Comparison-shopping Web company Shopzilla Inc. was breathing fire last year when it got a bill of $2.74 million for back taxes from the city – about 13 times what it normally paid. That’s because the city had pushed Shopzilla into a much higher tax classification and then charged unpaid past taxes.
But city officials promised to deal with the company’s grievances before the end of this year.
Now, with the deadline looming and no sign of a solution, the company is one step closer to moving its headquarters from West Los Angeles to Culver City or Santa Monica to escape the tax.
“We need a decision relatively soon or we won’t be able to wait,” said Blythe Holden, Shopzilla’s general counsel. “We are nearing the end of a six-year (office lease) commitment and we are about to embark on another long-term commitment. We need to know that we won’t be in this predicament again.”
The battle between Shopzilla and the city is part of the fallout from the city’s decision to reclassify about 30 businesses that used to get an 80 percent tax discount under 1997 rules adopted to lure multimedia and Internet companies to the city. The tax discount remains in place, but routine audits in recent years led the city to reclassify some companies out of that category and into a much more expensive one, then bill them at higher rates and assess them for back taxes.
The city has nine categories for business taxes. New-media companies are charged $1.01 per $1,000 in gross receipts, the lowest rate. The companies that have been reclassified no longer enjoy that rate, but are now subject to the rate for professional services companies, $5.07 per gross receipts, the highest rate. The professional services category includes law firms and the like.
Executives at Shopzilla, which has appealed its tax bill, and other companies said they could move to Burbank, Glendale or Santa Monica to avoid the higher taxes, which are believed to be motivated by the city’s hunger for dollars during these difficult budget times.
Critics point out that if the city insists on charging higher rates, some of the companies are likely to move, perhaps resulting in a net loss – not a gain – in tax revenue for the city.
“The city can’t solve its budget problems on the back of business,” said Sam Garrison, vice president of public policy for the Los Angeles Area Chamber of Commerce, who’s been working closely with businesses on the issue. “Business will be the engine that will ultimately pull the city budget and our local economy out of this recession, and that’s why the chamber is partnering with city officials to end these disputes and reform our business tax code.”
City officials have been talking about doing something. But no concrete action has been taken and it’s unclear which direction the city is leaning.
However, Mayor Antonio Villaraigosa and City Councilmen Bill Rosendahl, Eric Garcetti and Greig Smith are trying to redraft the tax code to include a new classification for Internet companies. Villaraigosa is trying to halt efforts to collect retroactive taxes in specific cases.
The city’s Office of Finance is preparing an analysis of an Internet tax classification, including how it will impact the city’s tax revenue, for the council’s information.
Meanwhile, the companies want quick action so they won’t be charged the higher rate for their 2009 business tax. Also, some of them, including Shopzilla, have to make decisions about their office leases soon.
“Time is really of the essence here,” Garrison said. “And we want to work with the city to make sure that there is some certainty in place before the end of the year or shortly after the holidays for these Internet companies.”
Antoinette Christovale, director of the Office of Finance, did not return requests for comment. City officials have said the dispute centers on whether the companies are really Internet or new-media businesses or whether they are more like doctors, lawyers and accountants, which fall under the professional services category and are taxed at the highest rate.
Companies self-select their categories, and would be inclined to seek the lowest rate. Questions about their tax classifications arose during city audits.
Several of the companies that were reclassified, including Shopzilla and online legal document company LegalZoom LLC said their businesses should qualify for the 1997 tax break, which applies to multimedia companies and businesses that “develop online and Internet services, including the design of Web sites for clients.”
The companies contend that the city has adopted an extremely narrow interpretation of the tax break in order to get more money.
“I think most people know what an Internet company is. It’s not difficult to define,” said John Suh, chief executive of LegalZoom. “But when the city is facing the kind of dire financial straits it is, it will favor what makes the most sense for the city coffers.”
The audits and resulting reclassifications have had an impact beyond Internet and new-media companies.
Creators Syndicate Inc., which sells syndicated columns and cartoons for publication by newspapers, magazines, books and newsletters, had been classified as a wholesaler but was reclassified as a professional services provider and placed in a higher tax bracket. As a result, the company paid $105,000 in back taxes, penalties and interest earlier this year.
Creators Syndicate then filed suit against the city in July claiming that its wholesaler classification came in a 1994 ruling by the city, and there was no justification for the reclassification.
Richard Newcombe, founder and chief executive of Creators Syndicate, wrote an opinion column that was published by the Wall Street Journal citing the unfairness of the tax reclassification and then raised his concerns with Villaraigosa.
Villaraigosa asked city Finance Director Christovale to amend the tax code in order to prevent collection of back taxes and reclassifications in cases where the city overrules itself.
Newcombe said the Mayor’s Office told him last week that the City Council is expected to vote on the proposed amendments sometime this month or in December.
Failing that, Newcombe said Creators Syndicate’s headquarters will decamp from Century Boulevard near the Los Angeles International Airport.
“We will absolutely move,” Newcombe said.
And he’s got plenty of options. He said 61 other cities have made efforts to lure Creators Syndicate and its 18 full-time employees from Los Angeles.
“Albuquerque, N.M., offered to fly five of our executives to the city, put us up in the best hotels in town, take us around and help our employees’ spouses find jobs,” Newcombe said. “There is great competition.”
He said he would move to Albuquerque – or Las Vegas or Lake Tahoe, other cities that have reached out to him.
Some companies scoping out relocation sites only need to look a few miles to move out of L.A.’s city boundaries.
Shopzilla’s headquarters at Olympic Boulevard and Bundy Drive is just a few blocks from Santa Monica, where Shopzilla would be classified as a service company and taxed lower than its contested rate in Los Angeles.
Under the new-media rate of $1.01, Shopzilla’s tax bill would have been about $200,000 year. Instead, under its reclassification, the city billed the company about $1 million. In addition, it charged Shopzilla $2.74 million in back taxes.
Shopzilla executives first thought about moving when the city audited the company in 2008 and reclassified the company as a professional service provider. But the company quickly appealed the audit to the Office of Finance’s board of review but didn’t get any results.
“It seemed like it was falling on deaf ears,” Holden said. “It didn’t feel like we were being heard, which is why we appealed to Rosendahl for assistance.”
Meanwhile, Shopzilla’s lease is set to end in June. Holden said the company would need several months to renovate any new office space to the company’s specifications, so a decision on whether to move will have to be made soon.
Like Shopzilla, LegalZoom was audited by the city, which determined it should not be receiving the discounted rate reserved for new-media companies. The city then reclassified LegalZoom as a professional service provider, increasing the company’s status to the highest tax rate, and slapped the company with a bill for back taxes.
LegalZoom then threatened to move from its Hollywood headquarters – where it occupies five floors of a six-floor building near Hollywood Boulevard and La Brea Avenue – and as a result it was able to negotiate a temporary solution with the city.
LegalZoom agreed to pay a blended rate, between $1.01 and $5.07 per $1,000 in gross receipts, for back taxes, and for the 2009 and 2010 tax years.
But it’s been two years since LegalZoom first started dealing with the matter, and the company is becoming increasingly concerned that a permanent solution isn’t in sight.
“The blended rate we negotiated is not sustainable,” Suh said. “We are currently paying it in good faith that something will change in 2010.”
But he said time is running out. The company had extended its lease until June with the idea that the issue would be resolved by now. But company executives have been looking at office space in Glendale and Burbank.
If LegalZoom and its more than 300 employees were to move, Suh said the company would need to make a final decision on its new office space by March.
Another company that’s been fighting with the city over its business taxes is Internext Media Corp., which changed its name to Advertise.com Inc. and operates search engine ABCSearch.com out of its Sherman Oaks headquarters.
The city informed Advertise that it no longer qualified for the discounted new-media rate, and the company filed a lawsuit against the city last year to recover $291,000 in taxes it claims it shouldn’t have paid.
Company executives declined to comment for this article, citing the pending litigation. However, a mandatory settlement conference in the case is scheduled for Dec. 2 and a trial is set for Dec. 8.
But the Chamber of Commerce’s Garrison is hopeful that any legal tussle over the city’s business tax policies won’t make it to a jury.
He said the chamber has been pushing for business tax reform, and the organization has proposed that the city put a moratorium on new tax reclassifications of businesses, place the companies that have been reclassified back into their original tax category and settle any litigation that’s resulted from the reclassifications.
“We see this as a real opportunity to make the statement that Los Angeles is open for business and the city values business,” Garrison said. “The weather isn’t going to keep businesses here.”
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