California Stands Out From the Pack With Its Local Taxing System

California Stands Out From the Pack With Its Local Taxing System

As e-commerce continues to reshape business operations, understanding California’s nuanced local tax framework becomes increasingly vital for companies aiming to navigate and make the most of the state’s distinct local tax system.

California boasts a unique system for sourcing and allocating local sales and use tax compared to other states. Its allocation system, characterized by a complex mix of origin-based and destination-based tax sourcing rules, plays a pivotal role in shaping the landscape of sales and use tax incentive arrangements between California municipalities and private companies.

Local Tax Law History

In 1955, California introduced the Bradley Burns Uniform Local Sales Tax Law to standardize the sourcing and collection of local sales and use taxes. The law was created as a solution to the explosion of local sales and use tax ordinances enacted across California cities and counties between the 1940s and 1950s.

A lack of uniformity in the imposition of municipal sales and use taxes created compliance difficulties for taxpayers and tax administrators alike. The Bradley Burns law authorizes counties and cities to adopt a sales and use tax ordinance at a uniform local sales and use tax rate of 1% based on the price of property sold at retail.

The law also requires counties and cities that enact a local sales or use tax to contract with the California Department of Tax and Fee Administration for the performance of all administrative functions, including tax collection. The CDTFA, in turn, is required to transmit those revenues back to the localities pursuant to contract or state law.

California implements a hybrid tax sourcing system to apportion tax revenue to local jurisdictions. Whereas statewide and local sales tax is sourced based on the origin of the sale, a destination-based sourcing system is employed for local use tax and district tax purposes.

Origin sourcing is a practice under which sales taxes for purchases of goods that are shipped to purchasers are sourced to the business location of the retailer where the sale originates. Destination sourcing is a practice under which a sale is sourced to the location where the customer takes possession of the product or service sold.

Mechanics of the Pool System

To help transmit local revenues back to the localities, the CDTFA’s predecessor agency crafted an accounting technique called the countywide pool system, which sought to ensure fair distribution of local taxes. Under this system, the tax is reported by the taxpayer to the pool and then distributed to each jurisdiction in the destination county on a pro-rata share of taxable sales.

The allocation of local tax revenue in California depends on the nature of the transaction and where the transaction is deemed to take place. Generally, a retail sale is subject to state and local sales tax if a retailer that has a place of business in California, participates in the sale, and if title to the goods passes to the retailer’s customer within the state. Use tax applies if either of those conditions aren’t met.

For the allocation of collected sales tax for in-state retailers, a significant portion of local sales tax revenue is distributed based on the point of sale, which is generally the physical location where the transaction takes place. The CDTFA’s rules dictate that when a particular municipality is deemed the point of sale, a portion of sales tax generated from that sale goes directly to that municipality.

For example, if an online retailer has a fulfillment center in California County A and sells a product to a customer located in California County B, the sales tax revenue is attributed to California County A because that’s the location from which the property was shipped—in other words, the point of sale.

In contrast, when it comes to allocating the collected use tax, the CDTFA’s rules dictate that the use tax revenue from transactions involving retailers with no California physical presence that ship goods into California flow into the countywide pool based on where the goods were shipped to—not shipped from.

Local use tax transactions are allocated to the jurisdiction where the property is first functionally used. The ship-to-address is presumed to be the place of first functional use. For businesses operating in this digital age, these distinctions become vital, especially when determining how and whether to establish physical operations.

Enter E-Commerce

The e-commerce boom underscores the need to understand California’s local tax origin versus destination-based sourcing distinction.

Increased consumer demand for fast shipping has led to the proliferation of strategically placed warehouses with vast inventories throughout the US. For a destination-based regime, the location of a warehouse has little significance because sales tax is sourced to the location of the buyer; however, the location of a warehouse is crucial for an origin-sourcing system.

California’s origin sourcing rules for local sales tax sourcing rules, combined with its revenue distribution system, create attractive opportunities for municipalities to accommodate businesses looking to establish warehouses in their regions. However, these opportunities have been met with concerns that the existing system could result in uneven revenue distribution. Such concerns emphasize the importance for businesses to stay alert and flexible in this ever-evolving landscape.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Shail P. Shah is a shareholder in Greenberg Traurig’s San Francisco office. He has been helping clients, who range from Fortune 25 companies to high-net-worth individuals, address California tax problems for more than 15 years.

DeAndré R. Morrow is of counsel in Greenberg Traurig’s Washington, D.C., office, where he focuses his practice on state and local tax issues, including Maryland, Virginia, and District of Columbia taxes.

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