California Is Trying to Redefine “Tax Rebates” in a Threat to Public-Private Partnerships

Taxes

Should municipal payments to a taxpayer under a public-private financing agreement be considered a tax rebate? This question is now before the Supreme Court of California, and the answer could impact tax policy and municipal financing.

The details are technical, but the implications are potentially broad: if the courts endorse an expansive view of tax rebates that encompasses contractual repayments, then governments will be able to exercise more control over private businesses, and those businesses will have more reason to be wary of public-private partnership deals that could subject them to unique requirements at a later date.

The Facts of the Case

In 2018, voters in Anaheim, California, approved Measure L, which requires certain employers with a tax rebate agreement with the city to comply with the Living Wage Ordinance. A City Subsidy is an important component of the Living Wage Ordinance and is defined as:

…any agreement with the city pursuant to which a person other than the city has a right to receive a rebate of transient occupancy tax, sales tax, entertainment tax, property tax or other taxes, presently or in the future, matured or unmatured.

In Grace v. Walt Disney Corporation, plaintiffs allege that Disney is subject to the Living Wage Ordinance by virtue of benefiting from a City Subsidy. The basic facts of the case are straightforward. The Anaheim Public Financing Authority, the City of Anaheim, Disney, and a bond trustee entered into several agreements which included issuing bonds to finance a public revitalization effort. Bondholders were to be paid using tax revenues.

The most relevant issue for our analysis is a contract in which Disney agreed to cover bondholder payments, on behalf of the city, in the event of a tax revenue shortfall. If Disney were to cover such payments, Anaheim would repay Disney when revenues rebounded. To date, Disney has not had to cover bond payments and, as a result, has not received repayment from the city of Anaheim. Nevertheless, the trial and appellate courts questioned whether Disney benefits from a City Subsidy by virtue of the agreement.

On this issue, the trial court granted summary judgment in favor of Disney, finding that no triable issue of fact remained and that the agreement was not a City Subsidy because any repayment would be made from the city’s General Fund without reference to identifiable taxes paid by Disney. (It would also be a repayment of money Disney paid on the city’s behalf, not a city benefit to Disney.) However, the appellate court disagreed and overruled the trial court, finding that the Living Wage Ordinance applied because of the definition of City Subsidy.

Simple Repayment Transaction or Tax Rebate?

If the appellate court’s decision stands, it has the potential to create significant uncertainty for public-private partnerships in the state of California and potentially beyond. Here, the agreement between the parties is not for a tax rebate. It is, in design and implementation, a contract for a repayment of funds. Recharacterizing it as a rebate improperly subjects the corporation to greater municipal regulation that was not contemplated at the time the contracts were signed.

Disney does not maintain a right to a tax rebate or tax reduction for covering bondholder payments during periods of city revenue shortfalls. Rather, the corporation stands in a position like that of a lender, which is entitled to be repaid for extending funds pursuant to a contract. A similar analogy was cited by the trial court. This is consistent with Perry v. Washburn, 20 Cal. 318 (1862), which held that a tax raises money for public purposes and is “not founded on contract.”

Any reimbursement to Disney for covering bondholder payments would be paid from the General Fund, which consists of revenue from a variety of sources, including taxes. However, this fact should not automatically convert an ordinary reimbursement into a tax rebate. Could Anaheim guarantee repayment without using tax revenue? Likely not.

Therefore, if the appellate court’s holding carries the day, it has the potential to recast any payment from a municipality pursuant to a contract as a tax rebate, regardless of how long ago the contract was executed or the nature of the transaction. Moreover, as noted above, the financing arrangement does not offset or reduce Disney’s tax obligations. Therefore, the repayment is, substantively, not a rebate.

Recharacterizing a rather simple repayment transaction as a tax rebate is concerning, not just for sound tax policy, but also for the future of public-private financing partnerships. Companies may be increasingly wary of taking on such obligations if doing so would expose them to additional obligations or liability later. Other municipalities should take note of this case, not for the opportunity to tack on additional business regulation, but for the potential impact on financing options.

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