By Lowell L. Kalapa
At the end of this month, Hawaii taxpayers will witness an event that they have not seen in more than 40 years, an increase in the general excise tax rate when the rate will go from 4% to 4.5% for all sales to Honolulu customers.
The department of taxation recently held a hearing on the rules to implement the new county surcharge, the proceeds of which will be used to fund Honolulu’s mass transit project. The new county surcharge will apply only to those transactions that are now taxed at the 4% rate. So that means goods and services sold at wholesale on which a 0.5% rate is currently levied and the tax paid by commissioned insurance agents, which is at a 0.15% rate, are not affected by the county surcharge.
However, what is interesting is that it appears that every effort was made by the department to avoid having Neighbor Island businesses and consumers pay the county surcharge. While the underlying rationale or philosophy appears to be based on the concept that where the goods or serves are consumed will determine whether or not the surcharge applies, there are some glaring inconsistencies in the rules that were heard.
The basic rule directs taxpayers to determine where the goods or services are to be consumed. Thus, a lawyer who has a client in Hilo that has requested a trust be established for him will prepare the trust document as directed. Regardless of where the lawyer is located or does his work, because the trust document will be used by the client who does not reside in the Honolulu district, the fee will not be subject to the county surcharge. The tax rate will be 4% on the fee charged regardless if the lawyer is located in Honolulu or is located in Kahului. It is because the client is not in Honolulu that the rate will not incur the surcharge.
But let’s reverse the circumstances and say the client is in Honolulu and has a lawyer who is located in Kona draw up another legal document, say a living will. Under the rules proposed by the department, Neighbor Island businesses who sell or deliver good or services to a Honolulu consumer are subject to the surcharge only if the business has a physical presence on Oahu. Having “physical presence” on Oahu means having an office, an employee or sales representatives traveling to Oahu to do business.
So in the case of the foregoing Kona attorney, if that attorney never travels to Oahu nor maintains an office or an employee on Oahu, the general excise tax rate on the fee for the living will would still be only 4% rather than 4.5% because the Kona attorney has no “physical presence” on Oahu.
Supposedly the department went to the “destination” approach in determining the rate of tax because they feared that if the tax was based on where the business providing the goods or services was located, it would create an interstate commerce violation granting sales from a Neighbor Island business to a Honolulu customer a competitive advantage over a mainland provider of goods or services. In the latter case, the customer on Oahu would have to pay the complementary “use” tax at a rate of 4.5%.
It appears the tax department may have created a violation of the interstate commerce clause as the Neighbor Island business, which has no physical presence on Oahu, pays only a 4% general excise tax while the Oahu customer purchasing the same item from a mainland vendor pays a use tax at the rate of 4.5%.
What will be even more interesting is how the tax department will monitor whether or not a Neighbor Island business has “physical presence” on Oahu. While determining whether or not a Neighbor Island business has an office or an employee may be easy to capture, knowing whether that Neighbor Island businessman visits Oahu to do business will be another matter. And what about the mainland vendor who also has no “physical presence” on Oahu but finds out that it has lost a sale to an Oahu business because its cost of goods or services would be subject to the higher 4.5% use tax while the sale of the same goods or services by a Neighbor Island business is subject only to a 4% general excise tax rate?
And while Neighbor Island consumers may believe that they are escaping the added cost of the 0.5% county surcharge, they should remember that more than 90% of all the goods and services consumed in the state flow through Honolulu. So even though the lawyer may be liable only for the 4% rate on a will drawn up for a Neighbor Island resident, the overhead costs of the Honolulu lawyer will be embedded in the charge for the will. Everything from the rent of the Honolulu office to the paper purchased by the lawyer on which the will is drafted to the fuel oil burned by the electric company that supplies the power of the lawyer’s computer will incur the additional county surcharge.