(Released on 06/17/07)
For years, observers of the general excise tax complained that while the general excise tax on the wholesale sale of goods was lowered from the full 4% rate to the 0.5% rate back in the late Sixties, the law did not recognize that there are also services that are sold for resale.
The anomaly existed because back in the days following statehood, it was hard to imagine that a service that was delivered at the time the service was performed could be “resold” to someone else. For example, it was hard for lawmakers to think a service like washing windows could be sold to someone else other than the owner of the windows. So despite the fact that a consultant to the state named Arthur D. Little recommended that the lesser rate be applied whenever goods or services are purchased for resale, the legislature reduced the rate only for the resale of goods and called that rate “wholesale.”
However, over the next thirty some years, it became increasingly apparent that there were services that could be resold. The obvious example of some “non-goods” being resold is the subleasing of property. A business seeking new office or store space may have no option other than to take a space that is much too large for its own use. To recover some of the cost of the rent paid to the landlord, the tenant carves out that portion of the property that can’t be used and rents that space to someone else.
The owner of the property was responsible for the general excise tax at the full 4% rate on the rent collected from the tenant. The tenant, in turn, becomes the “landlord” to the business that sublets the property and pays the full 4% on the rent he receives. That “rent” then went toward the payment of the rent to the property owner. The amount collected from the sublessee was subject to the general excise tax at the full “retail” rate of 4%, twice.
Because the owner of the property passes on the cost of the general excise tax to the original tenant, the tenant in leasing to the sublessee, includes the amount of the general excise tax as part of the base rent of the subleased portion of the property, making the square foot cost even higher.
Given that the subleased space is a smaller portion, it is probably subleased by a small business. Thus, by not reducing the rate on subleasing transactions, smaller businesses are affected even more. Thus the leasing and subleasing of real property is but one example of how services purchased for resale can be “resold.”
More and more examples came to light over the years especially in the area of professional services and in the area of amusements and entertainment. In the case of professional services, a good example is in the legal community where a client may need to have a survey taken of an accident scene and the attorney doesn’t have that particular skill. As a result, the attorney hires a survey specialist who can take the measurements, assess the accident scene and make an analysis of just how the accident occurred. The findings are sold to the attorney to help make the case for the client. Observers began to realize that the result of the survey analysis was not being used by the attorney, but was being used on behalf of the attorney’s client. The client was ultimately billed for the cost of the survey on top of which the attorney passed on the 4% general excise tax even though the survey expert also had passed on the general excise tax at the full 4% rate.
Here in Hawaii where the hospitality industry is such a large part of the economic base, there are numerous examples of where services are purchased for resale. For example, a hotel wants to offer its guests a luau experience. However, its chefs don’t know how to cook Hawaiian food. So they bring in a caterer from outside the hotel to cook the food. The same goes for the entertainment and the florist who does the floral arrangements on the tables. All of these services are subject to the full 4% rate when they are sold to the hotel. The hotel, in turn, accommodated all those costs in the ticket price of the luau which was then subject to the general excise tax rate of 4%. Thus, without the lesser 0.5% rate, the cost of those services increased by the cost of the tax or what is known as pyramiding of the general excise tax.
A few years ago in the midst of the economic slump of the 1990’s lawmakers were finally convinced that the rate on the purchase of services that were to be resold by the purchaser should be subject to the 0.5% rate instead of the 4% rate. The question now is are taxpayers taking advantage of this reduction of the rate?