California targets Apple, but Cupertino loses big

Cupertino may be forced to lay off dozens of workers, cut services and put new tax measures on the ballot to compensate for the loss of nearly $60 million likely to be ripped from its budget.

California’s Department of Tax and Fee Administration is targeting tech giant Apple over how it allocates local sales taxes, and Cupertino is caught in the crossfire with officials left scrambling to find solutions.

“The CDTFA has done an audit of one of our big taxpayers and has identified that there are dollars being allocated improperly, and through that audit they are asking for that process to be corrected,” Matt Morley, Cupertino’s Assistant City Manager, told San José Spotlight.

Under a longstanding tax sharing agreement between the city and Apple, dating back to 1998, the company designates all online product sales to California residents as taking place in Cupertino, and allocates the local 1% portion of the state’s 7.25% sales tax from those transactions to the city.

Cupertino – where Apple is headquartered and has grown into the world’s most valuable company at $2.78 trillion – benefits from the agreement because it earns more in sales tax revenue than it would without. The city in turn gives back about a third of that tax revenue to Apple.

But now state tax officials decided Apple needs to reimburse the state about $20 million to be reallocated to other places, and Cupertino would owe $56.5 million, covering the period from April 2021 through June 2023.

In response, the Cupertino City Council last month agreed to set aside that amount from the city’s reserves, including pulling $44 million from an unassigned general fund reserve, to prepare for potential losses in sales tax.

Going forward, if the decision is upheld, the city would see reductions of about $30 million annually in sales tax revenue in years to come, or a 73% drop in revenue from previous forecasts.

Amid that financial fallout, the city will need to cut nearly a quarter of its operational costs, or raise more funds through other avenues, officials said.

City and state tax officials decline to name Apple as the company being audited, citing confidentiality rules. However, some city leaders have indicated Apple is the target of the audit, and others have slipped out such confidential information while reading from a Bloomberg article on the dais during a public meeting. 

The city is appealing the CDTFA decision, but the process could take from seven to 10 years, Morley said.

“The city obviously isn’t happy with this and we don’t believe the CDTFA is on base,” Morley said.

While specific decisions about what to cut from city services will be made by the council in the coming months, Morley said it’s already clear the impacts will be significant. Morley said non-essential city services could be eliminated or severely reduced.

“We anticipate reductions in force, so staffing reductions,” Morley said. “We don’t know what those look like or can’t really quantify them at this point, but it could be upwards of 40 positions.”

Mayor Hung Wei told San José Spotlight that city leaders, employees and residents will need to come together to find solutions for the rough road ahead.

“It’s going to be a long process. We will have to look at our finances and be creative,” Wei said. “I’m very confident that Cupertino can weather this financial crisis.”

While she said the council will not make any decisions without resident input, Wei added “public safety and parks and recreation will not be minimized.”

It’s unclear why the state agency decided to audit Apple when it did, but Wei said she doesn’t believe Apple is to blame for getting Cupertino into this position. Other companies in California with tax sharing agreements have also been audited.

“I think because online sales have accounted for so much money during the pandemic, it caught the attention of CDTFA and they decided to investigate, and started to redefine online sales,” Wei said.

Tax guidelines from the agency suggest local sales taxes from internet transactions should go to the jurisdiction where the item is touched by people, such as a storage and distribution facility, which Apple has in places like Elk Grove, among cities.

Morley challenges that interpretation.

“Cupertino believes that the CDTFA has changed the rules for sales tax allocation. They have no legislative authority to define the physical touch part of their interpretation for where a sale takes place. This is a new creation of the CDTFA,” he said.

Wei agreed. While she is in favor of ensuring allocation of tax dollars is done fairly, she thinks the state’s current approach of going after individual companies, affecting cities on a piecemeal basis, is wrong.

She’s hopeful state legislators will be able to put a hold on any potential clawbacks from cities like Cupertino, and work to update “outdated” state regulations on how internet sales taxes are allocated.

Contact Joseph Geha at [email protected] or @josephgeha16 on X, formerly known as Twitter.