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HomeMy WebLinkAbout02/05/1991, 8 - BUSINESS LICENSE TAX REVIEW WORKSCOPE MEETING DATE: ��m�►NN►�►IIIIIIUI ��Ill City Of San WIS OBISPO -2 - ,5-- F/ COUNCIL AGENDA REPORT ITEM NUMBER Q FROM: William C. Statler, Director of Finance SUBJECT: BUSINESS LICENSE TAX REVIEW WORKSCOPE CAO RECOMMENDATION Approve the workscope for the review and evaluation of the City's existing Business License Tax Ordinance. DISCUSSION The City's business tax ordinance was last evaluated on a comprehensive basis in 1958. Updating the business tax ordinance is a high priority in the Council's Goals for 1991- 93, and was recommended by the Citizens' Advisory Committee in their report to the Council on February 5, 1991. The recommended workscope for this review is attached and includes the following key areas: ■ Purpose of the Business Tax Ordinance ■ Business Tax Review Goals ■ Key Elements of the Review ■ Special Considerations ■ Impacts of the Revised Ordinance ■ Action Plan and Schedule As noted in the Action Plan, it is recommended that the Council approve the formation of a seven member Business Advisory Committee to assist the CAO in preparing recommendations for Council consideration. This committee should be composed of owners and officers of businesses located in the downtown as well as other commercial areas in the City. Further, they should represent a broad range of business categories: retailers, professionals, contractors, services, manufacturing, and property owners and managers. The Chamber of Commerce has agreed to assist the CAO in forming this committee. ATTACHMENT Business Tax Revision Workscope BSTAX/YORKSCPE.YPF BUSINESS TAX REVISION WORKSCOPE A. PURPOSE OF THE BUSINESS TAX ORDINANCE 1. The purpose of the City's business tax ordinance is to raise revenues for general municipal purposes. 2. It is not intended for regulation. 3: Regulation of selected business categories, such as mechanical amusement devices, electronic game centers, taxicabs, massage establishments, bingo operators, or adult entertainment establishments (which are currently regulated under the Municipal Code), is an appropriate exercise of the City's inherent police powers. However, any such regulation should be accomplished through separate regulatory ordinances, not through the City's business tax ordinance. 4. Accordingly; use of the term "license" in defining and discussing the City's business tax ordinance should be discontinued as no "license" or any other approval to conduct business is granted when a Business Tax Receipt is issued. B. BUSINESS TAX REVIEW GOALS The review of the City's current Business Tax Ordinance should accomplish the following three goals: equity, revenue generation, and administrative simplicity. 1. Equity The revised Business Tax Ordinance should ensure, to the greatest extent possible, that similar businesses are treated equally and that tax rates reflect a general ability to pay. In considering "ability to pay" it should be noted that net profit, which may be the best measure of ability to pay, is not allowed by the State as a basis for local business taxes. Achieving this goal will require evaluation of the following issues in the current Business Tax Ordinance as well as any proposed revisions: a. What are the current business classes, tax rates, tax measures, and tax structures? b. Are rate structures regressive? c. Are similar businesses grouped together and treated the same? d. Is the same tax rate and tax rate structure applied to similar types of businesses? e. Do tax rates reflect a general ability to pay? L Are differential rates in place which reflect the general profitability of different types of business activities? g. Are all types of business activity clearly subject to paying business taxes? h. In addressing these equity objectives, which is the primary purpose for this revision, we need to recognize that we cannot achieve perfect "equity" in all situations. Ths complexity of any proposed ordinance in achieving "equity" needs to be consistent with level of taxation and amount of revenue raised. 2. Revenue Generation As discussed above, equity issues are the primary reason for this business tax revision. However, in meeting the primary purpose of the City's Business Tax Ordinance - to raise revenues for general municipal purposes - any revisions to the business tax ordinance should meet the following revenue generating criteria: a. Reflect changing economic conditions (up or down). b. Be a source of revenue that the City can rely upon in funding general municipal purposes. c. Remain competitive with the practices of other comparable communities. Achieving this goal will require the evaluation of the following issues in the current Business Tax Ordinance as well as any proposed changes: d. What is the relative importance of business taxes in comparison to total general purpose revenues? e. How have business taxes grown over time? L Is the rate structure likely to reflect economic growth and changes in the economy generally? g. How does the rate structure compare with those in neighboring and comparable cities? h. What percentage of current business tax revenues come from various types of businesses? 3. Administrative Complexity The revised Business Tax Ordinance should not be difficult or costly for the City to administer and enforce nor should it be difficult for the business 83 community to understand and comply with its provisions. - Achieving this goal will require the evaluation of the following issues in the current Business Tax Ordinance as well as any proposed changes: a. Is the ordinance well-organized? b. Is it lengthy and difficult to understand? c. Does it contain everything necessary to understand and administer it? d. Is it consistent and well-documented? e. Are payment amounts easy to calculate? f. Are business activities clearly identified? g. Are policy considerations clearly presented such as apportionment guidelines, penalties, and any exemptions? C. KEY ELEMENTS OF THE REVIEW There are four key elements of the Business Tax Ordinance revision that directly impact its equity, revenue generation capabilities, and administrative complexity: business classification system, tax measures, tax rate structure, and tax rates. 1. Business Classification System How businesses are classified or grouped together in the ordinance is the single most important factor in meeting our three goals of equity, revenue generation, and administrative simplicity: a. Improves equity by ensuring that tax rates and measures assigned to a class of business (such as retailers, professionals, or contractors) reflect the profitability and nature of particular type of business. b. Improves equity by ensuring that similar types of businesses are treated similarly. c. Depending on tax measures and rates, determines the ordinance's revenue generating capabilities. d. Enhances administration by the City and compliance by the business community by clearly defining the different types of business subject to the tax. To achieve these objectives, the business classification system needs to: e. Appropriately group businesses based on their nature and profitability. O '� L Balance the number of classes between too many and too few in achieving equity vs administrative simplicity goals. g. Ensure that all business activities are clearly subject to business taxes. h. Use the Standard Industrial Classification system (SIC Codes) of U. S. Department of Commerce as the basis for the grouping of business types in order to simplify and standardize their development. 2. Tax Measures The term "tax measure" refers to the base upon which tax rates are levied in determining the amount of tax due. The following are common tax measures used by California cities: a. Flat fees, such as $100.00 per year, per business. b. Number of employees, such as $15.00 per employee c. Gross receipts, such as $50.00 per $100,000 of annual gross receipts. d. Gross payroll; such as $25.00 per $50,000 of annual gross salaries and wages paid. e. Units, such as $25.00 per motel room. L Square footage, such as $5.00 per gross square feet of business area. The "tax measure" selected will clearly affect the ordinance's revenue generating capabilities in reflecting economic growth and changing economic conditions. For example, little revenue growth will be reflected in flat fee structures (revenues per business will remain constant even though sales and profits per business may rise annually) whereas gross receipts will increase (or decrease) with changes in economic conditions. The advantages and disadvantages of each "tax measure" needs to be evaluated in meeting our three goals of equity, revenue generation, and administrative simplicity. 3. Tax Structure After determining business groupings and tax measures, tax structures need to be developed which will meet equity and administrative simplicity goals. Tax structures should: a. Reflect profitability or general ability to pay. �r` b. Not be regressive: similar businesses with lower gross receipts and profitability should not pay higher rates than similar businesses with greater gross receipts or profitability. c. Treat similar business similarly. d. Not be more complex than warranted by the level of taxation and revenues raised. One of the methods available to achieve these objectives is the use of tax ratios or differentials by business type to reflect general ability to pay. For example, although cities are precluded by the State from using net profit in determining local business taxes, standard ratios of net profit to gross receipts by business type is an acceptable method of achieving equity in business taxes. This type of information is available from a wide variety of sources, including authoritative income statistics such as the following provided by U.S. Department of the Treasury, Internal Revenue Service as of 1987 for sole proprietors: Ratio of Net Profits Business Class to Gross Receipts Wholesaling 9% Retailing 8% Manufacturing 19% Contractors 20% Services 20% Private Utilities 20% Recreation/Entertainment 29% Property Rental 28% Professions 50% These profit margins can be readily converted to tax ratios which reflect the relative profitability of various business types: Relative Profitability Business Class to Gross Receipts Wholesaling 1.0 Retailing 1.0 Manufacturing 2.0 Contractors 2.0 Services 2.0 Private Utilities 2.0 Recreation/Entertainment 3.0 Property Rentals 3.0 Professions 5.0 4. Tax Rates Three of the four business elements to be reviewed - business groups, tax measures, and tax structures - can (and should) be developed without knowing how much specific businesses will pay or how much revenue will be raised overall This is the sole purpose of tax rates. Once the database regarding existing businesses is developed and business groups, tax measures, and tax structures are agreed upon, tax rates are set which will determine the amount that individual businesses will pay and how much revenue the City will receive. The following criteria should be used in determining tax rates: a. Overall business tax revenues cannot be less than would be received under the current ordinance. b. Revenues from retail businesses should stay about the same as received under the current ordinance. c. Minimum business taxes should not be less than the cost of issuing, renewing, and administering business taxes. The current minimum of $25.00 for most business tax receipts meets this objective. d. Tax rates should be straight-forward and easy to understand. D. SPECIAL CONSIDERATIONS There are several factors that require special considerations in reviewing the business tax ordinance: 1. Apportionment Under State law, businesses must be taxed on a basis that reflects their level of activity in the City. a. For businesses located within the City limits that derive their sales solely from this location, this is not a concern. b. However, for businesses with their principal places of business located outside of the City but that conduct business operations in the City, this may be more difficult to determine. c. Similar difficulties (although in an opposite direction) are encountered with businesses that are headquartered in San Luis Obispo but principally sell their products to other businesses or individuals located outside of the City. d. These are not insurmountable problems; they are faced by every City in California. However, some method needs to be developed to tax these B�� businesses in proportion to their business activity that occurs in the City. 2. New Businesses Gross receipts is the primary "tax measure" used in the existing business tax ordinance, and even greater reliance may be placed on this tax base in any revision. For new business, this poses a problem in issuing their first Business Tax Receipt as there are no actual gross receipts yet. There are several alternatives for resolving this issue which need to be evaluated during the business tax revision. 3. Gross Receipts Period Under the current business tax ordinance, Business Tax Receipts are renewal annually on a City focal year basis (July to June). This is an inconvenient time period for many businesses as they maintain their records on a calendar year basis. E. IMPACTS OF THE REVISED ORDINANCE The following impacts of any revisions to the existing Business Tax Ordinance need to be evaluated: 1. Have equity, revenue generation, and administration been improved? 2. What are the financial impacts on: a. Broad classes of businesses? b. Individual businesses? c. Overall City revenues? 3. How do the revised tax measures, structures, and rates compare to neighboring and comparable communities? 4. Is the revised ordinance easier for businesses to understand and comply with its provisions? Is it easier for the staff to administer and enforce? F. ACTION PLAN AND SCHEDULE 1. Business Advisory Committee The Council should approve the formation of a seven member Business Advisory Committee to assist the CAO in preparing recommendation for the Council's consideration. This committee should be composed of owners and officers of businesses located in the downtown as well as other commercial areas in the City. Further, they should represent a broad range of business categories: retailers, professionals, contractors, services, manufacturing, and property owners and managers. �'8 The Chamber of Commerce has agreed to assist the CAO in forming this committee. 2. Schedule a. Orientation for committee members 2/91 b. Develop and present background materials to committee 3/91 c. Two to three committee meetings to discuss 4/91 and finalize business classifications, tax measures, tax structures, and tax rates d. Present recommendations to Council 5/91 BSTAX/RARKSCP.YPF �- 9