Who is Subject to Gross Receipt Tax?

Cataldo explains the facets of Gross Receipt Taxes.

SAN FRANCISCO— The process of the Gross Receipt Tax (GRT) and its implications may leave some with more questions than answers. Michael Cataldo and Rachel Horsch of Pillsbury Winthrop Shaw Pittman LLP recently discussed the impact of the GRT on companies involved in real estate ownership and operation in this exclusive to GlobeSt.com. GlobeSt.com: Who is taxed? Michael Cataldo/Rachel Horsch:  GRT is generally imposed on a broad array of business entities engaging in business in San Francisco, including entities that are not subject to federal income tax (i.e., “pass-through” entities). However, single-owner entities that are disregarded for federal income tax purposes are likewise disregarded for the GRT. A person is not subject to the GRT solely as a result of being an owner of a pass-through entity that is engaged in business in San Francisco. For example, an owner (a disregarded limited liability company) is engaging in business in San Francisco as a result of its direct ownership and rental of property. However, it will be disregarded for GRT. Thus, the activities of the owner will be attributed to venture (wholly owned by another limited liability company) and subject venture to GRT. Parents (unaffiliated corporations that acquire commercial real estate) should not be subject to GRT solely as a result of indirect ownership interests in venture. However, if either parent is otherwise directly engaged in business in San Francisco, it could be subject to GRT as a result. A wholly owned subsidiary of a manager-owner, a listing broker and any procuring/tenant brokers would be subject to GRT regardless of where their offices are located because they conduct leasing and management activities in San Francisco. GlobeSt.com: What is taxed? Cataldo/Horsch:  Operations gross receipts subject to GRT are broadly defined to include total amounts received or accrued from whatever source, and encompass all amounts that constitute gross income for federal income tax purposes subject to certain exceptions. In the ongoing example: venture is subject to the GRT on the gross rental receipts of owner without deduction for any of the operating expenses relating to the property. However, the venture should not be required to pay GRT on any gross rental receipts from any property it owns directly or indirectly located outside of San Francisco.  While the venture would likely be subject to GRT on receipt of payments from San Francisco tenants to reimburse owners for operating expenses, if the tenants were responsible for operating expenses under the leases, and paid those expenses directly without reimbursement from the owners, payment of such expenses should not be included in the owners’ gross receipts, as they would not be legal obligations of the owners. Distributions from the venture to the members would be treated for GRT purposes as if made to parents. However, partnership income which was already subject to GRT by the venture and any actual distributions thereof are not subject to GRT. Thus, distributive shares or actual distributions of income from the venture attributable to the property should not be subject to GRT at the parent level. Furthermore, distributions of income from the venture attributable to property located outside of San Francisco should not be subject to GRT, as excluded gross receipts “derived exclusively from an investment in such entity, and not from any other property sold to, or services provided to, such entity.” A wholly owned subsidiary of a manager-owner will be subject to GRT on the fees paid to it by owners with respect to the management services it renders for the property. Management fees earned by a wholly owned subsidiary of a manager-owner for managing the property located outside of San Francisco should not be subject to GRT even if the subsidiary is based in, or conducts all of its management activities in San Francisco. However, the subsidiary’s fees may be excluded from GRT if they were paid by a “related entity” required to be included with the wholly owned subsidiary of a manager-owner in a single combined GRT return.  If the subsidiary collects rents on behalf of the owner and deposits into the owner’s bank account, and withdraws from such accounts to pay for expenses relating to the properties (i.e., insurance, taxes, repairs) should not be considered gross receipts of the wholly owned subsidiary of a manager-owner for GRT purposes as they are acting merely as the owner’s agent. If the subsidiary paid these expenses directly from its own account, and was reimbursed for these expenses pursuant to the management agreement, the reimbursement may be considered a taxable gross receipt of the wholly owned subsidiary. If a listing broker receives a full commission and in turn pays half of it to the procuring brokers, the listing broker may be required to pay GRT on the full commission. However, if the owners are required to, and do in fact, pay the commission to procuring brokers directly, the risk that part of the commission would be taxed twice: first upon receipt by the listing broker, and again upon payment by the listing broker to the procuring brokers. GlobeSt.com: What is taxed? Cataldo/Horsch:  Dispositions-transfers of real property located in San Francisco are exempt from GRT if they are subject to a transfer tax. If a transfer tax does not apply, gross receipts from the sale or exchange of real property excludes the cost to acquire the property. Additionally, if such a transaction involved a so-called “1031” tax deferred exchange, the GRT would similarly be deferred.  Finally if the sale were of an interest in the venture, it could be subject to an exclusion for “investment receipts”–capital gains and amounts received on account of financial instruments (including stocks or other similar written instruments evidencing a right to participate in the assets of any business, bonds or other evidence of indebtedness, or any other marketable security), so long as such gains/amounts are directly derived exclusively from the investment of capital and not from the sale of property other than financial instruments, or from the provision of services. Application of GRT in the commercial real estate context is surrounded by a myriad of uncertainty. Additional guidance from a tax collector is certainly needed.