Bloomberg Tax
Free Newsletter Sign Up
Bloomberg Tax
Welcome
Go
Free Newsletter Sign Up

California Cities Snub Retailer, Share Sales Tax With Each Other

Jan. 13, 2022, 9:45 AM

When it appeared things might get uncomfortable between two cities near downtown Los Angeles over sales-tax revenue from online retailer Fashion Nova, Vernon, Calif., did something unusual: It cut a deal with its neighbor instead of the company.

It’s a new twist on the controversial practice of online retailers snagging a slice of local sales tax they collect from customers by earmarking it to a particular city with an office or warehouse.

City councils in Vernon, an industrial city that serves as Fashion Nova’s headquarters, and Santa Fe Springs approved the sharing agreement in December to avoid complexities and conflict stemming from California’s sales tax rules, which they say pit cities against each other to compete for revenue.

SIGN UP for The Exchange, our free weekly tax newsletter.

The cities banded together after Fashion Nova officials questioned whether some of the revenue that has been going to Vernon should go to Santa Fe Springs instead. At the same time, the company said it could keep the revenue flowing to Vernon if the city gave half of it back to Fashion Nova, Vernon officials said.

A handful of California cities have accepted offers like Fashion Nova’s to give companies a share of sales tax proceeds—typically 50% or more—in exchange for locating warehouses or offices in their boundaries. Retail giants including Apple Inc., eBay Inc., Best Buy Inc., Walmart.com, and Williams Sonoma Inc. have cut deals with cities hungry for jobs and revenue as e-commerce flourishes.

But the agreements create intercity tension, because they concentrate tax revenue in a few municipalities at the expense of hundreds of others. Vernon said no to Fashion Nova’s proposal to share with the company and turned to its neighbor instead.

“This agreement represents a model for cities working together in mutual interest rather than litigating or undercutting one another in business competition,” Vernon interim City Attorney Zaynah Moussa told the City Council before members unanimously approved the agreement Dec. 22.

An attorney for Fashion Nova, a fast-fashion brand popular with social media influencers, didn’t respond to requests for comment about any other steps it may take.

Dispute Avoided

The company also approached the nearby city of Whittier in 2019 about relocating its headquarters there in exchange for half of the tax revenue it generated. Whittier officials dropped talks with the company after learning Fashion Nova would need to move there from Vernon and was also negotiating an agreement with Santa Fe Springs, City Manager Brian Saeki said.

Fashion Nova has negotiated with Santa Fe Springs in the past, City Manager Raymond Cruz said before that City Council voted Dec. 22. But Santa Fe Springs has never entered into tax-sharing agreements with private entities.

“It goes counter to why sales tax is established—it’s to go to the jurisdictions where the service is being provided, not to the private entity” Cruz said.

At issue is a 1 percentage point share of the 7.25% state sales tax that is allocated to cities based on location of the sale, not location of the customer.

Vernon, south of downtown Los Angeles, has been receiving the local tax on all of Fashion Nova’s online sales to California customers since 2016. It will now split the revenue with Santa Fe Springs, its neighbor 11 miles to the southeast. The amount of revenue is confidential.

A dispute could have existed between Vernon and Santa Fe Springs about where Fashion Nova’s online sales transactions take place, city officials said, but they didn’t push for one. Sales staff in Vernon collaborate with staff at the fulfillment center where merchandise is stored and shipped.

Vernon could have asked the California Department of Tax and Fee Administration to determine where online transactions take place, and therefore where the tax should flow. Officials from both cities said the tax department’s guidance on the issue isn’t clear.

“The city recognized that could have resulted in a lengthy process, and if either party disagreed, there could be legal challenge,” Vernon spokesperson Margie Otto said.

What Are the Rules?

California law, regulations, and department guidance give retailers the responsibility to allocate the local portion of the sales tax correctly, department spokesperson Tamma Adamek said in an email. But allocation is a matter of law, and neither retailers nor jurisdictions can choose where it goes, she said.

“Allocation is determined by the facts of each transaction at issue,” she said.

The tax department’s rules are clear but difficult to apply to online retailers that use ever-changing combinations of staff, computer servers, and warehouses in multiple locations to fulfill orders, according to Michael G. Colantuono, an attorney with Colantuono Highsmith Whatley PC who specializes in municipal law. As long as California law requires the local portion of the sales tax to be allocated based on location of the sale—not the customer—a granular examination will be necessary to determine where sales take place.

The cities’ sharing agreement “is an artful solution to a common problem,” he said.

As an example of what the cities could face without an agreement, Williams-Sonoma Inc. and the Central Valley city of Shafter are opposing a challenge from the tax department and 300 other municipalities in a case pending before the California Office of Tax Appeals. The municipalities and the department argue that the company set up a sham “order review” process to make it appear that online transactions take place at a call center in the city so Shafter can receive the local tax revenue and give half of it to the company. Items are shipped from a warehouse in another city.

Vernon and Santa Fe Springs had the authority to craft their deal under a 1998 provision of the California Constitution that allows neighboring cities to enter into sales tax-sharing agreements.

Cities rarely use the provision “because it’s not very often that people want to give away money,” Colantuono 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: Jeff Harrington at jharrington@bloombergindustry.com; Kathy Larsen at klarsen@bloombergtax.com