San Jose Fights California Tax Department Over Revenue From eBay

The city of San Jose is locked in a dispute with California’s tax department over about $100 million in sales tax revenue it has received from hometown company eBay Inc. since 2020, a city spokesperson confirmed.

The spokesperson said San Jose is appealing a determination from the California Department of Tax and Fee Administration that some portion of the revenue it’s received through a tax-sharing agreement with the auction and shopping website was improper—an argument similar to an ongoing fight between the tax department and nearby Cupertino over that city’s deal with Apple Inc.

At issue is eBay’s designation of all sales in California as taking place in San Jose, giving the city a 1 percentage point increment of the sales tax consumers pay. The city gives about a quarter of the proceeds to eBay.

San Jose’s dispute appears to be further along in the department’s internal appeal process than Cupertino’s, but the two city governments are taking different approaches. While Cupertino’s City Council has publicly discussed a potential 73% drop in sales tax revenue due to the tax department’s review, and started weighing budget cuts and tax increases, San Jose leaders haven’t spoken openly about the dispute or accounted for a possible loss of revenue in the city budget.

“The city’s general fund contains unrestricted reserves for any financial or public emergency,” city spokesperson Carolina Camarena said.

San Jose exposed its dispute with the tax department when it backed a recent proposal from six lawmakers representing Santa Clara County that would protect the two cities. Those lawmakers want Gov. Gavin Newsom (D) to support a change in state law blocking redistribution of the tax revenue in question away from cities in Santa Clara County—or the county as a whole—until 2035, according to a letter to Newsom obtained by Bloomberg Tax.

The lawmakers’ proposal would preempt the tax department’s actions and create an exception for Santa Clara that wouldn’t apply to several other cities and counties that enjoy similar deals with retailers like Best Buy Co. Inc., Walmart Inc., Home Depot Inc., and Nike Inc. The deals leverage state rules that a retailer’s involvement determines where a transaction takes place. That jurisdiction gets the 1 percentage point increment of the total sales tax customers pay, and the jurisdiction shares it with the retailers.

“The city firmly believes that the CDTFA’s efforts to reallocate local tax revenue paid to the city are inconsistent with current law,” Camarena wrote in an email.

It is unclear how much of San Jose’s revenue could be shifted elsewhere, but it would be some portion of the $97.2 million the city received from eBay’s sales since the tax-sharing agreement took effect in 2020. Under state law, the tax department can reach back as far as two quarters before it “obtained knowledge of the improper distribution.” EBay could be required to give back all of the money it’s received from San Jose, based on terms of the agreement,

According to the agreement, San Jose keeps the first $5 million it gets from eBay annually, then pays eBay 30% of additional proceeds. According to records the city provided to Bloomberg Tax in June, San Jose has paid eBay $26.4 million of the $97.2 million it’s received through sales to Californians on eBay’s platform through October 2022. A request under the California Public Records Act for more recent payment information is pending.

The tax department’s disputes with San Jose, Cupertino, and other cities with similar revenue-sharing deals hinge on a clash between the retailers’ assignment of sales to those cities and the department’s position that the location of the transaction depends on human participation. The department’s regulations and guidance state that the storage location where an item is picked, packed, and shipped is often the only place of business that participates in an internet transaction. The location of automated online processes like servers and website hosting don’t count as participation.

A Legacy of Wayfair

While other cities with tax-sharing deals typically tout them as a boon for jobs and economic development, San Jose said its deal with eBay is neither a subsidy nor an economic development tool. It doesn’t require the company to stay in San Jose or hire more workers. EBay brought the proposal to San Jose leaders in 2019 on the eve of a new state law requiring it to begin collecting sales tax from customers making purchases on its platform.

The law followed the US Supreme Court’s 2018 decision in South Dakota v. Wayfair, which permitted states to impose tax collection duties on remote retailers based on economic activity rather than physical presence. Assigning all California sales to San Jose simplified tax administration for the company.

San Jose and eBay agreed to “render reasonable assistance” to each other in disputes or proceedings related to their deal, like the city’s appeal of the tax department’s actions, but neither is obligated to contribute to the other’s legal defense. San Jose differs from Cupertino in this regard also: Apple bears the cost of administrative proceedings with the state related to the dispute and must cooperate in efforts to avoid reallocation of revenue away from Cupertino, according to its agreement with its hometown.

If the cities still disagree with the tax department at the close of their administrative appeals, they can take their case to the California Office of Tax Appeals, an independent administrative body that adjudicates state tax disputes.