More than a decade ago, lawmakers and Tax Department officials finally realized that it is possible to purchase services for resale and that the person making the purchase of those services did not necessarily have to consume the services.
The idea of selling goods for resale dates back to the late 1960s, when the state hired a consultant to look at the structure and performance of the state's unique general excise tax. While the state wanted to know about the many idiosyncrasies of the tax, it was also keenly aware that the general excise tax imposed a heavy burden on taxpayers, especially since the rate had been increased from 3.5 to 4 percent in 1965 to help generate the revenues the fledgling state needed to build the necessary infrastructure as the jet age of visitor travel dawned in Hawaii. The general excise tax rate had last been increased in 1957, when the rate was raised to 3.5 percent from the 2.5 percent rate effective since the end of World War II.
The retail rate of 4 percent was imposed on all transactions except for agriculture, manufacturing and wholesaling. The consultant found that the high retail rate imposed on many of these transactions caused the cost of the tax to pyramid because the 4 percent was often imposed on a transaction that had already been levied with the 4 percent tax. In particular, the consultant recommended that any purchase of goods or services that were subsequently resold should be imposed with a lesser rate in order to mitigate the pyramiding effect.
While the rate on the purchase of goods for resale was eventually reduced to 0.5 percent, lawmakers found it difficult to conceive of a service that is purchased for resale to a subsequent customer. After all, once a service is performed, it is hard to imagine that the service could again be performed for a subsequent customer.
It was not until the late 1990s that examples of how a service could be resold became apparent, with the first example being the subleasing of real estate or office or store space. Inasmuch as leasing or rental of real property is considered a service, this particular transaction was very much a tangible example of a service that can be resold. And as the small-business community flourished after the demise of most of the Big Five, smaller spaces increased in demand, allowing a master lessee to carve up a rented space to be subleased to smaller businesses. But since each lease and sublease was considered a retail transaction in the belief that a sublessee would be the consumer of the reduced floor space, the full retail rate of 4 percent was imposed on that sublease.
However, as has been the practice, sooner or later the business realized that it did not need some of the space it subleased and subsequently leased a small portion to another business or sublessee. Lawmakers then devised a formula to help determine a lesser rate of tax on each subsequent sublease of a portion of the property. While that action did get closer to imposing a lesser rate that would be the equivalent of the 0.5 percent on the purchase of goods for resale, it did not address other types of services nor clearly identify that the resale rate for services is an explicit 0.5 percent.
As part of a push to secure re-election, the governor at the time established a task force to come up with ideas to revitalize the state's flagging economy. Among the many recommendations made was one to address this issue of the pyramiding of the general excise tax on services. That recommendation did not take off immediately - not because depyramiding was misunderstood, but because it was also recommended that the retail rate of the general excise tax would need to be increased to offset the perceived loss of revenue. It was not until a year later that the depyramiding solution was adopted.
Even though the purchase of services for resale has been on the books for more than a decade, some specific provisions of the general excise tax that were adopted prior to the enactment of the depyramiding statute probably should be repealed as those provisions represent attempts to address the depyramiding of specific types of services.
Repealing some of these specific provisions and bringing those transactions under the depyramiding provisions would ensure all sales of services for resale are treated alike. Among these provisions is the contractor-subcontractor deduction, the division of income of tourism-related activities, and sales of printing to a publisher for resale to advertisers.
* Lowell L. Kalapa is president of the Tax Foundation of Hawaii.