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Daily Tax Report: State

Apple’s 22-Year Tax Break Part of Billions in California Bounty (1)

April 24, 2019, 3:05 PMUpdated: April 25, 2019, 3:37 PM

Apple Inc. was on the brink of bankruptcy in 1997 when it cut a deal with the city of Cupertino, California.

In exchange for keeping its headquarters in the Silicon Valley city, Apple would get half of Cupertino’s share of sales tax revenue generated by the company’s sales to businesses in California for at least five years.

Apple is now the world’s most valuable company— and, after several extensions of its deal, it’s still getting sales-tax rebates, according to a city official. How much Apple now gets each year, and has gotten over the past 22 years, is kept confidential.

It’s among dozens of agreements with small California cities that give tens of millions of dollars a year in sales-tax collections to the companies, often for decades, out of $6 billion a year collected by localities statewide. Contracts show that Fresno gives Ulta Inc. up to 75 percent of sales tax revenue it gets from the company’s fulfillment center there. Deckers Outdoor Corp., the maker of Uggs boots and Teva shoes, gets up to 60 percent of revenue back from Moreno Valley for locating a distribution center there. Macy’s has a deal with Sacramento County in which it is eligible to receive half the tax revenue generated by sales from a distribution center. However, a Macy’s spokeswoman said April 24 that the company has not asked Sacramento for payments.

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The agreements, while legal under cities’ authority in the state Constitution to manage their municipal affairs, “are special deals for the wealthiest companies in the world and they come at the expense of our cities that could use the money,” said state Sen. Steven Glazer (D), author of a bill to ban them going forward.

Anatomy of a Tax Subsidy

The cities—some of them economically distressed—negotiate the deals to lure warehouses and call centers for retailers racing to meet demand from online shoppers. In some cases they’ve been used to keep existing jobs in town. City officials say the agreements are one of few economic development tools they have left following the legislature’s repeal of other long-standing incentives, and that they generate additional tax revenue even with some of the money going back to the companies.

The agreements apply to a 1 percent increment of the state’s 7.25 percent sales tax that goes to local governments. Typical agreements call for cities giving about half of their 1 percent increment generated by the operations they land.

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About 10 percent of the state’s 482 cities and a few counties have the agreements, said Michael Coleman, a consultant to the California League of Cities, which lobbies on behalf of municipalities statewide, and founder of the California Local Government Finance Almanac.

A 1950s law created the 1 percent share, which the state distributes to local governments based on the location of a sale, not the customer. Lawmakers have banned cities from luring big-box retailers and car dealers with financial incentives, but California’s nonpartisan Legislative Analyst’s Office said they can still use incentives to encourage other businesses to relocate or redirect their portion of the sales tax.

“E-commerce is putting this whole problem on steroids,” said Greg LeRoy, executive director of Good Jobs First, a think tank that tracks tax subsidies.

Cypress City Manager Peter Grant said the agreements are a symptom of a larger problem: a broken state tax system that starves local governments. Cypress has one tax sharing agreement—with carpet manufacturer Shaw Industries Inc., a subsidiary of Berkshire Hathaway Inc.

“One has to wonder if Sacramento takes things like that away, given California’s business climate, how cities are supposed to generate the revenue they need to provide services to their residents,” Grant said.

Set In Concrete

Some of the deals haven’t involved new economic activity or jobs at all, merely shifting of sale location designations that increase tax collections for some communities by taking revenue away from others.

The Legislative Analyst’s Office first raised concerns about the sharing agreements in a 2007 report that highlighted one between Corona and cement manufacturer Robertson’s Ready Mix. In 2000, the company reassigned all of its California sales to Corona while keeping its facilities and dispatch offices spread across more than 20 jurisdictions in Southern California.

Robertson’s has renewed its agreement several times, and most recently in 2015 agreed to a 50 percent split for 25 years, with automatic five-year extensions. The 25-year agreement has an estimated value to the company of $55 million, according to the contract.

The agreements often are buried in contracts approved by city councils or county boards of supervisors. Although a 2015 law requires that cities post them on their web sites, the agreements aren’t easy to find. Finding Corona’s agreements, for example, requires clicking on two links and two tabs beyond the home page to a heading labeled Subsidy Reports.

The 2015 law also clamped down on the sharing agreements somewhat. Since 2016, cities haven’t been allowed to enter into ones that shift the assignment of sales on paper from one city to another, as Robertson’s did.

That law passed after the city of West Sacramento discovered it was no longer receiving as much as $1 million in annual sales tax revenue from an HD Supply Inc. distribution center within its boundaries. Unbeknownst to the city, the industrial supply company had designated a different city, Santee, as its point-of-sale for California sales without shifting any operations, said Katy Jacobson, West Sacramento director of economic development and housing.

The company gets 50 percent of the 1 percent increment it generates from Santee, in suburban San Diego.

Robertson’s and HD Supply didn’t respond to requests for comment.

Apple’s Infinite Loop

Apple and Cupertino renegotiated their deal most recently in 2013 when the company sought city approval for construction of its 2.8 million-square-foot Infinite Loop building.

The company now receives 35 percent of the city’s sales tax revenue on its sales of devices to businesses within California as well as sales at its two retail stores in the city, Kristina Alfaro, Cupertino director of administrative services, told Bloomberg Tax. The city can’t disclose the amount Apple receives under the agreement because it would violate taxpayer confidentiality requirements of the California Revenue and Taxation Code, she said.

But the city didn’t always keep the value of the agreement confidential. In 2007, the year Apple introduced the iPhone, a Cupertino city staff report said Apple was getting $2.2 million a year, and that the city’s sales tax receipts from Apple had increased from $290,000 per year before the agreement to an average of $2.5 million. Apple’s worldwide revenue has increased more than 10-fold since then.

Apple officials didn’t respond to requests for comment.

Some other cities with tax sharing agreements disclose the amount of expected or maximum payments to the companies in contracts approved by city councils, and in staff reports summarizing the terms. They also don’t disclose the actual amounts paid due to taxpayer confidentiality rules.

Dinuba’s Best Buy

About 200 miles southeast from the wealth of Silicon Valley, Dinuba reached agreement in 2015 with Best Buy to retain one of the largest employers in a city where jobs have long been scarce. The Central Valley agricultural community of about 25,000 residents had an unemployment rate in February of 14.5 percent, more than three times the U.S. average, according to statistics on the website of the California Employment Development Department.

Dinuba has agreed to give Best Buy 45 percent of its sales tax revenue from the company’s warehouse and point-of-sale designation for online California sales in all but the first year of their 40-year deal, according to the contract. Payments in the first four years are contingent on a minimum amount of overall revenue coming in. Based on city projections for annual revenue, the agreement could mean $33.3 million for the company and $34.2 million for the city through 2055.

The city saw the agreement as an opportunity to create a partnership with Best Buy that keeps much-needed jobs, Dinuba Assistant City Manager Daniel James said in an interview.

In a written statement, a Best Buy spokesman said its warehouse in Dinuba is key to filling orders from West Coast customers in two days or less.

“We’re proud to employ hundreds of people in Dinuba and we’re pleased to have an agreement in place with the city that benefits both the city and Best Buy,” spokesman Jeff Shelman said.

QVC Shopped Around

QVC, part of Qurate Retail Inc., receives 55 percent of the local share of sales tax revenue every year for 41 years from the city of Ontario, or 60 percent if its annual sales are above $500 million, under a 2015 agreement.

“We’re competing with other states in the western United States for these facilities,” John Andrews, economic development director for the city of Ontario, said in an interview. Council policy calls for the city to work within the law to use mechanisms like the agreements to attract them, he said.

QVC carefully weighed site location, lot size, proximity to transportation, and other factors when deciding where to open a warehouse, the company said in a written statement.

“More broadly, we wanted to open a West Coast distribution center to enhance our shipping and fulfillment operations on the West Coast,” the statement said. “Ultimately, we determined that Ontario, California was the best area suited for our needs.”

Ontario, with an airport at the intersection of several major freeways, is a major hub for warehouses and goods movement. The city has 10 sales and use tax sharing agreements with retailers posted on its web site.

Other companies with tax sharing agreements examined by Bloomberg Tax didn’t respond to requests for comment.

Lawmakers Have Noticed

Two state lawmakers have proposed to restrict or ban the agreements.

California Assemblyman Jose Medina’s bill, A.B. 485, would require local governments to conduct public hearings before approving the agreements. Cities and retailers would have to provide more detailed information about expected tax revenue, jobs, and other state and federal subsidies the companies are getting.

Former Gov. Jerry Brown (D) vetoed a similar bill from Medina in 2018, saying he favored transparency with economic incentives but the measure would be too burdensome. New Gov. Gavin Newsom (D) hasn’t taken a position on this year’s bill.

The California Labor Federation backed last year’s bill and is trying again.

“If our public dollars are going to businesses it should be transparent and the public should have some assurances that their money is creating good jobs that pay enough for workers to makes ends meet,” federation policy coordinator Sara Flocks said.

The California Retailers Association and California Chamber of Commerce opposed the vetoed bill. They also oppose A.B. 485 unless it is amended to drop requirements that companies disclose confidential or proprietary information, according to April 10 testimony from a lobbyist for the retailers and a letter from the chamber.

Glazer’s bill, S.B. 531, would ban new agreements in which cities give the revenue directly or indirectly to retailers for sales from warehouses in their jurisdiction. Current agreements could remain in effect.

Glazer’s bill raises concerns about the state interfering with local government control, but the retailers recognize the agreements can concentrate the businesses in certain jurisdictions, Retailers President Rachel Michelin said in an interview.

“The state should allow them to have some leeway in making those decisions,” she said. “It’s a fine line.”

Some Bipartisan Support

Medina’s bill passed 6-2 in the Assembly Local Government Committee April 10. Glazer’s bill will have its first hearing in the Senate Governance and Finance Committee April 24.

Democrats who control both houses of the legislature may have some Republicans joining them to support the bills.

In debate on the Assembly floor April 8 about a different bill to set tax rules for online retailers who are outside California, Assemblyman Jay Obernolte (R) said he objects to the tax sharing agreements.

“We really need to address this situation and get that revenue out of the pockets of big corporations and back to cities and counties where it belongs,” Obernolte said.

Glazer’s bill also aligns with a new policy adopted by the California League of Cities in February.

“They are inappropriate because they have the effect of encouraging revenue to be shifted away from numerous communities and concentrated to the benefit of one,” the league’s Revenue and Taxation Committee said in its recommendation.

Santa Fe Springs, southeast of downtown Los Angeles, doesn’t use sharing agreements. City Manager Ray Cruz said he sees them as bad public policy. Luring new businesses with the payments could drive away existing businesses, he said.

“They could say, ‘Hey, where’s mine?’” he said. “You want to keep your top 100 sales tax providers in your city.”

Where It’s Delivered, Not Sold

A broad solution would be to change the way the 1 percent increment is allocated, LeRoy said. Keeping it tied to the transaction location locks in the cities’ incentive to cut the tax sharing deals.

Glazer in 2018 proposed a state constitutional amendment to shift tax allocation to the point of a sale’s delivery rather than its point of origin. It passed two Senate committees but never reached the Senate floor for a vote.

Cruz said cities like Santa Fe Springs, with concentrations of warehouses and commercial activity, oppose such a change because they would lose tax revenue to residential areas where the orders are delivered.

More transparency about the agreements is a good idea, said James, the Dinuba assistant city manager.

“To stop them is incredibly shortsighted,” he said.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif. at lmahoney@bloomberglaw.com

To contact the editors responsible for this story: Bernie Kohn at bkohn@bloomberglaw.com; Jeff Harrington at jharrington@bloombergtax.com