Making reimbursements could incur tax liability

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In recent years, various laws have been enacted to exempt reimbursement of amounts paid out by managers or operators of a number of business activities because the general excise tax law would otherwise have made such arrangements too costly to undertake.

In recent years, various laws have been enacted to exempt reimbursement of amounts paid out by managers or operators of a number of business activities because the general excise tax law would otherwise have made such arrangements too costly to undertake.

Under the GET 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 that product or service. If the third party receives no additional compensation, then the amount of the reimbursement received by the third party is exempt from the GET.

If the third party receives some sort of compensation for performing this service, in addition to the amount that represents the reimbursement, then the entire amount the third party receives from the requester is subject to the 4 percent GET. Thus, the third party pays the tax on the compensation received and the amount of the reimbursed cost of the product or service.

Beginning in the early 1990s, 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 by property owners to run the day-to-day hotel operations because the owners did not have the required expertise. Since the receipts of the hotel accrue to the owner of the property, the owner must reimburse hotel management or the operator the cost of operations, which consists largely of the wages, salaries and benefits of the hotel employees. 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.

The state Legislature granted an exemption for amounts reimbursed to 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 because of their tenure with the hotel operator.

Similar exemptions were extended to operators of a county transportation system which allowed an experienced operator to operate the system as opposed to having appointees — who turn over with every new mayor or managing director — operate that public 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.

The concept of taxing reimbursements prompted lawmakers to extend the idea of exempting 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 timeshare projects are also extended a similar exemption. The latter two were recently renewed by this year’s session of the legislature.

While some 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 to find a way to avoid the tax. A good system allows taxpayers to be productive without having to structure themselves to avoid being subject to a tax on what would otherwise have not been taxed, had they been structured differently.

While the GET 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 GET can actually do a lot of damage to the state’s economy.

Lowell L. Kalapa is president of the Tax Foundation of Hawaii.