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New San Francisco Business Tax

On November 6, 2012, San Francisco voters passed Proposition E, the San Francisco Gross Receipts Tax on Business.  Currently, businesses operating in the City pay a flat 1.5% tax on their total employee payroll expense when total payroll exceeds $250,000. Proposition E replaces the payroll tax with a gross receipts tax over a five-year phase-in period beginning in 2014.

Definition of Gross Receipts
“Gross receipts” means “the total amounts received or accrued by a person from whatever source derived, including, but not limited to, amounts derived from sales, service, dealings in property, interest, rent, royalties, dividends, licensing fees, other fees, commissions and distributed amounts from other business entities. Except as otherwise specifically provided in this article, gross receipts includes but is not limited to all amounts that constitute gross income for federal income tax purposes.”

Hedge Funds and Management Companies
Sec. 953.6(b) states, “financial services includes the activities of engaging in or facilitating financial transactions; it includes business activities described in NAICS codes 521 and 523.”

The base gross receipts tax rates for financial services are as follows:
.400% - Between $0 and $1,000,000
.460% - Between $1,000,001 and $2,500,000
.510% - Between $2,500,001 and $25,000,000
.560% - Over $25,000,000

Good News for Hedge Funds
Under section 952.3(d), hedge funds are generally exempt from the gross receipts tax. Sec. 953(d) states that, “gross receipts shall not include any investment receipts. ‘Investment receipts’ includes interest, dividends, capital gains, other amounts received on account of financial instruments, and distributions from business entities, provided such items are directly derived exclusively from the investment of capital and not from the sale of property other than financial instruments, or from the provision of services, to any person.”

Bad News for Management Companies
Unfortunately, management fees are subject to the gross receipts tax, and under Proposition E a management company potentially could end up paying a higher tax instead of the current 1.5% payroll tax. For example, assume Management Company A received management fees of $5,000,000 and paid out $1,000,000 in wages. Under the current payroll tax system, Management Company A will pay $15,000. Under the new gross receipts tax, based on $5,000,000 in management fees, Management Company A will end up paying a tax of $23,650, a potential increase in tax of $8,650.

Incentive Fees/Profit Allocations
It is unclear at this time whether incentive fees will be subject to the gross receipts tax. However, we believe that incentive fees will be subject to the gross receipts tax under Section 957. Section 957 states, “The Tax Collector may, in his or her reasonable discretion, independently establish a person’s gross receipts within the City and establish or reallocate gross receipts among related entities so as to fairly reflect the gross receipts within the City of all persons. This authority extends to determining whether any amount excluded from gross receipts by virtue of Section 952.3(f) is in whole or in part compensation or payment for services and thus included in gross receipts.”

 

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