By Lowell L. Kalapa
Years ago, economists pointed out to lawmakers that capital goods, like machinery and equipment, were crucial to the creation of new jobs.
Local businesses pointed out that the 4% general excise tax on those purchases just made the acquisition of those goods that much more expensive, reducing the potential to create new jobs.
Although the business community called for an exemption from the 4% tax on the purchase of capital goods, the legislature provided for a tax credit which they believed would be easier to administer and verify. Lawmakers looked to the federal investment tax credit for guidance on how to apply the credit since the federal credit was also aimed at the purchase or acquisition of capital goods.
However, in drafting the tax credit, lawmakers provided that the basis against which the credit was to be calculated would be what is called the depreciable basis or the actual invoice price, whichever was less. No one paid much attention to what the difference might be because it was believed that the old federal investment tax credit rules would apply.
And indeed for years, accountants and bookkeepers applied the tax credit to what many took as the depreciable basis of the capital goods they purchased. However, recently as a result of audits, the department of taxation has taken a strict interpretation of what the base or cost of the goods should be in determining the tax credit. Because the law says the base or cost should be the lesser of “actual invoice price” or the “depreciable basis,” department auditors have interpreted “actual invoice price” as the cost of the goods and that cost will always be less than the “depreciable basis” since the depreciable basis will sometimes include the cost of installation of the capital goods.
Because there is no guidance or definition of what is meant by “actual invoice price,” the assumption is that it is the number value associated with each piece of capital goods. Thus, if a business was putting together a computer system for its operations and orders a CPU from one manufacturer and the memory chips from another manufacturer and the wireless mouse from another manufacturer and the screen from yet another manufacturer, the credit would be calculated for each component part’s shelf price. And yet, until the chips are installed in the CPU and the screen connected to the CPU, the computer is nonfunctional. And if it is not working, then the job of operating the computer is not created.
The department argues that they don’t want to give the credit for an installation that might be done in- house, but they seem to overlook the fact that in order to claim the credit, the general excise tax has to have been paid at the rate of 4%. The department also argues that if the credit was to apply to depreciable basis and therefore the cost of installation, it would create a tremendous revenue loss for the state.
However, many accountants and tax professionals have been applying the credit to the depreciable basis for years. Thus, it seems if there is any loss, it is already occurring. This is because many have assumed that the old federal investment tax credit rules applied.
What makes little sense is the department’s refusal to recognize that in many cases installation services are crucial to the use of the capital goods. If a generator is not bolted to the floor or if a commercial range is not connected to its electric or gas energy source, those pieces of equipment cannot be operated and there would be no job created.
In the case where parts of some piece of equipment need to be assembled before the capital goods can be operated or turned on, what this interpretation of the tax credit will do is to favor the assembly of the goods outside the state so that the parts will be assembled before they are landed in Hawaii so that the credit can be taken on the assembled piece of equipment, including the labor it took to assemble the equipment.
If the department of taxation does not recognize depreciable basis as the standard for determining the capital goods excise tax credit, it will be able to go back and penalize every claim for the credit because in most cases, “actual invoice price” will always be less than depreciable basis. This will cast a pall over the business community and seemingly run counter to the intent of the credit, which is to encourage the creation of new job opportunities.