Gross Receipts Tax – City Real Estate Braces For Yet Another Expense

Like many other California municipalities, San Francisco continues to make efforts to increase its tax revenue while encouraging business growth. Unfortunately, these goals are not always compatible. In an effort to level the playing field between businesses with few employees and those with many, Mayor Lee and Supervisor Chiu have proposed a new gross receipts tax on businesses that would replace the current payroll tax. According to the draft legislation’s findings, the current payroll tax “discourages job creation and economic growth, lowers wages, and provides an unstable revenue stream.” The findings go on to state that by imposing a gross receipts tax, the tax burden will be better distributed “based on a business’s ability to pay.”

While some of these concerns with the payroll tax may be legitimate, the proposed legislation is yet another financial burden on real estate development and ownership. The Mayor’s office has worked to make the gross receipts tax “revenue neutral”, so that there is no net increase in taxes on all San Francisco businesses compared to the payroll tax. (However, business license fees would increase under the legislation and raise an additional $13 Million in new revenue.) There is no question that certain industries, including real estate, will be hit harder than others. Many property owners are concerned that the additional expense could slow the recent recovery.

Overview of Proposed Gross Receipts Tax

The gross receipts tax would impose different tax rates based on the type of business. The rates would be progressive, determined by the total amount of gross receipts received. For the most part, “gross receipts” include all payments of cash and property of any kind received by the business. There are no deductions or exclusions for companies that receive payments for client costs, cost of materials, or other expenses. The tax would be imposed regardless of where the revenue is generated – which could have a major impact on companies that make their headquarters in San Francisco. To help alleviate this burden, certain industries (not real estate) are allowed to determine 50% of the tax based on the percentage of payroll that is located in the City. Deductions are allowed for taxes imposed on retail sales or taxes that are reimbursed by a separately stated charge (for example, sales taxes, parking taxes, or real estate taxes paid by a tenant).

The new tax structure would be phased in over a five year period, based on a formula that allocates a portion of the tax to gross receipts, and a portion to payroll.

The real estate industry would be subject to the following gross receipts tax rates:

Amount of Gross Receipts / Rate
$0-$1M / 0.3%
$1M-$2.5M / 0.325%
$2.5M-$25M / 0.325%
Over $25M / 0.4%

Amounts received for the sale of real estate are excluded from the gross receipts tax, assuming that a transfer tax is paid. Also, rental income is only part of gross receipts if derived from properties located in the City. Rent controlled properties may deduct 50% of their gross receipts.

These rates are in the middle of the pack compared to other industries. For comparison, here is a brief overview of the other rates:

Retail 0.075% to 0.175%
Food and Manufacturing 0.125% to 0.45%
Real Estate 0.3% to 0.4%
Construction 0.3% to 0.45%
Professional/Financial/Tech 0.4% to 0.55%
Private Education/Health 0.525% to 0.65%

Other industries will certainly have concerns about the real estate tax, but we will focus on some of the concerns raised by the real estate community.

Real Estate Issues

The reaction from many in the real estate industry is that property owners already bear a high burden of taxes and City fees, beginning with the development of a project. Developers are well aware of the many fees to build or renovate a project in San Francisco, not to mention the length of time and political uncertainty. Property owners are also subject to real estate taxes, transfer taxes on sales (which just increased in 2010), and complying with other state laws and local ordinances applicable to real property. While in some cases the gross receipts tax will be passed on to tenants as part of common area expenses, this will further burden businesses that are located in San Francisco, and these businesses will essentially be paying the gross receipts tax twice. In addition to the tax rate, the following are concerns and comments that have been raised by the industry:

  • Gross receipts should exclude payments made by tenants for particular expense reimbursements or services such as parking fees, direct repairs, and tenant improvement costs
  • There should be an exception to avoid double taxing real estate receipts when distributions are made to partners or members of an LLC that also do business in San Francisco
  • Gross receipts should exclude any amounts necessary to repay initial capital contributions and acquisition loans, since these expenses are unique to the real estate industry, and this expense is already taxed as part of transfer taxes
  • Clarify that receipt of loan funds, equity contributions, and insurance proceeds are not part of the definition of gross receipts
  • Clarify that real estate development work and real estate consulting are not subject to the higher tax rate applicable to “Professional Services”
  • Tenant groups also are concerned that a tenant improvement allowance paid to the tenant could be caught up in the definition of gross receipts

Status of the Ordinance

Mayor Lee’s ordinance was scheduled to be heard today at the Budget and Finance Committee. In order to be included on the November 2012 ballot, the Board of Supervisors must approve the legislation by August 2, 2012. A potential competing measure, proposed by Supervisor Avalos, includes even higher tax rates and is also being considered by the Board. We will keep you updated as the legislation proceeds.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient. Readers should consult with legal counsel before relying on any of the information contained herein. Reuben & Junius, LLP is a full service real estate law firm. We specialize in land use, development and entitlement law. We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

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