San Francisco voters recently approved Proposition M, which changes how businesses calculate their San Francisco gross receipts tax. Under the new framework, all businesses other than those in specific real estate and accommodation activities must determine San Francisco receipts using 75% sales allocation and 25% payroll apportionment.
As required by Proposition M, the San Francisco Office of the Treasurer and Tax Collector (Tax Collector) has issued proposed regulations interpreting how gross receipts are allocated (or sourced). The proposed regulations apply to tax years starting on or after January 1, 2025.
In response to taxpayer requests, the proposed regulations are modeled after the California Franchise Tax Board’s (FTB’s) draft sourcing regulations. Like the FTB’s cascading rules for sourcing receipts from sales of services or intangible property, San Francisco’s proposed regulations use a waterfall approach. They allow receipts to be sourced through reasonable approximation if the location of the benefit of the service or of the use of the intangible property cannot be identified in the contracts, books and records, or other sources of information. Likewise, San Francisco’s proposed regulations include presumptions that apply to sales of services based on what the service predominantly relates to.
However, the city’s proposed regulations diverge from the FTB’s draft regulations in a few areas. For the sale of financial instruments, the city’s proposal allows the use of reasonable approximation (e.g., census and gross domestic product) to determine the sourcing location if the taxpayer is unable to use contracts, books and records, or other sources to determine the customer’s billing address (for individuals) or commercial domicile (for businesses). The proposed regulations also have special sourcing rules for franchisors; film producers, distributors, and networks; print media; mutual fund service providers; and asset management service providers. They do not have special rules for partnerships; contractors; banks and financial corporations; and commercial fishing, air transportation, rail and trucking, and space transportation companies.
Under the proposed regulations, the Tax Collector may apply an alternative apportionment methodology if following San Francisco Business and Tax Regulations Code Section 956.1, including the proposed regulations, does not result in a fair reflection of gross receipts within the city.
The Tax Collector has scheduled a public hearing for April 8 at 2 p.m.; written comments on the proposed regulations are due the same day by 5 p.m.
BDO Insights
- San Francisco has aligned its market-based sourcing regulations with California’s, which, as proposed, also apply to tax years beginning on or after January 1, 2025. However, because the FTB rules are not final, they are subject to change. Taxpayers should monitor any changes to California’s proposal, which could affect the city regulations.
- Taxpayers — especially those that have historically computed their gross receipts taxes using payroll — should review their sales sourcing methodology, given the shift to an apportionment formula using 75% sales and 25% payroll.
- The increased weighting of sales and the use of market-based sourcing could result in larger fluctuations in tax liabilities for some taxpayers, such as those in financial services and financial technology (see our previous alert on California’s proposal to shift to a single sales factor for financial institutions), professional services, technology or information, and biotechnology industries. Therefore, taxpayers should consult with their tax advisors regarding how the proposed regulations affect the sales receipts reported to San Francisco and explore tax planning opportunities.
Please visit BDO’s State & Local Tax Services page for more information on how BDO can help.