, licensing
fees, other fees, commissions and distributed amounts
from other business entities’’ related to activities conducted, services performed or properties located or
used within the City.29 The definition also includes ‘‘all
22
Proposition E, San Francisco Gross Receipts Tax Ordinance Article 12-A-1 (approved Nov. 6, 2012) provides the basis for tax, reasons for the change and regulations for entities
engaged in business in the City.
23
San Francisco Bus. and Tax Regs. §954.1 (a number of
exemptions are discussed below).
24
Id. §953(a).
25
Id. §953(b).
26
Id. §6.2-12 (defining what the City considers to be nexuscreating activities). It is important to note that the City did not
explicitly adopt California’s recently implemented economic
nexus standard; whether or not the City will consider economic nexus sufficient to subject an entity to taxation is not yet
determined.
27
Id.
28
Id. §952.3(g).
29
Id. §952.3(a).
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amounts that constitute gross income for federal tax
purposes.’’30
In general, gross receipts include those of all related
entities, but gross receipts generated through intercompany transactions between members of the same combined unitary group will be excluded.31 Gross receipts
do not include any federal, state or local tax on retail
sales, regardless of whether the tax is separately stated
or included as part of the sales price.32 In addition, refunds of federal, state or local taxes paid are excluded
from gross receipts for purposes of the GRT.33 Additionally, gross receipts of pass-through entities that are
subject to tax in the hands of the entity that first receives them are not includable in the gross receipts of
the entity’s owners.34 Further, gross receipts do not include any allocations of income or gain from passthrough entities, but only to the extent these allocations
are derived ‘‘exclusively from investment’’ in a lower
tier pass-through entity.35
Classification A business’s GRT is calculated using
gross receipts as reported on its federal income tax return, less any exclusion(s).36 The amount of gross receipts to be taxed by the City can be determined based
on location of property, benefit received or services performed, or using the payroll expense method.37 Businesses will register under one of seven different North
American Industry Classification System (‘‘NAICS’’)
classifications with rates varying from 0.075 percent
30
Id. The ordinance states that no deduction may be taken
on account of the cost of the property sold, the cost of materials used, labor or service costs, interest paid or payable, losses
or any other expense whatsoever, except that cash discounts
allowed or taken on sales shall not be included as receipts. The
ordinance makes no reference to the inclusion of bad debt in
gross receipts.
31
Id. §952.3(d).
32
Id. §952.3(c).
33
Id.
34
Id. §952.3(d).
35
Id. Pass-through entities such as private equity funds will
likely be significantly affected by the nuances of the GRT. In
the context of private equity funds, amounts a general partner
receives in the form of carried interest are generally not exclusively from investment in the partnership (carried interest is
generally not directly tied to the general partner’s capital contribution in the partnership) in which it manages, therefore,
gross receipts earned from carried interest may likely be subject to tax under the GRT. It is important to note that the taxability of carried interest may vary based on the facts and circumstances of the partnership and should be reviewed on a
case-by-case basis. For instance, real estate investment partnership carried interest may be measured based on the amount
of rental receipts earned from the lower-tier partnership. Under this scenario, there may be opportunities to exclude certain gross receipts as these receipts may have been previously
taxed. Of additional concern is where the same general partner has both a carried interest in an investment fund and a
capital investment in the fund. Under general partnership tax
rules, a partner is generally treated as having one unified partnership interest. It is unclear whether, for purposes of the
GRT, a distribution or allocation will be bifurcated so that the
general partner can treat a portion of its return as derived from
its capital investment and a portion as attributable to the carried interest. Current guidance surrounding this issue is unclear, and this issue may be a matter of contention and controversy for investment funds doing business within the City.
36
Id. §952.3(a).
37
Id. §956.1.
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-0.65 percent of total gross receipts depending on the
NAICS classification applicable to the particular taxpayer.38
If a business engages in multiple activities classified
under different NAICS classifications (and thus, under
different GRT rates), the rate that applies to the business will be determined based on the percentage of
gross receipts derived from each individual business activity.39 If a taxpayer engages in multiple business activities, and more than 80 percent of gross receipts are
from one activity, the taxpayer may take the single primary classification election and tax all receipts at that
activity’s rate.40 If no single activity comprises 80 percent of gross receipts, the GRT is computed separately
for each business activity. If any activities consist of less
than 20 percent of gross receipts, the taxpayer may
choose to aggregate and use the highest rate within the
group of business activities for determining its GRT.41
Under the GRT, there is a limited subset of taxpayers
referred to as ‘‘administrative offices’’ that may continue to pay the payroll expense tax to the City. A 1.4
percent payroll expense tax will be imposed on such a
taxpayer based on the total San Francisco payroll of administrative offices located within the City.42 To qualify
as an administrative office, the taxpayer must have at
least 1,000 employees and $1 billion of combined gross
receipts between itself and its affiliated group.43 Administration and management services include activities
that do not directly generate gross receipts. For purposes of the GRT, any taxpayer with over 50 percent of
its payroll within the City associated with administrative and management services shall be considered an
administrative office.44
Apportionment of Gross Receipts The GRT provides for
different apportionment methodologies based on a
business’s classification.45 The three primary methodologies are as follows:
38
The seven NAICS classifications will pay GRT at the following rates that are progressive depending upon the taxpayer’s gross receipts: a) retail and wholesale: 0.075 percent
-0.160 percent; b) manufacturing, technology and transport:
0.125 percent -0.475 percent; c) hospitality, art and entertainment: 0.300 percent -0.400 percent; d) education and healthcare: 0.525 percent -0.650 percent; e) construction: 0.300 percent -0.450 percent; f) financial services and insurance: 0.400
percent-0.560 percent; and g) real estate: 0.285 percent-0.300
percent. See, San Francisco Bus. and Tax Regs. §953.
39
Id. §953.9.
40
Id. §953.9(a).
41
Id. §953.9(b)(1).
42
To qualify as an administrative office, the taxpayer must
have at least 1,000 employees and $1 billion of combined gross
receipts between itself and its affiliated group on a worldwide
basis. Administration and management services include activities that do not directly generate gross receipts. Compensation
includes wages, salaries, commissions and any other form of
remuneration paid to employees for services. See, Id. §953.8.
43
Id. §953.8(b).
44
It is important to note that even if an entity has only one
employee in the City and meets the other requirements set
forth by this section, it will be deemed to qualify as an administrative office for purposes of the code. The administrative
classification may give rise to a constitutional challenge, as it
may subject inter- and intra-city businesses to different tax
rates. See, Id. §953.8(b)(1).
45
Id. §956.
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a. Allocation by location (market-based approach): Requires
taxpayers to source receipts where real property is located, where the benefit of services is received, or, in
the case of financial instruments, where the customer is
located.46
b. Allocation based on payroll: Requires apportionment
based on total payroll for services provided in the City
over total payroll everywhere.47
c. Combined apportionment method: Requires a taxpayer
to apportion half of its receipts using a market-based
approach and half of its receipts based on payroll apportionment.
A company must closely examine its classification
not only to determine its rate but also to determine
which apportionment methodology should be employed. For example, gross receipts from the sale, lease,
or rental of real property or licensing of tangible personal property are in the City and included in the GRT
calculation if the property is located in the City.48 Alternatively, companies generating gross receipts from the
sale of tangible personal property (e.g., wholesale/
retail), use a combined filing methodology whereby 50
percent of the company’s gross receipts are apportioned based upon the ship-to location of the customer
and the other 50 percent are sourced using payroll apportionment.49
Entities classified within the ‘‘financial services’’ NAICS code generally use the apportionment by payroll
method and assign gross receipts using a single payroll
factor.50 Payroll includes compensation for services
paid to employees within the City and generally excludes compensation of owners for GRT purposes.51
However, if a business has no W-2 employees and no
payroll (i.e., the company uses a separate payroll entity), ‘‘payroll’’ is determined using all taxable income
of owners and proprietors who are individuals.52 Outside the plain language of the statute, the City has offered no further guidance related to the mechanics of
entities without payroll that are subject to payroll-based
apportionment.
Combined Filing Requirement Prior to the implementation of the GRT, taxpayers were required to compute
their payroll tax returns on a separate basis, regardless
of whether they were part of a combined filing group
for federal or state income tax purposes.53 Under the
GRT, taxpayers and related parties will be required to
file their GRT returns on a combined basis.54 Related
parties are defined as those entities whose income the
taxpayer would be permitted or required to reflect on a
California combined report.55 The City follows the Cali46
Id. §956.1.
Id. §956.2(a),(b).
48
Id. §956.1.
49
Id. §953(e).
50
Id. §956.
51
Id. §956.2(f).
52
Id.
53
Id. §907(b).
54
Combined reporting requires that a business disregard
the legal existence of affiliates and report on a combined basis
the operations of all related entities involved in a unitary business. This requirement imposed by the City differs from reporting in jurisdictions such as Los Angeles, which requires
taxpayers to file on a separate-company basis. See, Id. §956.3.
55
The key word in this sentence is ‘‘or,’’ as the form in
which an entity files its California income tax return may dif47
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fornia combined reporting group to calculate combined
gross receipts and combined payroll filing.56 As such, if
the taxpayer was a member of a water’s edge election
on its California return, the City would define the combined group in accordance with its group’s election.
The combined group must elect one member of the
combined group to file on the group’s behalf. In accordance with this election, all members of the combined
group engaging in business within the City must grant
a power of attorney to the person filing the combined
GRT return to file and pay on behalf of the entire combined group.57
For California income and franchise tax purposes, a
partnership, limited liability company (‘‘LLC’’) and limited liability partnership (‘‘LLP’’) is generally not includable with affiliated corporations in a California
combined return. However, for purposes of the GRT, a
related party permitted or required to have its income
reflected on its California combined return must be included in the group.58 It may be possible that a partnership, LLP or LLC will be required to file in combination
with related entities for purposes of GRT reporting.
b. Application of Joyce or Finnigan
The City has not yet released guidance on whether
taxpayers will be subject to Joyce59 or Finnigan60 apportionment rules with respect to sourcing sales to the
City.61 Under the City’s apportionment and allocation
rules, however, whether the City adopts a Joyce or
Finnigan approach to its sales sourcing could play a
critical role in determining which entities’ gross receipts are includable for GRT apportionment purposes.
The first approach comes from a California State
Board of Equalization (‘‘BOE’’) case, Appeal of Joyce.62
In Joyce, the BOE held that receipts from the sale of
goods to California customers by a seller who was not
taxable in California because of Pub. L. No. 86-272,63
fer from that for which it files its City return. This comes into
play with a water’s edge filing in California. See, Id. §952.5.
56
Id.
57
Id. §956.3.
58
Id. §952.5 (citing California Revenue and Taxation Code
§25102) (providing that the Franchise Tax Board may permit
or require a ‘‘person’’ to file a combined return if a combined
filing is necessary to reflect the proper income of such persons.
A ‘‘person’’ is defined as any person, firm, partnership, general
partner of a partnership, limited liability company, or registered limited liability partnership).
59
Appeal of Joyce Inc., No. 66-SBE-070 (Cal. SBE Nov. 23,
1966).
60
Appeal of Finnigan Corp., No. 88 SBE-022-A (Cal. SBE
Aug. 28, 1988).
61
San Francisco Bus. and Tax Regs. §956.3.
62
Appeal of Joyce Inc., No. 66-SBE-070 (Cal. SBE Nov. 23,
1966) (holding that where Pub. L. No. 86-272 barred California
from taxing a member of a unitary group, the sales made by
that member of the group into California could not be included
in the numerator of the sales factor for purposes determining
the California taxable income of another group member).
63
With the enactment of the Interstate Income Act (commonly known as ‘‘Pub. L. No. 86-272’’) in 1959, the U.S. Congress for the first time acted to limit the states’ power to tax net
income derived from interstate commerce. Pub. L. No. 86-272
restricts any state from imposing its net income tax on net income derived within its borders from interstate commerce if
the only business activity of the company within the state consists of the ‘‘solicitation’’ of orders for sales of tangible personal property, which orders are to be sent outside the state for
acceptance or rejection and, if accepted, are filled by shipment
or delivery from a point outside the state. It is important to
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but was part of a unitary business, could not be included in the unitary group’s combined California sales
factor.
The second approach comes from another BOE case,
Appeal of Finnigan.64 In Finnigan, the BOE overturned
its prior decision in Joyce, holding, for purposes of the
sales throwback rule, a taxpayer is defined as the entire
unitary group and not the individual member of the
group making the sale.65 The BOE determined that for
purposes of the sales factor for the sale of tangible personal property, the term ‘‘taxpayer’’ encompassed not
just an individual company but also the entire unitary
group, regardless of number of companies. The issue in
Finnigan dealt with California’s sales throwback rule
(the California statute regulating sourcing of sales of
tangible personal property). The statute required sales
to be sourced to the destination state of the goods unless the taxpayer is not taxable in that state; in that
case, the sales will be sourced or ‘‘thrown back’’ to California. The taxpayer in Finnigan was not taxable in the
destination state, although other members of its unitary
group were. The BOE held that if any member of the
unitary group were taxable in the destination state, the
receipts would not be ‘‘thrown back.’’66
As discussed previously, the City applies one of three
methodologies when apportioning receipts — payrollbased apportionment, allocation, or a combined apportionment methodology.
Under the payroll-based approach, application of
Joyce or Finnigan will have no bearing on determining
which entities’ gross receipts are includable in the combined group’s City tax base. If a member of a unitary
group has City payroll, the entity will be taxable in the
City.67 As such, for entities applying classifications using a payroll-only apportionment, whether the city
adopts a Joyce or Finnigan approach will have no impact. The computation will include the payroll of all entities in the reporting group’s apportionment numerator
and denominator.
However, if a company is applying the allocation or
combined reporting methodology, whether the City
adopts a Joyce or Finnigan approach could be more significant. Specifically, under the allocation method of apportionment, a taxpayer is required to apply marketbased sourcing rules to determine how to source receipts to the City. However, a member of a unitary
group could be deemed to have receipts marketsourced to the City without having a taxable presence
in the City under Article 6-A.
The City’s market-based sourcing rules require gross
receipts to be sourced to the City if the market for the
services or the benefit of the use of an intangible asset
note that Pub. L. No. 86-272 only applies to taxes based on net
income. Thus, it does not apply to sales taxes, capital/franchise
taxes, gross receipts taxes, property taxes, or any other tax
based on a measure other than net income. In addition, the
protections provided by Pub. L. No. 86-272 only apply to taxpayers whose activities in the state are limited to sales of tangible personal property. Consequently, it does not apply to sellers of real property, intangible property or services providers.
See, 15 U.S.C. §§381-384.
64
Appeal of Finnigan Corp., No. 88 SBE-022-A (Cal. SBE
Aug. 28, 1988).
65
Id.
66
Id.
67
San Francisco Bus. and Tax Regs. §6.2-12.
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is within the City.68 Without application of Joyce or
Finnigan concepts, there is a clear conflict between the
Article 6-A nexus requirements and the market sourcing rules under Section 956.1.69 Since the City requires
filers to report receipts on a combined basis, is a taxpayer required to allocate gross receipts to the City only
from those companies with stand-alone nexus as defined under Article 6-A? Do all members of the combined reporting group need to source intangible receipts to the City if one of the affiliates has Article 6-A
nexus? The City has not yet released guidance on this
matter.
Exemptions The City’s municipal code includes an exemption from the GRT for certain organizations such as
nonprofit organizations, tax-exempt organizations,
banks and insurance companies exempt from local
taxation, for-hire motor carriers of property, household
good carriers and charter-party carriers domiciled outside the City.70 Individual sales of non-business real
property, such as a homeowner selling a personal residence, are also exempt from the tax.71 Being a partner,
member, shareholder or other owner of a pass-through
entity engaging in business within the City does not
subject a person to the GRT.72 The small business exemption is also available to certain companies in the
City.73 A business is not required to pay the GRT if its
San Francisco gross receipts from the prior year were
less than $1 million.74
Exclusions and Credits Exclusions from gross receipts
include amounts derived from or related to real or personal property located or used outside the City, investment receipts,75 and certain taxes collected on behalf of
government agencies.76 Issuance of equity and costs to
acquire assets shall also be excluded from gross receipts.77 Receipts from the sale of real property located
in the City are excluded if the real property transfer tax
has previously been paid to the City.78 Receipts from
renting or leasing residential real estate are excluded if
the owner rents a total of less than four units, as are 50
percent of receipts from rental of rent-controlled buildings.79 Additionally, to the extent that any taxpayer has
paid a substantially similar tax to any other taxing jurisdiction on any gross receipts attributed to the City,
the tax paid to such taxing jurisdiction(s) shall be cred68
Id. §956.1(e, f).
Id. §956.1(a)-(f).
Id. §954(f)(1-6).
71
Id. §954(e).
72
Id. §952.3(d).
73
Id. §954.1.
74
Id. However, the business must still register with the City
and pay the annual registration fee. For the amount of the fee,
see footnote 82 and the accompanying text.
75
Id. §952.3(d) defines investment receipts to include interest, dividends, capital gains, other amounts received on account of financial instruments and distributions from business
entities, provided such items are directly derived exclusively
from the investment of capital and not from the sale of property other than financial instruments, or from the provision of
services, to any person).
76
Id. §952.3(c).
77
Id. §952.3(e).
78
If the transfer tax is not paid, the cost basis of real property is excludable in the calculation of gross receipts. See, Id.
§954(e).
79
Id. §954(d).
69
70
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ited against the GRT due.80 The City has not yet provided a definition regarding what is considered to be a
substantially similar tax, so the question remains as to
what specific taxes will be allowed as credits against the
GRT.
Registration Fee In addition to paying the GRT, every
person or entity engaging in business in the City is required to apply for a registration certificate and pay an
annual registration fee ranging from $75 to $35,000,
based on81 the amount of gross receipts it apportions to
the City. A combined unitary group should apply for a
single business license certificate and calculate its annual registration fee on combined unitary gross receipts
attributable to the City. A question arises as to whether
the registration fee may face constitutional scrutiny as
it could be deemed to be a second tax on gross receipts.82
Buck Act Implications The Presidio area of the City is
a federal enclave.83 As such, businesses located in the
Presidio have long been exempt from City business
taxation due to the Buck Act of 1940. The Buck Act
states that no person shall be relieved from liability for
80
Id. §954(g).
Businesses with $0 - $66.66 of in-City gross receipts for
the immediately preceding year will be subject to the $75 registration fee. The registration fee increases gradually until a
maximum $35,000 registration fee is imposed on businesses
with more than $40,000,000 of gross receipts. See, Id. §855(c).
82
California courts have previously struck down fees
deemed to be second taxes on gross receipts or income. Prior
to enactment of Assembly Bill 198 (Stats. 2007, Ch. 381, effective on Oct. 10, 2007, and operative for taxable years beginning
on or after Jan. 1, 2007), California LLCs paid an annual fee
based on the LLC’s total income from all sources reportable to
the state. The LLC fee was in addition to the annual tax set
forth in CR&TC Section 17941. See, Northwest Energetic Services, LLC v. California Franchise Tax Bd., San Francisco Superior Court, Case No. CGC-05-437721 (holding that California’s annual LLC fee was unconstitutional because it violated
the commerce and due process clauses of the U.S. Constitution
by levying the fee based on worldwide income rather than on
that portion fairly apportioned to California), see also, Ventas
Finance I, LLC v. Franchise Tax Bd., 165 Cal. App.4th 1207
(2008), review den. Nov. 12, 2008, cert. den. 129 S. Ct. 1917
(2009).
83
The Presidio is located within the boundaries of the City
and County of San Francisco, but the federal government owns
it and has exclusive jurisdiction over it, with limited exceptions. Mexico ceded the Presidio to the U.S. in 1848 under the
Treaty of Guadalupe Hidalgo. When California was admitted
to the Union two years later, the Presidio passed to the state
without any reservation of federal jurisdiction, although the
federal government owned the property and occupied it as a
military reservation at the time. (U.S. v. Watkins (N.D. Cal.
1927) 22 F.2d 437, 438.). In 1897, California ceded to the federal government ‘‘exclusive jurisdiction over all lands within
this state now held, occupied, or reserved by the government
of the U.S. for military purposes or defense. . .’’ (Cal. Stats.
1897, Ch. LVI, §1, p. 51; emphasis added.) The state reserved
‘‘the right to serve and execute’’ civil and criminal process.
(Ibid.) The U.S. accepted jurisdiction over the Presidio. (U.S. v.
Watkins, supra, 22 F.2d at pp. 439-40; See Standard Oil v. California (1934) 291 U.S. 242, 244.) The Presidio is now part of
the Golden Gate National Recreation Area, and non-military
branches of government manage the property as a public park.
(Pub. L. 104-333, as amended (the Presidio Trust Act); 16
U.S.C. §440(bb)). See, Presidio Trust Act, Title 1 of Pub. L. No.
104-333, 110 Stats. 4097.
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any income tax levied by any State due to their location
in a federal enclave.84 In a 2002 opinion, the City attorney stated that, for purposes of the Buck Act, it is very
unlikely that a court would consider the payroll tax or
the registration fee an income tax, as neither was based
on ‘‘net income, gross income, or gross receipts.’’85 The
City attorney further stated that the payroll expense tax
bears no particular relationship to a business’ receipts,
is not levied on any form of income and does not vary
as the taxpayer’s income varies.86 As such, the City has
not subjected businesses located in the Presidio to business taxes under the payroll expense tax regime.
For purposes of the Buck Act, a gross receipts tax
such as the City’s is classified as an income tax, so entities located in the Presidio are subject to the GRT.87 Additionally, as the registration fee is now based on gross
receipts, it is likely that these businesses will be subject
to both the registration fee and the GRT even though
they were previously exempt from the payroll expense
tax.
Administrative Relief Process The GRT administrative
relief process requires taxpayers to follow a three-step
method for any controversy arising from the GRT prior
to seeking judicial relief. Taxpayers against whom a determination of deficiency is made must exhaust their
administrative remedies by satisfying each of the following steps:
1) Submit a petition to the tax collector for redetermination that includes all relevant facts and specific
grounds supporting the petition for redetermination.
This petition must be filed no later than 30 days from
the date of the notice from the tax collector. Failure to
do so may result in a taxpayer losing the ability to file a
claim;88
2) Pay the full amount owed as set forth in the final
determination; and
3) Present a claim for refund to the controller, which
the City attorney has denied or which the claimant has
deemed denied.89
If a petition is timely filed, the tax collector will reconsider the determination.90 If requested in the petition, the tax collector will grant the taxpayer or its authorized representative an oral hearing, at which the
84
4 USCS §105-108. (providing that ‘‘[no] person shall be
relieved from liability for any income tax levied by any State,
or by any duly constituted taxing authority therein, having jurisdiction to levy such a tax, by reason of his residing within a
Federal area or receiving income from transactions occurring
or services performed in such area; and such State or taxing
authority shall have full jurisdiction and power to levy and collect such tax in any Federal area within such State to the same
extent and with the same effect as though such area was not a
Federal area.’’).
85
Id. See also, San Francisco City and County Attorney
Opinion 2002-02 (Jan. 29, 2002).
86
San Francisco City and County Attorney Opinion 200202. (citing U.S. v. Denver, 573 F. Supp. at p. 692)(holding that
the city’s per capita employment tax was not an income tax for
purposes of the Buck Act, despite exemption for persons earning less than a threshold amount).
87
4 USCS §105-108. See also, S.F. Att’y Op. 2002-02 (stating ‘‘income’’ is defined broadly to include any tax levied on or
measured by net income, gross income or gross receipts).
88
San Francisco Bus. and Tax Regs. §6_6.13-1.
89
Id. §6_6.13-5.
90
Id. §6_6.13-2.
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taxpayer can make its case as to the reason(s) why the
tax collector’s determination is in error.91 At the oral
hearing, the taxpayer is allowed to plead his or her case
and attempt to obtain a decrease in the amount of the
determination of taxation.
If a taxpayer exhausts its remedies through the administrative relief process, it may pursue judicial relief
in Superior Court.92 The Superior Court will conduct a
de novo hearing, except that the contents of the tax collector’s file will be received into evidence.93
Revenue Projections The taxes and fees from the new
GRT, expected to generate approximately $450 million
in 2014, will be contributed to San Francisco’s General
Fund.94 According to the Controller’s office, this makes
the GRT the City’s second-largest contributor to the
General Fund, behind property taxes.95 The City expects to increase net revenue from business taxation by
$28.5 million in the first year of implementation due to
the increase in business registration fees required by
the new GRT.96 While the City expects an increase in
91
Id.
Id. §6_6.19-10(a).
Id. §6_6.19-10(b).
94
See, Proposition E Gross Receipts Tax San Francisco,
http://www.smartvoter.org/2012/11/06/ca/sf/prop/E/. The GRT
was designed to be revenue neutral regarding taxes collected,
though the City’s tax base will be significantly broadened and
registration fees will increase under the new system.
95
See, City and County of San Francisco, Office of the Controller, San Francisco Business Tax Reform: Summary of
Gross Receipts Tax Legislation Introduced on June 12, 2012,
http://sfgsa.org/Modules/
ShowDocument.aspx?documentid=8934.
96
See, San Francisco Controller’s Office of Economic
Analysis, Enacting a Gross Receipts Tax, and Phasing-Out the
92
93
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tax revenue after switching from the payroll expense
tax to the GRT system, the City’s chief economist projected that the change would create a net increase of
about 2,000 jobs over the next 20 years.97 Critics of the
GRT state that this increase in job production is unlikely, however, and that the GRT may result in higher
prices, lower wages and fewer jobs.98
The Future of the GRT If the GRT increases payments
to City coffers in the expected amounts, the City will be
reluctant to revert to a payroll tax or other regime.99
Though only in its infancy, the GRT seems likely to play
a major impact in the City’s business community and
will continue to be subject to much debate in the near
future.
Payroll Expense Tax: Economic Impact Report, (Aug. 24,
2012),
http://sfcontroller.org/Modules/
ShowDocument.aspx?documentid=3426. Prior to the implementation of the GRT, business registration fees were based
on City payroll expenditures; the City has restructured the registration fee for years after 2014 to be based on an entity’s
gross receipts. The fees have substantially increased; where
they were formerly $25 - $500, they now range from $75 $35,000.
97
See, John Cote, SF Gate, Prop. E: Rare Chance to
Change Tax, (Oct. 22, 2012), available at http://
www.sfgate.com/bayarea/article/Prop-E-rare-chance-tochange-tax-3969843.php.
98
See, Proposition E Gross Receipts Tax San Francisco,
http://www.smartvoter.org/2012/11/06/ca/sf/prop/E/.
99
In the event that the GRT does not meet revenue projections, the City reserves the right to reverse its decision to sunset the payroll tax and continue a mixed regime of payroll and
receipts taxes, or revert to a payroll tax-only structure. See,
San Francisco Bus. and Tax Regs. §903.1(d)(3).
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