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Coblentz, Patch, Duffy & Bass LLP v. City and County of San Francisco

California Court of Appeals, First District, Third Division

December 24, 2014

COBLENTZ, PATCH, DUFFY & BASS LLP, Plaintiff and Appellant,
v.
CITY AND COUNTY OF SAN FRANCISCO et al., Defendants and Respondents.

[As modified Jan. 9, 2015.]

City & County of San Francisco Super. Ct. No. CGC-11-514292

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COUNSEL

Silverstein & Pomerantz, Amy L. Silverstein, Edwin P. Antolin, Johanna W. Roberts, Charles E. Olson and Lindsay T. Braunig for Plaintiff and Appellant.

Dennis J. Herrera, City Attorney, Julie Van Nostern, Chief Tax Attorney, James M. Emery and Andrew N. Shen, Deputy City Attorneys, for Defendants and Respondents.

OPINION

Jenkins, J.

By its lawsuit Coblentz, Patch, Duffy & Bass LLP, a limited liability partnership practicing law, challenges the validity and scope of Proposition Q, which amended the Payroll Expense Tax Ordinance of the City and County of San Francisco (the city) (San Francisco Bus. & Tax Reg. Code, art. 12-A, § 901, et seq.[1]). Plaintiff paid the payroll expense tax calculated pursuant to Proposition Q, and the city rejected its administrative claim. Plaintiff now seeks a refund of that portion of the tax that it paid on the profits distributed to the law firm’s equity partners. After a review of Proposition Q and the arguments of the parties, we conclude the trial court correctly determined that some portion of plaintiff’s profit distributions to its equity partners represents “compensation for services, ” which sum is to be included in the payroll expense tax base. We further conclude Proposition Q does not violate either article XIIIC of the California Constitution (added by Proposition 218) or Revenue and Taxation Code section 17041.5. Accordingly, we affirm the judgment entered in favor of defendants city and its treasurer and tax collector Jose Cisneros.

FACTUAL AND PROCEDURAL BACKGROUND

A. Applicable Law - City’s Payroll Expense Tax Ordinance

In 1970, the city’s voters approved a Payroll Expense Tax Ordinance (hereinafter also referred to as the tax ordinance). As now codified in the

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City’s regulations, the payroll expense tax is imposed “for general governmental purposes and in order to require commerce and the business community to carry a fair share of the costs of local government in return for the benefits, opportunities and protections afforded by the City. Proceeds from the tax shall be deposited in the City’s general fund and may be expended for any purposes of the City.” (§ 903, subd. (b).) The payroll expense tax is payable by “every person engaging in business within the City as defined in Section 6.2-12 of Article 6 [2]; provided, that such tax shall be levied only upon that portion of the person’s payroll expense that is attributable to the City as set forth in Section 904 [3].” (§ 903, subd. (a).)

Before the general election in November 2008, the tax ordinance defined “payroll expense” to mean “the compensation paid to, on behalf of, or for the benefit of an individual, including salaries, wages, bonuses, commissions, property issued or transferred in exchange for the performance of services (including but not limited to stock options) and any other form of compensation, who, during any tax year, perform work or render services, in whole or in part in the City; and if more than one individual during any tax year performs work or renders services in whole or in part in the City, the term ‘[p]ayroll [e]xpense’ means the total compensation paid including salaries, wages, bonuses, commissions, property issued or transferred in exchange for the performance of services (including but not limited to stock options) and any other form of compensation, to all such individuals.” (Former § 902.1, subd. (a).) The tax ordinance also described the method for the calculation of the expense payroll tax: “The rate of the payroll expense tax shall be 1-1/2 percent. The amount of a person’s liability for the payroll expense tax shall

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be the product of such person’s taxable payroll expense multiplied by 0.015. The amount of such tax for Associations [4] shall be 1-1/2 percent of the payroll expense of such Association, plus 1-1/2 percent of the total distributions made by such Association by way of salary to those having an ownership interest in such Association. Amounts paid or credited to those having an ownership interest in such Association prior and in addition to the distribution of ownership profit or loss shall be presumed to be distributions ‘by way of salary’ and for personal services rendered, unless the taxpayer proves otherwise by clear and convincing evidence.” (§ 903.1.)

In the general election of 2008, the voters were asked to consider Proposition Q, which was titled “Modifying the Payroll Expense Tax.” In pertinent part, the voters were asked: “Shall the City specify that certain partnerships and other businesses are subject to the City’s payroll expense tax... ?" (S.F. Voter Information Guide, Gen. Elec. (Nov. 4, 2008) p. 193.) The digest by the Ballot Simplification Committee read, in pertinent part, as follows: “THE WAY IT IS NOW: The City imposes a 1.5% tax on the payroll expenses of businesses that have employees working for them in San Francisco. Payroll expenses include salaries, wages, bonuses and commissions. The payroll expense tax does not apply to compensation to owners of certain partnerships and businesses.... [¶] THE PROPOSAL: Proposition Q would specify that the City’s 1.5% payroll expense tax applies to compensation paid to shareholders of professional corporations, members of limited liability companies, and owners of partnerships for their services. [¶] Proposition Q would allow these types of businesses to choose one of two ways to calculate how much of the payments to their owners is a taxable payroll expense. The business could: [¶] determine how much of the payment to its owners is taxable compensation for services, or [¶] calculate payroll expenses for each owner using a formula specified in the Tax Code.” The City controller explained to the voters the import of Proposition Q as follows: “Should this ordinance be approved, in my opinion, it would result in a net annual tax revenue increase to the City of approximately $10.5 million. The ordinance would change the number and types of businesses in the City that pay the payroll tax. [¶] Some types of corporations compensate their partners by paying them a share of the firm’s annual ...


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