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Quiet tax change a blow to vendors

Companies that supply federal clients say the suspension of a long-standing exemption could benefit mainland firms

By Derrick DePledge

LAST UPDATED: 6:12 p.m. HST, Jul 19, 2011

John Thomson, owner of Mc Ferne Sales Co., which sells tools and other industrial supplies to the Navy, had heard the state temporarily suspended some general excise tax exemptions to help balance the budget.

He casually assumed the tax exemption on the sale of liquor, tobacco and other tangible personal property to the federal government — on the books since 1951, before statehood — had survived.

But after asking his accountant, a tax attorney and the state Department of Taxation, he learned what many other business owners have discovered: The exemption is gone for the next two years.

"I'm usually pretty wrapped up just dealing with the day-to-day stuff," he said of the demands of running a business. "I watch the news, and I'll read a little bit of this and that as I'm able."

But he concedes he did not follow what happened at the state Capitol as closely as he should have.

The state hopes to generate about $35 million a year by lifting the tax exemption and imposing a 4 percent general excise tax on vendors who sell as much as $1 billion worth of products to federal outposts from military commissaries and office buildings to the shipyard.

The tax does not apply on gross income from binding written contracts with the federal government before July 1 that do not permit passing on tax increases.

The Department of Taxation will require all companies that have previously received GET exemptions to complete surveys about their exempt business activities so tax analysts will have more information to track compliance.

"Sales of tangible personal property that had been exempt from the GET could include items like locally grown vegetables sold in the commissary to staplers and paperclips used in the federal building," Mallory Fujitani, a spokeswoman for the Department of Taxation, said in an email.

Temporarily suspending nearly two dozen general excise tax exemptions was the most significant tax adjustment state lawmakers and Gov. Neil Abercrombie made to balance the budget. The state expects to bring in about $200 million a year through the suspensions to help reduce a projected $1.3 billion deficit.

Abercrombie and most lawmakers agreed that lifting the tax exemptions was preferable to raising the general excise tax, which many economic and business analysts warned would have a greater drain on economic recovery.

Lawmakers had targeted the tax exemptions at the end of the 2010 session, but the idea became a focal point of the budget debate this year. Many of the state's most influential lobbyists tried to save exemptions that benefited some of the state's largest business interests, and the issue was covered extensively by the news media.

But most of the attention concentrated on tax exemptions for contractors, businesses that sublease and airlines. In the hundreds of pages of written testimony submitted to lawmakers, there was no substantial defense of the exemption on the sale of liquor, tobacco and other tangible personal property to the federal government. (The Star-Advertiser mentioned the exemption in an April article on the top targets for elimination.)

"I don't think people really understood how many businesses were taking advantage of it," said Tim Lyons, a lobbyist who tried to preserve tax exemptions for contractors and others.

Lyons said he discussed the exemption on sales to the federal government with lawmakers on behalf of one of his clients, beer giant Anheuser-Busch, but agrees it was largely overlooked in the debate.

Thomson, owner of Mc Ferne Sales, is not the only business owner caught unaware.

"Not a word," said Robert Morneau of Hydra-Air Pacific, which sells industrial supplies to the military. "I was surprised. A lot of the advocates didn't pick up on this thing. It came without warning, pretty much. Most of us didn't know about it."

Thomson and Morneau said adding the tax to the cost of their products could put them at a competitive disadvantage with mainland companies vying for federal contracts.

"They have a 4 percent advantage now," Morneau said.

Revenue estimates on lifting the tax exemptions changed several times during session, and tax researchers privately cautioned lawmakers that the figures they provided might be soft.

Tax researchers based the estimate of $35 million a year in revenue from suspending the exemption on sales to the federal government on a report prepared five years ago for the Tax Review Commission.

The report estimated that applying a 4 percent GET on $994 million in federal procurement spending for goods in the islands would generate about $39 million a year in tax revenue. This year, tax researchers discounted that figure to about $35 million a year to account for potential behavioral changes in the market once the tax is imposed.

But tax researchers have warned that such estimates can involve rough assumptions, or as the Tax Review Commission report noted, "Sometimes, the estimate is little more than an educated guess."

Lawmakers, who have taken a political hit in the business community for suspending the tax exemptions, could find they have to do more if the revenue does not materialize.

"I think it's hard to tell," state Rep. Pono Chong (D, Maunawili-Kaneohe) said of whether the estimates are accurate. "Given the circumstances, I think it's the best they can come up with."

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