Following the money government spends isn't easy in Hawaii, according to a new report - Photo: Emily Metcalf
Photo: Emily Metcalf

By Lowell L. Kalapa – In recent years, various proposals to exempt the reimbursement of amounts paid out by managers or operators of a number of business activities have been enacted into law because Hawaii’s general excise tax law would otherwise have made such arrangements too costly to undertake.

Under the general excise tax law, a provision called the cost of reimbursements and advances addresses situations where a third party secures a product or service on behalf of a requesting party and is reimbursed for the cost of the product or service.  If the third party receives no additional compensation for having performed this task, then the amount of the reimbursement received by the third party is exempt from the general excise tax.

On the other hand, if the third party receives some sort of compensation for performing this service in addition to the amount that represents the reimbursement for the product or service, then the entire amount that the third party receives from the requester is subject to the 4% general excise tax.  Thus, the third party is paying the tax on the compensation received and the amount of the reimbursed cost of the product or service.

Beginning in the early 1990’s a variety of businesses that got paid for managing the operations of a variety of businesses asked to be exempt from the cost of reimbursement provisions.  This started with hotel management companies which were hired to run the day-to-day operations of a hotel by the owners of the hotel property because the owners of the property did not necessarily have the expertise to run a hotel.

Since the receipts of the hotel accrue to the owner of the property, the owner must reimburse the hotel management or operator for the cost of operating the hotel which consists largely of the wages and salaries and benefits of the employees who service the guests of the hotel.  Because the management company is also compensated for the management of these employees, the fee received by the management company technically taints the entire amount paid by the owner to the hotel operator including the wages and salaries paid out to the employees.

Thus, starting with hotel operators, the legislature granted an exemption for amounts reimbursed to those hotel operators for the wages, salaries and benefit premiums which were then disbursed to the employees or on their behalf.  Because investors in hotel properties often bought and sold properties, it made more and more sense to recognize the unique situation of hotel operators and the stability it gives the employees of hotel operations.  Conversely, hotel owners can be assured of having experienced workers that will provide quality service because of their tenure with the hotel operator.

Similar exemptions were extended to operators of a county transportation system which allowed an experienced operator of a transportation system to operate the public system as opposed to having appointees who constantly turn over with every new mayor or managing director operate that transit system.  Eventually, a similar exemption was extended to operators of orchards who were reimbursed by the orchard owner and to managers of related entities which provide telecommunication services.

While not necessarily the management of employees, the concept of taxing reimbursements caused businesses to operate inefficiently and prompted lawmakers to extend the idea of exempting amounts of reimbursements to providers of the federal TRICARE program which reimburses managers of the federal medical program for amounts paid to health care providers.  Similarly, amounts paid to managers of condominiums and time share projects are also extended a similar exemption.  The latter two were recently renewed by this year’s session of the legislature.

While some observers may question the special interest nature of these exemptions, they should remember that one of the principles of a good tax policy is that the tax system should not cause taxpayers to contort themselves just to find a way to avoid the tax.  A good tax system should allow taxpayers to be productive without having to structure themselves just to avoid having to be subject to a tax on what would otherwise not been taxed had they been structured differently.

While the general excise tax is a prolific producer of funds which pay for state government services, it also has insidious effects on the way business is conducted in Hawaii.  If these situations are not addressed with exemptions or remedial treatment, the general excise tax can actually do a lot of damage to the state’s economy.

 

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