A reader of this commentary called to ask if the services of another business that he had procured for his client qualified for an exempt reimbursement under the general excise tax law.
Unfortunately, because the taxpayer was also providing a service in connection with the services procured from the other business, the charge for those services would be considered an additional consideration and, therefore, the entire amount received from the client, including the costs for the purchase of the services of the other business, would be subject to the full retail rate of 4 percent. However, another part of the general excise tax law recognizes the services that were purchased by a taxpayer on behalf of his client represent a purchase of goods or services intended to be resold to the client and not for consumption by the purchasing business.
For many years it was difficult for policymakers and administrators to conceive that services, like goods, could be purchased for resale. As a result, the general excise tax law only recognized that goods, or tangible personal property, could be purchased for resale. A lesser rate was recommended by a consultant hired by the state in the 1960s to evaluate the tax, thus mitigating the pyramiding of the tax. Until that time, the retail rate was applied to all transactions, partly because the rate had been rather low and the tax was not shown out as a separate charge.
However, when the rate was increased to its current 4 percent as part of a revenue-raising package during the 1965 session, the onerous feature of the tax known as pyramiding became more apparent. But again, even though pyramiding of the tax became an issue that was eventually addressed by lowering the tax rate on purchases of goods for resale, services were always perceived as being consumed by the person who made the purchase of the service and, therefore, taxed at the full retail rate of 4 percent.
It was not until almost the end of the 1990s that it was demonstrated that services could be purchased by a business for a client and, therefore, resold for consumption by the client.
The first step in this direction came with the leasing and subleasing of real property. Inasmuch as the rental of real property is considered a service, it helped demonstrate that to impose the full retail rate on real property that was eventually subleased to another business at the full retail rate on every stage of a leasing and subleasing transaction merely exacerbated the cost of the tax, with the heaviest burden falling on the last sublessee that in many cases was a small business. Once the leasing and subleasing of real property was addressed by affording a lesser rate to income from a subleased portion of the original lease, policymakers and administrators could now see how services could be resold.
Another early recognition of the fact that the tax could pyramid by imposing a retail rate of tax on a service that was already imposed with a retail rate is the treatment of subcontracting services that are rendered through a general contractor. This is what is known as the subcontractor deduction but was limited only to construction contracting. This provision allowed a general contractor who outsourced a certain type of specialized work to a subcontractor to pay the tax only on the amount he retained.
For example, a general contractor who does not have the license or expertise to lay tile subcontracts the work to a tile firm. The subcontractor deduction allows the general contractor to subtract out the amount that will be paid to the subcontractor and pay the full retail rate of 4 percent only on the amount the general contractor retains. The subcontractor then pays the retail rate of 4 percent on the amount received from the general contractor.
This splitting of income was part of the original general excise tax law. A similar provision was added in the late 1980s when tourism-related services were purchased for resale to visitors at, say, a tour desk in a hotel.
The tour operator paid 4 percent on what was received from the hotel tour desk and the tour desk salesperson paid the 4 percent on whatever was the difference paid to the operator and what the visitor paid the tour desk.
When it was realized that there are many other businesses that purchase services that will benefit the customer or client of that business, the lesser wholesale rate of 0.5 percent was extended to the purchase of services for resale to the customer or client.
For example, a lawyer who needs to have the scene of a traffic accident surveyed in order to prove who was at fault secures the services of a surveyor that will ultimately benefit his client. The surveyor is told that his services will be resold to the lawyer's client. The surveyor then pays the 0.5 percent rate on the income of that job. Thus, the transaction will not be taxed twice at the full retail rate of 4 percent.
* Lowell L. Kalapa is president of the Tax Foundation of Hawaii.