The San Francisco gross receipts tax, or GRT, began phasing in this year and will completely replace the city’s payroll tax beginning in 2018. Given the structure of the GRT, while the tax rates are lower than those under the expiring payroll tax system, the GRT may result in materially more overall tax liability for businesses that have both activities in San Francisco and significant revenues.
The following summary provides a brief introduction to certain key elements of the GRT that may be relevant to fund sponsor entities and their affiliates. Many contours of the GRT, however, have not been well-defined and there remain a number of questions and uncertainties that may bring compliance challenges for taxpayers and their advisors.
The GRT applies to persons “engaging in business” in San Francisco, which includes, among other things, maintaining an office in San Francisco or performing work within San Francisco for all or part of any seven days during a tax year (regardless of whether an office is maintained in the city). Subject to certain exceptions, all amounts received or accrued from business activities are taxable under the GRT, including in the case of a fund sponsor entity, investment management fees and, most likely, carried interest allocations.1 A notable exception applies to businesses with gross receipts in San Francisco of $1 million or less, which should provide relief for fund sponsors and their related entities that conduct limited activities within San Francisco.
Tax rates under the new GRT range from 0.40% to 0.56% for financial services businesses, including fund sponsor entities, and apply to all business revenues apportioned to San Francisco. Revenues are apportioned to San Francisco based on the ratio of total compensation paid in San Francisco to total compensation paid everywhere. Revenues of the taxpayer and all entities that are required or permitted to file a combined income tax return with the taxpayer in California are included in the apportionment calculation.
In the case of an entity that does not have any employees, the amount of “compensation” for purposes of the apportionment described above includes all taxable income of the individual owners of the entity. There is considerable uncertainty around how this standard will be applied in many real-world situations. For example, it is not clear how a fund sponsor entity that does not have employees but does have individual partners who spend time working in San Francisco and who receive significant fee and/or carry income from the fund sponsor entity would determine its “compensation” apportionment under these rules. Absent further official guidance, such entities will need to work with their advisors to determine a reasonable and practical approach to complying with the GRT.
During the GRT phase-in period, taxpayers will pay both a GRT and a payroll tax. For 2014, 10% of the calculated GRT is due (and 90% of the payroll tax is due). The GRT percentage will increase to 25% in 2015, 50% in 2016, 75% in 2017 and 100% in 2018.
As with the current payroll tax, businesses will be required to pay a registration fee in addition to the GRT tax. The amount of the fee is based on the amount of the preceding year’s gross receipts, but the maximum fee has been increased from $500 to $35,000.
Fund sponsor entities should take steps now to assess their GRT exposure and consider whether any planning opportunities may be available to reduce their tax costs under the GRT.
______________________________________________1 Income and gains derived exclusively from the investment of capital (and not attributable to the performance of investment services) are not subject to the GRT. Therefore, investment funds themselves generally are not expected to be liable for the tax.