Council Meeting: May 25, 2005 Santa Monica, California

TO: Mayor and City Council

FROM: City Staff

SUBJECT: Introduction of Ordinance Exempting Small Businesses From Business License Tax

Introduction

The attached proposed ordinance would create an exemption from the Business License Tax for small businesses with annual gross receipts up to $40,000. Staff is proposing this ordinance for Council consideration in response to issues which arose in conjunction with the recent audit activities.

Background

The Municipal Code establishes a Business License Tax applicable to all persons doing business within the City. Section 6.04.010 (a) of the Santa Monica Municipal Code defines business as “Any business, commercial enterprise, trade, calling, vocation, profession, occupation, or means of livelihood, whether or not carried on for gain or profit.” The City currently imposes a gross receipts based tax on most businesses located within Santa Monica. A minimum tax of $75 is levied on gross receipts up to $60,000. An additional tax is levied on gross receipts over $60,000 at rates ranging from $1.25 to $5 for each $1,000 over the initial base. A few business activities, such as administrative/headquarters offices, taxicabs, delivery services, and lunch trucks, are taxed on a basis other than gross receipts and are excluded from the proposed exemption.

In the last year, the City has undertaken auditing activities which have been productive in several ways. Revenues have been enhanced. Additionally, City staff has gained important information which should help the Council shape business tax policy in this area. In particular, auditing activities have shown that there are a significant number of very small businesses located within the City. As of April, 2005, approximately seventy-five percent of the new businesses licensed during the audit reported less than $40,000 in gross receipts during 2004. In many instances, these businesses are operated from the owner’s home.

The tax revenue the City derives from small businesses with up to $40,000 in gross receipts represents a little less than 3% of business tax collections. However, the impact of business tax on these businesses can be significant.

In response to the City’s auditing activities, a representative of the Screen Writers Guild has suggested that the City consider creating a special tax exemption applicable to screen writers who work in their homes as independent contractors for studios or production companies.  Such independent contractors fall into a special category under state law, and the Guild has requested that the City give those in this category special tax treatment by exempting them from the Business License Tax on the general theory that they do not operate businesses.  The Guild made the same request to the City of Los Angeles.  That city denied their request but created, instead, an exemption for all creative talent in the entertainment industry earning gross receipts of under $300,000 per year.

Discussion

Staff recommends that the Council approve an exemption for small businesses from business license tax to foster the growth of start-up and home-based businesses in the City. In the long run, this step would preserve and enhance the City’s economy. Moreover, the exemption would likely further the City’s goals of reducing commuter trips and consequent auto emissions and of preserving and promoting social and cultural diversity. The proposal to create a uniform small business exemption is preferable to creating a special exemption for screen writers or artists, which would, in effect, afford a favored status for one type of business activity.  This could raise questions of fairness and might raise doubts about the City’s commitment to economic and social diversity.   Moreover, the system requested by the guild would be very difficult for the City to administer.  It would require the City to “police” the system by interviewing individual community members about the exact nature of their activities.  This would be both costly and intrusive.  The Guild has argued that many of its members have fluctuating incomes.  Staff’s proposal would take this into account.  In years of low gross receipts, screen writers, as well as other small business people, would be exempt from the business license tax. 

The Los Angeles model is untested. The exemption is extremely high and will deprive that city of very substantial revenue.  The policy rationale underlying the very high exemption threshold for one class of businesses is unclear.   Moreover, the conceptual boundaries of the special class are vague.  In short, the Los Angeles system is very costly to that city and is difficult to rationalize and administer. 

The proposed ordinance, which would exempt businesses with gross receipts under $40,000 would provide a benefit to all small businesses, including start up businesses and various home businesses.  Artists and writers with low or fluctuating gross receipts would benefit from this ordinance.  Moreover, the proposed ordinance is fair and relatively simply and unobtrusive to administer.            

In the FY05-06 budget adoption staff report, staff will propose a substantial reduction in the zoning code compliance review fee for home-based businesses to further benefit small businesses.

Financial Impacts

Business license tax revenue would be reduced by an estimated 3%, or $320,000, per year. In addition, the City would forgo other fees and charges collected in connection with the business license tax (late payment penalties, planning review fees) of approximately $220,000 for a total potential reduction of up to $540,000. There would be no reduction in administrative costs since all businesses will continue to register for an annual business license in order to both ensure that only qualified businesses are exempted from tax and that all City permitting and other requirements are met.

Recommendation

Staff recommends that the Council introduce the attached ordinance for the first reading.

Prepared By: Steve Stark, Director of Finance/City Treasurer

Eva U’Ren, Revenue Manager

Pamela McGarvey, Revenue Operations Supervisor

Attachments: Ordinance