Defining In Lieu Taxes For Certain Taxpayers

A query was made after one reader found a real property tax exemption provided to utilities as to why utilities are exempt from the real property tax.

Taxation of property owned by a public utility presents a challenge in that much of the property a public utility owns consists of bits and pieces of property over which the service is provided. These include rights-of-way, utility boxes, strips of land over which cables and lines run and, of course, where either the energy is produced or the switching panels are located for telephonic services.

Not only is it difficult to assess these pieces of real property because of topography, but also because there are no comparables by which the assessor can determine a like kind of property. Another difficulty that other states grapple with in attempting to tax utilities under their real property tax laws is that it is difficult to assess the value of such property because the situs of the property does not necessarily indicate where the income is earned.

As a result, the territorial legislature when it adopted the predecessor of today’s general excise tax separated out utilities into what eventually became the public service company tax. Readers have to remember that until 1978, the territory, and later the state, controlled the whole ball of wax when it came to taxation. Recognizing the difficulty of assessing the real property of utilities, the territorial legislature created, in addition to the new business excise tax, a public utilities tax and a bank excise tax.

The public utilities tax and the bank excise tax imposed higher rates than the general business excise tax which was set at 2% for all other general businesses. This was to compensate for the exemptions provided for real property taxation of utilities and for the exemption from the corporate income tax for financial institutions. Because the territory, and later the state, set tax policy for the real property tax, it didn’t make any difference if utilities were afforded an exemption from the real property tax in return for paying the in-lieu public service company tax.

However, once the counties were given complete control over the real property tax by the 1978 constitutional convention carrying that exemption for utilities did not seem fair from the counties’ perspective. So when the constitutional provision that froze all pre-existing exemptions under the real property tax expired in 1989, eleven years after the 1978 constitutional convention, the counties began to make noises about this unfair situation.

It took more than twelve years to resolve this issue when the legislature in 2001 decided that the counties should receive a portion of the public service company tax revenue. Under the prior law, the minimum tax rate was 5.885% with a maximum rate of 8.2%. The 2001 legislation directed that receipts generated from a four percent rate under the public service company tax should be a receipt of the state’s general fund while everything generated by a rate greater than 4% should accrue to the county in which the income is generated. Thus, the counties were finally compensated for the real property tax exemption.

While this might sound like a good deal for the utilities, readers should know that electric and gas utilities also pay 2.5% of their gross income to the counties in the form of the public utilities franchise tax. This is a tax that dates from 1916 when businesses sought licenses to be the exclusive service provider of what was then considered a utility. Although imposed by state law, the receipts of the utility franchise tax are county revenues dedicated to the repair and maintenance of county roads.

To the consternation of the counties, the phone company is not subject to the franchise tax as it does not hold a franchise but has a charter from King David Kalakaua which was upheld under the Organic Act of 1900 which set out the conditions upon which Hawaii was granted territorial status. 

So what started out as an inquiry about why the utilities enjoy an exemption from the real property tax hopefully will be a good lesson in how the counties do benefit from the utilities as taxpayers albeit for taxes levied in lieu of the property tax and for use of county property in order to transmit their services be it energy or communications. 

Although Hawaii has a well-defined tax structure, the devil is sometimes found in the details and the history of the tax itself.