California Cities Agree to Rein in Apple-Like Tax Windfalls

California cities will seek legislation to limit tax-sharing arrangements that give windfalls to a handful of cities and millions in public money to retailers like Apple Inc., Best Buy Co. Inc., and Williams-Sonoma Inc.

The League of California Cities has endorsed a plan to limit deals that hinge on e-commerce and a quirk in California’s sales tax rules sending the local portion of sales tax to the location where the transaction takes place, rather than where the customer lives.

The plan would end a years-long stalemate between cities such as Ontario, which has arrangements with the likes of Nike Inc. and QVC, and places like Rancho Cucamonga, which borders Ontario in the heart of Southern California’s warehouse-filled landscape and opposes its neighbor’s deals.

But city officials are still far from agreeing on how to change California’s underlying rules that gave rise to the deals in the first place. Unless they come to a truce, the agreement about tax-sharing deals will be only an incremental fix to a high-stakes conundrum, they said. Cities are continuing to argue among themselves about rules that put them at the mercy of retailers that decide how much of $9.6 billion in annual local sales tax they’ll get.

“Because current rules allow online retailers to effectively choose the point of sale if they operate multiple distribution centers and credit all those sales to one city in return for a higher percentage of rebate, it creates a very pernicious competition amongst cities to give back a higher percentage in rebates to be the one winner,” said Charles Bourbeau, a city council member from the central coast city of Atascadero and chair of the league’s Revenue and Taxation Committee.

The proposed changes would limit—but not eliminate—that type of competition, he said.

At stake is every city’s share of about $9.6 billion in local sales tax collected annually. The money comes from a 1 percentage point increment, called the Bradley-Burns tax, earmarked for local governments out of the 7.25% statewide sales tax. The California Department of Tax and Fee Administration collects the tax and distributes it to 561 cities and counties primarily based on where transactions take place.

“It’s one pie. The issue is how it gets allocated,” said Joseph A. Vinatieri, mayor of Whittier, southeast of downtown Los Angeles, and member of the league’s tax committee. He is also a tax attorney with Bewley, Lassleben & Miller LLC. Whittier has considered entering into tax-sharing agreements but hasn’t carried them out.

Bonanza for a Few

A few dozen California cities have cut deals with retail giants like Apple, Best Buy, and Walmart, which assign in-state online sales to those cities based on the presence of a warehouse or sales office. The arrangements often last decades. In return, the cities give a share—typically half—of the resulting sales tax revenue back to the companies in the name of economic development. Sometimes the cities also give a portion of the annual proceeds to consultants and lawyers who broker the deals.

The deals create losses for two-thirds of cities and a bonanza for fewer than 30, according to a recent CDTFA report.

Bloomberg Tax has found that the Central Valley city of Dinuba paid Best Buy $42.6 million between 2016 and the first quarter of 2023 under the terms of its deal. A lawyer who brokered the deal earned $9 million over the same time. Apple’s deal with Cupertino has resulted in one of the world’s richest companies getting $107.7 million from its hometown between 1998 and the end of 2022, although the validity of the deal is in doubt.

Cupertino officials announced in April that the state tax department is questioning whether Apple’s assignment of sales to the city is proper, threatening 73% of its annual sales tax revenue. The city will appeal the state’s determination, and Apple could be required to repay at least $20 million it has received from the city if the state tax department prevails.

The league, a coalition of city governments, convened a task force in 2021 to craft options that would minimize concentration of revenue in a few cities at the expense of hundreds of others. More than two years later, the league is proposing that all new sharing agreements be capped at 20 years and city payments to retailers be capped at 50% of tax revenue they generate. Existing agreements could remain in place, but cities would be unable to extend them in perpetuity to avoid the new limits.

Cupertino’s 1998 agreement with Apple would thus expire in 2033, but any new deals would be subject to the legislation’s terms. The same would apply to Shafter’s 2008 agreement with Williams-Sonoma expiring in 2036, Fresno’s 2018 agreement with the Gap Inc. expiring in 2048, Dinuba’s 2016 agreement with Best Buy expiring in 2055, and others.

To further reverse the concentration of revenue, cities would also exclude payments they make to the companies from a separate calculation that determines how much they get from pools of revenue tied to items shipped from out of state.

Under the current formula, established in the 1950s, the local sales tax on items shipped from out of state—considered a use tax—is placed in a county pool based on the location of the customer. Some of it ends up in a much smaller statewide pool when the destination county can’t be determined.

That pool is divided proportionally between jurisdictions within a county based on revenue from in-state sales. The more a city gets from California sales, the larger its percentage of the pool from out-of-state sales, giving cities with tax-sharing deals distorted shares, city representatives agreed.

Take Cupertino, where all online sales to Apple’s California customers are assigned. Cupertino’s 57,856 residents make up 3.1% of the Santa Clara County population of 1.8 million. In the fourth quarter of 2022, Cupertino received 8.2% of the Santa Clara County pool and 0.49% of the statewide pool, totaling $2.3 million. This was added to $9.9 million in revenue from all transactions in the city, most of which were from Apple purchases, for a total of $12.3 million.

In the same quarter, Cupertino paid Apple $2.7 million for its share of all revenue the city received. Under the league’s proposal, that payment would be subtracted from the $9.9 million, reducing the amount used to calculate Cupertino’s percentage share of the county pool.

But next-door Sunnyvale has 153,091 residents, or 8.2% of Santa Clara County’s population. In the fourth quarter of 2022, Sunnyvale received 6.4% of the county pool and 0.4% of the state pool, for $1.8 million. That was added to its $8.1 million in revenue from local sales, for a total of $10 million. Sunnyvale doesn’t have any sales tax-sharing agreements.

Acknowledging Unfairness

The League of California Cities’ proposal is a fair compromise, said Dinuba City Council member Kuldip Thusu, who is vice chair of the organization’s tax committee.

“It wouldn’t impact Dinuba or any other city that has a similar tax-sharing agreement, and prepares them to create future alternative revenue streams to fulfill their respective needs and goals,” Thusu said.

The CDTFA doesn’t have a position on the league’s proposal, but the change to the county pool calculation would require cities to provide more information to the department, spokesperson Tamma Adamek said.

The league’s proposed legislation would ease tension between the haves and have-nots, but the cities are still trying to reach an agreement on changing the underlying rules that send local sales tax to the origin of the transaction rather than the destination. The rules play out in ways the legislation wouldn’t address.

Plenty of California cities don’t have sales tax-sharing agreements with retailers but still enjoy windfalls from the presence of warehouses, while others with warehouses get little because the retailer has decided to assign sales elsewhere.

For example, when Amazon Inc. changed its corporate structure in 2019, it started a new flow of revenue to fewer than 20 cities with fulfillment centers where the company decided to assign California sales. The city of Eastvale, in Riverside County, with two Amazon warehouses, has seen its tax revenue more than quadruple from $10.3 million to $44.7 million in three years due to Amazon’s change. Amazon doesn’t cut tax-sharing deals with cities, but does receive other incentives from some cities like property tax relief or payments based on employment levels. It doesn’t receive incentives from Eastvale.

The league has made some progress. In July, it abandoned a years-old policy position calling for a change in the law so all tax proceeds from internet sales would go to the location of the purchaser. A constitutional amendment proposed in 2018 to make that change went nowhere because of stiff opposition from cities on the winning side of the equation, but those cities are increasingly acknowledging the current rules aren’t fair.

“There’s agreement on both sides that it’s neither equitable nor realistic to do a winner-takes-all approach,” Rancho Cucamonga City Manager and league tax committee member John Gillison said.

Instead, the league adopted a new position to preserve the current rules while its members negotiate a compromise to split the 1% local sales tax between the location of the transaction and the customer. The question is: What is an equitable split?

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Any change would require a two-thirds vote of the Legislature and possibly approval from voters because the current rules are enshrined in the state constitution. Committee members said they are aiming for an agreement in 2024.

“The rebate agreement stuff is irritating but it’s peripheral,” Bourbeau, the Atascadero City Council member who chairs the league’s taxation committee, said. “The elephant in the room is what happens to the Bradley-Burns 1% on online sales. The big deal is where that sales tax goes.”

In the meantime, the league is drafting the bill to limit tax-sharing deals and will look for a member of the Legislature to introduce it in 2024. Gov. Gavin Newsom (D) might be inclined to support the idea. He vetoed a bill in 2019 that would have banned such deals, but signed another bill increasing disclosures about them. At the time, he said the deals are important tools for the few cities that use them, especially those in rural and inland areas facing high unemployment.

“Therefore, completely removing these tax options from local decision makers is the wrong approach,” Newsom said.