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(Bloomberg) -- A tax agreement between Apple Inc. and its hometown of Cupertino, California, has come under scrutiny from state regulators, potentially slashing the amount of money that the company sends to the city.

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The California Department of Tax and Fee Administration launched an audit of the arrangement in 2021, and Cupertino’s finance director is scheduled to explain the findings to the city council on Thursday. The upshot for Cupertino is that local tax revenues are expected to fall 73% this year.

Although Apple isn’t named in the city staff report, the company is Cupertino’s largest source of sales tax revenue. According to the audit, revenue will drop to $11.4 million in the current fiscal year from $42.1 million, and Cupertino may be required to return money to the state that it has received in previous years. The city may have to cut staff and other spending to cover the shortfall.

“This decline in revenue is due to a change in sales tax distributions based on the anticipated outcome of a state audit of one of the city’s taxpayers,” Cupertino said in a written statement. The city is taking early action to inform the council members and community “in preparation for developing budget-balancing strategies as we prepare next year’s budget.”

At issue is the company’s treatment of online sales. Under California law, a local portion of sales tax goes to the location where the transaction takes place, not the location of the customer.

Apple treats all online purchases of products in the state of California as if they were made in Cupertino, setting aside the 1 percentage point local portion of the 7.25% state sales tax for its hometown. The arrangement applies to Apple’s online sales to consumers in the state, as well as transactions with other businesses in California, sales at its two retail stores in Cupertino, and use tax on the company’s own equipment purchases, city officials have said.

The company remits all sales tax it receives to the state tax department, which then allocates the local portion to Cupertino. The city passes on 35% of its total to Apple. Those payments to Apple have added up to $107.7 million since 1998, according to city payment records examined by Bloomberg Tax.