| Although it is has been much discussed both in this column as well as through other media, it appears that many readers still do not understand what the pyramiding bill will do and how it will work.
In the case of the latter, how well it will work has yet to be seen as the department of taxation will no doubt have to issue information releases and rules. That is, of course, assuming that SB 638, HD-2 will be signed into law. What is known is that the tax rate will go down on the purchase of services which will be subsequently resold to someone else. The rate will go from the current 4% to 0.5% at the end of the seven-year phase-in of the rate.
Some readers have asked for examples of services which can be purchased for resale where this change will apply. Well, here in Hawaii where the visitor industry is a major source of economic activity, the sale of services for resale happens all the time. Take, for example, that a hotel in Wailea or Poipu wants to put on an authentic Hawaiian luau. The hotel doesn’t want to expand its food and banquet staff just to hold a once a week luau on their property, so they contract with an authentic Hawaiian caterer.
The contract specifies that the caterer must provide everything from food to entertainment to flowers to decorations. However, the caterer only knows how to cook the food, in fact, most of the staff is tone deaf. So the caterer contracts with a local Hawaiian trio to provide the music. Similarly, a contract is made with a local florist and a production company to provide the special effects.
Under current law, each of these transactions is subject to the 4% general excise tax rate since there is currently no provision for the lesser rate on services which are being purchased for someone else. In this case, the caterer is not “consuming” the entertainment, the flowers, or for that matter the special effects. The hotel, in turn, is not consuming the food, the entertainment, the flowers or the special effects, yet the caterer has to pay the 4% rate because it is providing a service to the hotel regardless of the fact that the hotel intends to sell tickets to the luau to its guests.
Under the de-pyramiding bill, all of the transactions noted above would eventually have to pay only the 0.5% rate as those services would be deemed to be sold for resale. The entertainers income would be subject to the lesser rate as would the florist and the production company. The income the caterer receives from the hotel would also be subject to the lesser rate. Only when the hotel sells the tickets to the luau would that income then be subject to the full 4% retail rate as it is the visitor who will actually be consuming the food, enjoying the entertainment and flowers and be amused by the special effects.
How much savings would this change in the tax rate mean for these services? Well, let’s say the entertainers charge $10,000 a month for their performance. At the 4% rate, the entertainers are currently paying $400 in general excise taxes. When SB 638, HD-2 is fully phased-in, that amount will drop to $50. While some dispute the cost savings, the point of the matter is to put services on the same playing field as goods. Currently, when goods are purchased for resale, like the box of corn flakes purchased by your local supermarket from a wholesaler, the rate of tax imposed on that sale is 0.5%. The whole idea is to reduce the final cost of the goods – and with the approval of SB 638, HD-2 – services, to the final consumer.
Some argue that the pyramiding bill does not go far enough in helping to reduce the cost of doing business, that in fact, all services sold to businesses should be at the lesser rate of 0.5%. Unfortunately, that was not the intent of the legislation. The intent is parity with the sale of goods purchased for resale, not wholesale tax reduction for businesses. If the intent was to make all sales of services to businesses taxable at the lesser rate, then that same application should have applied to the purchase of goods.
In fact, the bill specifies that the lesser rate will not apply to purchases that represent “overhead” of a business. For example, accounting services purchased to examine the books of a company is considered overhead or an attorney’s fees for advice to a company on how it should draft it personnel policies would also be considered overhead and not granted the lesser rate.
So will the de-pyramiding bill help reduce the cost of living and doing business in Hawaii? When one considers that 60% of the general excise tax base is attributable to services, imposing the lesser rate on some of those transactions will be a good step in the right direction.
By Lowell L. Kalapa