Startups resist payroll tax

SAN FRANCISCO – In a startup’s initial public offering, a lot of people can get fabulously rich: the founders, early employees and the venture capitalists who staked the company.

Should the city where the company resides also share in the windfall? San Francisco officials had thought so.

But two of the city’s hottest technology startups, Twitter and Zynga, are threatening to leave San Francisco unless they get a break from a city payroll tax that could, given the estimated multibillion-dollar valuations of the two companies, amount to tens of millions of dollars.

Local officials, fearing the loss of thousands of jobs and a considerable amount of prestige as a tech centre, are scrambling to placate the disgruntled businesses. But the city is also struggling with a budget deficit that may require firing hundreds of public employees to bring it under control.

The dispute centres on San Francisco’s payroll tax, the only one of its kind in the state. Companies with more than $250,000 in payroll are required to pay the city the equivalent of 1.5 percent of total employee compensation each year. The compensation includes salaries, bonuses and, of much concern to a company contemplating a public offering, the gains from exercised stock options.

The bigger issue for the city is battling its anti-business image. For years, San Francisco has been a hub for startups, but relatively few big technology companies are based in the city limits compared with some other cities in Silicon Valley.

Jennifer Matz, director of the city’s Office of Economic and Workforce Development, said the payroll tax is a disincentive for businesses to grow in San Francisco. The city approved a payroll tax break for biotechnology companies seven years ago, and Matz said it has helped attract dozens of biotech startups.

“This tax is particularly ill-suited to the new wave of businesses that we are trying to make the centre of our economy,” Matz said.

But with an Internet boom under way and the market for public offerings heating up – both Zynga and Twitter were recently valued at well over $7 billion – the future revenue from the payroll tax is hard to resist.

Twitter, the online messaging service, first spoke up about the issue last year as it was considering a move to bigger offices. In a recent letter to Mayor Edwin M. Lee and the city’s Board of Supervisors, Twitter said it had all but decided to leave the city because of higher rent, taxes and other expenses that would cost it an extra $30 million over the next five years.

“Given these economic realities, there was simply no way for us to justify the cost burden of staying in San Francisco,” Ali Rowghani, Twitter’s chief financial officer, wrote.

Not willing to call Twitter’s bluff, the city offered a deal to the company, which now works out of space in the gritty but fashionable South of Market district where many Internet startups begin. Move to a building in the even more gritty and decidedly less fashionable mid-Market neighbourhood – on a section of Market Street that is marred by drug dealing, homeless encampments and shuttered storefronts – and get a payroll tax exemption.

Twitter, or any other company with a payroll of more than $1 million that moves into that “rehabilitation zone,” would have its payroll tax capped at its current level for the next six years. Hiring more employees would not increase the tax bill. And any stock option windfall would be exempt.

In March, Twitter signed a letter of intent to rent the space if the supervisors approved the tax break. Almost immediately, Zynga, the creator of social games like Farmville, as well as other companies with offices outside the special tax zone, tried to broaden the terms of the tax break so it would include them. In theory, companies have had to pay the tax – stock gains included – for decades.

The city cannot say whether companies have actually paid the tax. Businesses self-report the tax to the city and do not have to break out different types of compensation on their forms. City audits show that some businesses follow the law while others do not, said Jose Cisneros, the city’s treasurer.

San Francisco, which had a $6.6 billion budget last year, raises around $350 million annually from the payroll tax.

Critics of the proposed tax breaks rallied recently in front of Twitter’s offices, accusing the company of hypocrisy for espousing social consciousness while seeking concessions from the city.

Meanwhile, Roxanne Sanchez, president of the Service Employees International Union, Local 1021, called the Twitter tax break a bailout for commercial real estate owners. She preferred a blanket proposal, like Mirkarimi’s, which she said would help create more new jobs.

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