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To raise revenue and tackle health concerns, a number of localities have imposed sugar-sweetened beverage taxes. However, localities may have limited guidance on how these taxes are administered. In this article, Eversheds Sutherland (US) LLP's Jonathan A. Feldman and Alla Raykin discuss the compliance burdens local beverage taxes impose.
By Jonathan A. Feldman and Alla Raykin
Jonathan A. Feldman is a partner in Eversheds Sutherland (US) LLP's Atlanta office. Jonathan counsels clients in all areas of state and local taxation including income, franchise, sales and use and property taxes. Alla Raykin is an associate in Eversheds Sutherland (US) LLP's Atlanta office. Alla adviises clients on a full range of state and local tax matters, including tax controversy, policy matters and planning.
A Cook County, Illinois, judge recently dismissed a group of retailers' legal challenge to the County's Sweetened Beverage Tax. Cook County's Sweetened Beverage Tax was originally intended to go into effect July 1, but was delayed when a trial court issued a temporary restraining order while it evaluated the legality of the tax. The tax survived the legal challenge despite widespread confusion, limited and inconsistent guidance, and administrative uncertainty. It went into effect August 2. Already, at least three class action suits have been filed in Cook County involving retailers' attempted compliance with the tax. The implementation of Cook County's tax, despite all of the identified problems, demonstrates that taxpayers—retailers, distributors and bottlers—cannot rely on courts to stop these taxes, but must be prepared to shoulder the administrative burden.
As local governments continue to seek new sources of revenue, various forms of sugar-sweetened beverage (“SSB”) taxes have gained traction nationally. Proponents of these taxes rely on public health studies to show the role of SSBs in the obesity epidemic and the health risks of such beverages, although other sugar-sweetened food, such as candy, has been largely unaffected. However, it is debatable whether the imposition of, and revenue from, such taxes actually accomplish anything towards the purported public health objectives. Or are these taxes simply a general revenue raising mechanism disguised in noble purposes?
While each new SSB tax elicits debate on whether such taxes are morally justified, influence health behavior, strain the local economy, are inherently regressive, etc., these debates obfuscate how the tax will actually be administered. Any new tax requires thoughtful guidance, an administrative infrastructure, and, inevitably, creates a headache for taxpayers to implement and comply with new requirements. SSB taxes are generally adopted by localities, which often are unable to use any existing tax's administrative infrastructure since state law prohibits localities from imposing sales taxes, or duplicating the existing sales taxes. Thus, localities with limited tax administrative resources and structure leave taxpayers to navigate a new tax with little guidance or clarity.
Recently, several localities have passed new taxes on SSBs: Four California cities (Albany, Berkeley, Oakland and San Francisco); Boulder, Colorado; Philadelphia, Pennsylvania; Cook County, Illinois; and Seattle, Washington. Other jurisdictions are considering similar taxes. For example, Massachusetts is considering a statewide tax. Mass. H. 3329 (190th Current Sess. 2017). However, a recent ballot initiative in Santa Fe, New Mexico for an SSB tax to fund education was defeated, after millions of dollars were spent by campaigns for both sides. Also, in 2014, New York's highest court struck down New York City's ban on sales of SSBs in containers over 16 ounces.
SSB taxes are generally imposed at $0.01 to $0.02 per fluid ounce (compared to sales taxes based on sales price). For example, Boulder's SSB tax is imposed at a rate of $0.02 per fluid ounce of “sugar-sweetened beverage.” Boulder, Colo. Ord. §3-16-2. It is customary for localities to state policy objectives and supporting health studies within their ordinances. For example, San Francisco's SSB tax ordinance states that its intent is to “discourage the distribution and consumption” of “sugar-sweetened beverages.” San. Francisco Bus. & Tax Regulations Code §551. However, the funds for these taxes are generally not limited to furthering the stated policy objectives. If these policy objectives were truly the goal of the taxes, one would think that at least some funds would be earmarked towards public health programs. See University of Connecticut Rudd Center, Sugar-Sweetened Beverage Taxes: An Updated Policy Brief (Oct. 2012). Not only does the discretionary use of SSB revenue raise questions about the motivations of the new taxes, but it also makes it harder, if not impossible, to evaluate the efficacy of any purported public health objectives.
Cook County's SSB tax raises questions about the motivations for such taxes. When the trial court temporarily enjoined the Cook County tax from going into effect, the Cook County Board President blamed the injunction for the layoff of county employees—initially reported as 1,100 employees (but ultimately it was around 300 employees). As discussed further, Cook County's tax has many problems, but the President's statements suggest the SSB tax primarily aims to cure Cook County's budget woes rather than public health problems. In fact, Cook County's inability to provide clear guidance or ensure compliance undermines the purported public health objectives. Despite the administrative problems of many SSB taxes, courts have generally not been receptive to the legal challenges on the validity of such taxes. E.g., Williams v. City of Philadelphia, Nos. 2077 and 2078 C.D. 2016 (Pa. Commw. Ct. June 14, 2017) (en banc) (upholding Philadelphia's SSB tax, but the decision is currently being appealed to the Pennsylvania Supreme Court).
SSBs are generally subject to state and local sales taxes. Most states exempt or apply a reduced sales tax rate, for “food and food ingredients,” but this exemption generally excludes soft drinks. The Streamlined Sales & Use Tax Agreement defines “soft drinks” as “non-alcoholic beverages that contain natural or artificial sweeteners,” excluding “beverages that contain milk or milk products, soy, rice or similar milk substitutes, or greater than fifty percent of vegetable or fruit juice by volume.” Thus, in many states, SSBs are already subject to a higher sales tax rate than other beverages. Additionally, some states also impose excise taxes on soft drink wholesalers and distributors. E.g., Va. Code §58.1-1702; W. Va. Code §11-19-2.
Unlike sales taxes, SSB taxes are generally not administered at the state level. In some states, such as Illinois, localities have broad home rule abilities to pass taxes and administer such taxes. SSB taxes generally take one of two forms: an excise tax remitted by the manufacturers/distributors or a sales tax remitted by retailers. To affect consumption behavior and public health (as is the purported intent), one would think that the consumer would bear the economic impact of the tax. However, localities are generally limited on the types of taxes they can impose, or are unwilling to raise their local sales tax rates. Thus, SSB taxes may (or in some localities, must) avoid appearing as another sales tax. With SSB taxes' goal of affecting consumer behavior, the taxes are structured to either assume that the excise tax will ultimately be passed through to the consumer, or alternatively, to require that the tax be passed through to consumers while prohibiting the retailer's “absorption” of the tax in the same way that sales tax does, without actually making it a sales tax.
Since SSB taxes are administered at the local level, they generally have less resources to provide guidance or audit taxpayers than for state level taxes. Administration of taxes is more difficult the more taxpayers there are. An excise tax imposed on manufacturers may be the easiest to enforce, but most localities would likely not have nexus to the manufacturers to impose such a tax. A tax collected and/or remitted by retailers is most visible to a consumer, but poses the problem of numerous retailers, of various sophistication levels. Also, a consumer can easily avoid local SSB tax—just leave the locality to get drinks. There generally appears to be no “use tax” component of the SSB taxes.
With limited resources, and little guidance on how to follow the law, it is not surprising to see localities struggle to effectively enforce the tax. As Cook County's SSB tax demonstrates, taxpayers, particularly retailers, bear the burden of figuring out how to implement and administer these taxes.
Unlike some of the other SSB taxes which are imposed on distributors, Cook County's SSB tax is imposed and remitted by distributors, but retailers are to “in turn” collect the tax from customers. Retailers are not permitted to absorb the tax on behalf of their customers. Cook County, Ill., Code of Ordinances §74-852(c). The tax is $0.01 per ounce of sweetened beverage. Cook County, Ill., Code of Ordinances §74-852(e)(3). This structure creates questions for retailers about exactly how to pass through the tax to consumers, and the guidance issued has been confusing, conflicting, and unhelpful.
Distributors determine the SSB tax charged to retailers based on the syrup or powder used to sweeten the beverages sold and the volume such sweeteners or powders would produce, or alternatively, the ounces in a bottle. It is not clear how retailers pass through the tax for drinks that do not have a predetermined volume. How will a retailer know how much SSB a consumer is purchasing? What happens if the retailer offers refills? Will the retailers have to charge the tax for each refill? What about when ice is offered with drinks? And the list goes on.
Although a retailer may make a good-faith effort to answer these questions, there may be no correct answer. Nor is there an answer on whether taxpayers could be subject to the hefty penalties imposed by Cook County's SSB for not properly “in turn” passing through the entire amount of the tax ($1,000 for the first offense, and $2,000 for each subsequent offense). Cook County, Ill., Code of Ordinances §74-857.
The County's guidance has been obtuse. In the County's FAQs, in response to questions about what exactly is taxable, the County responds that “[a]ll beverages that meet the definitions in the ordinance are taxable.” To the reasonable question of how to handle ice, the County opined, “the retailer should charge tax on the ounces sold. The addition of ice is at the discretion of the retailer/customer and does not affect the amount of tax due.” While taxpayers may seek more specific individualized rulings from Cook County, there is no guarantee that each taxpayer will not get a different answer, creating an inadvertent competitive advantage for one taxpayer compared to another.
The plaintiffs in the challenge to Cook County's SSB tax alleged that the tax violated the Illinois Constitution's uniformity clause, and that it was unconstitutionally vague. The Cook County Circuit Court dismissed the complaint, and determined that there was (1) a real and substantial difference between beverages taxed and not, and (2) a reasonable relationship between the ordinance and the public policy. In response to the plaintiffs' argument that the tax is unconstitutionally vague as to its implementation, the Court said that the ordinance is not so vague that it is unconstitutional. The fact that there are mathematical uncertainties in the collection of the tax does not reach the level of unconstitutionality. Ill. Retail Merchants Ass'n v. Cook Cnty. Dep't of Revenue, No. 17 L 50596 (Circuit Court of Cook Cnty., Ill, Jul. 28, 2017). The plaintiffs appealed this decision to the Illinois Court of Appeals on August 1, 2017. Additionally, the US Department of Agriculture has threatened to withhold $87 million dollars of state funding because of the tax's application to food stamps.
As with any new tax, there will be questions on how it should be administered. With the wave of new SSB taxes, affected taxpayers should be aware of the administrative complexities with these taxes. Unfortunately, taxpayers may be left in the difficult position of deciding how to comply with the tax, particularly if retailers have obligations under the tax. Not only is this onerous for the taxpayer, but it also shifts the burden to taxpayers to enforce a tax and policy objectives designed to discourage consumers from purchasing their products.
First, the taxes have been the subject of many legal challenges. Cook County's tax was enjoined on the eve of its effective date. Once the court dismissed the case, the County announced the tax would go into effect less than one week later. Philadelphia's tax, although in effect, is still facing an appeal of the Commonwealth Court's decision to the Pennsylvania Supreme Court. Thus, a taxpayer's implementation plans for the new tax should also come with an off switch, just in case the tax is legally stopped or paused. Taxpayers should also be aware that administrative uncertainties alone are not enough to strike down an SSB tax. As the Cook County Circuit Court noted, perfect clarity and precise guidance are not a requirement for constitutional laws.
Second, taxpayers should ensure that they are clear on which point of the distribution cycle the tax is imposed, and if there is any potential for imposition of the tax on the taxpayer. For example, many SSB taxes are imposed on distributors, but a retailer purchasing from a distributor that does not collect the tax is itself responsible for collection. SSB taxes collected by the retailer get more complicated because the retailer must determine how to advertise the tax, how to factor the tax into its prices, and how such pricing may affect its various product offerings. In Cook County, within a week of the SSB tax's implementation, at least three class action law suits were filed against retailers who were allegedly improperly collecting the tax from their customers. See, e.g., Leon v. Walgreens Boots Alliance, Inc., No. 2017-CH-10758 (Circuit Court of Cook Cnty., Ill., filed Aug. 4, 2017); Wojtecki v. McDonald's Corp., No. 2017L008008 (Circuit Court of Cook Cnty., Ill., filed Aug. 8, 2017).
Third, to the extent possible, taxpayers should understand which of their products are subject to the tax. For example, Seattle's SSB tax does not apply to diet drinks, unlike many other SSB taxes.
And fourth, a taxpayer should understand the administrative procedure related to the tax. What are the relevant risk of audits, penalties, or even litigation if the tax is over or under collected? Does the locality have a tax protest/appeal procedure that applies to the SSB tax? What is the procedure to get a refund from the locality? Would a retailer-taxpayer have to request the refund from its distributor, or could the retailer request the refund directly from the locality? Does the consumer have any right to a refund from the locality or the retailer? These considerations may affect taxpayers' decisions on how they analyze and implement new SSB taxes.
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