Apple’s Local Tax Arrangement With Hometown Comes Under Fire

(Bloomberg) — A tax agreement between Apple Inc. and its hometown of Cupertino, California, has come under scrutiny from state regulators, potentially slashing the amount of money that the company sends to the city.

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The California Department of Tax and Fee Administration launched an audit of the arrangement in 2021, and Cupertino’s finance director is scheduled to explain the findings to the city council on Thursday. The upshot for Cupertino is that local tax revenues are expected to fall 73% this year.

Although Apple isn’t named in the city staff report, the company is Cupertino’s largest source of sales tax revenue. According to the audit, revenue will drop to $11.4 million in the current fiscal year from $42.1 million, and Cupertino may be required to return money to the state that it has received in previous years. The city may have to cut staff and other spending to cover the shortfall.

“This decline in revenue is due to a change in sales tax distributions based on the anticipated outcome of a state audit of one of the city’s taxpayers,” Cupertino said in a written statement. The city is taking early action to inform the council members and community “in preparation for developing budget-balancing strategies as we prepare next year’s budget.”

At issue is the company’s treatment of online sales. Under California law, a local portion of sales tax goes to the location where the transaction takes place, not the location of the customer.

Apple treats all online purchases of products in the state of California as if they were made in Cupertino, setting aside the 1 percentage point local portion of the 7.25% state sales tax for its hometown. The arrangement applies to Apple’s online sales to consumers in the state, as well as transactions with other businesses in California, sales at its two retail stores in Cupertino, and use tax on the company’s own equipment purchases, city officials have said.

The company remits all sales tax it receives to the state tax department, which then allocates the local portion to Cupertino. The city passes on 35% of its total to Apple. Those payments to Apple have added up to $107.7 million since 1998, according to city payment records examined by Bloomberg Tax.

Even so, the sales tax revenue at issue in Cupertino is a small portion of the total taxes that Apple pays to California, the city and other jurisdictions.

A representative for Apple didn’t have an immediate comment. The California tax department declined to confirm that the audit is related to Apple due to taxpayer confidentiality rules.

“Our Local Revenue Branch is continually reviewing reported local revenue allocations by taxpayers to determine if those allocations are correct or need reallocation,” agency spokeswoman Tamma Adamek said.

Cupertino can appeal the tax department’s findings. Under the agreement between Apple and Cupertino, the company bears all costs in defending the city in administrative proceedings “relating to whether the city is the proper point of sale location.”

The sales tax department has noticed that local sales tax revenue is concentrated in a few cities, due to agreements like the Apple-Cupertino pact, director Nicolas Maduros has said. The department has been auditing whether companies participate enough in online sales to assign them to cities with warehouses or offices.

In a similar case, the city of Shafter, California, and Williams-Sonoma Inc. are appealing the department’s determination that a tax-sharing agreement between them is a sham. The agency found that most of the transactions assigned to a call center in Shafter take place elsewhere. The Office of Tax Appeals heard the case in February and will issue a ruling in a few months.

(Updates with comment from Cupertino in fourth paragraph.)