No doubt this was the largest and most high profile tax case to come out of Hawaii in many years. The OTCs are potentially on the hook for taxes of $500 million or more!
The Hawaii tax appeal court ruled that online travel companies are not liable for transient accommodation taxes on their online hotel bookings. The court noted that online travel companies are similar in nature to travel agents that do not pay the transient accommodation tax on their sales. The result is that the court made a determination that the transient accommodations tax does NOT pyramid (i.e. multiple layers of tax on the same transaction) in the same way the GET does.
The parties will have another hearing in December 2012 to determine whether OTCs are liable for Hawaii GET on their Hawaii hotel bookings. I’d bet that they are liable at least on their profit margin and fees generated. This would be a GET scheme similar to how a travel agent is taxed on their commissions from the hotels and any fees charged to the customer. No doubt this could produce a tax bill in the tens of millions of dollars or more.
Click here for news coverage.
I wrote earlier that the Hawaii attorney general is seeking upwards of $500 million from online travel companies (OTCs) such as Expedia and Travelocity for unpaid transient accommodations and general excise taxes.
While the vast majority of courts nationwide have held that OTCs do not owe hotel taxes on their retail markup, the DC Superior Court has granted partial summary judgment that OTCs are liable for DC’s gross sales tax on their hotel room retail markups. For DC, this could mean an additional $6 million annual revenue plus another $200 million in back taxes, penalties, and interest.
The court reasoned that OTCs are considered taxable “vendors” under the DC gross sales tax law. No doubt the Hawaii attorney general will cite to this case in his briefs to the tax appeal court. However, its persuasive value may be limited as Hawaii taxes hotel “operators” and not necessarily hotel “vendors.”
On August 28, 2012, the Hawaii Tax Review Commission released its “Study of the Hawaii Tax System: Final Report” . While most of its findings were bland, it recommended the more controversial action of raising the GET from 4% to 4.5%:
Increase the GET rate to 4.5 percent
Hawaii’s GET rate is among the lowest in the country for states with this sort of broad-based consumption tax. While Hawaii has not raised its rate in over 35 years, over half of the states have raised this rate since 2000 – in many cases multiple times. Given the need to restore structural balance, an incremental increase in the GET rate is the logical method to improve the long-term financial outlook. While the GET is considered regressive, other recommended changes would reduce some of that impact.
Legislators on both sides of the aisle voiced their vehement opposition to this proposal in the report. Click here to read more. While increasing the GET seems to be dead on arrival, other proposals made in the report may get a legislative boost:
- Make permanent Act 105 (2011), which eliminated certain GET exemptions and deductions (i.e. for subcontracting and subleasing).
- Capping open ended tax credits such as the renewable energy and film tax credits with targeted grants and loan programs.
- Restoring the temporary increases on transient accommodation tax and rental cars, shifting the tax burden to tourists.
- Expand nexus.
These proposals build upon and tweak what has already passed the legislature and could provide added revenue and reduced tax expenditures with limited political backlash.
Of course, any Hawaii tax debate would not be complete without a discussion of gambling. Not surprisingly, the report declined to endorse gambling as a source of added tax revenue. Chinatown underground game rooms aside, Winner’z Zone has been operating “legal” casinos all over Honolulu for quite a while now.
While Hawaii may be an expensive business travel destination, Hawaii’s taxes on travel appear to be a mitigating factor. The Global Business Travel Association Foundation has released its annual rankings of 50 top travel destinations based on daily taxes on things such as hotel stays, restaurants, and car rentals. Chicago taxes travelers the most at $40.31 per day while Honolulu taxes travelers a mere $24.38 per day. The lowest tax city for travelers is Fort Lauderdale at $22.21 per day.
In Honolulu the taxes on travelers are primarily the 4% general excise tax on most purchases including at restaurants plus the 1/2% Honolulu County Surcharge, the 9.25% transient accommodations tax on hotel stays, and $3 per day surcharge on car rentals (down from $7.50 per day prior to June 30, 2012). Tobacco, Liquor, and Fuel taxes could also add to the total visitor tax burden.
Read NBC News’ coverage of the report by clicking here.
Over the past few months, I have taken up the hobby of signing up for points and miles credit cards. I signed up for 8 so far. I have bene saving up my points and miles for a trip (hopefully in a premium class) to New Delhi to see my college roommate get married!
These points and miles from these cards have real value. I signed up for the Chase Sapphire Preferred card that pays a bonus of 40,000 Chase Ultimate Rewards points after meeting minimum spending requirements. That is worth about $500 in free travel! Multiply by 8 cards…. You get the picture. How is this not taxable?
Being a tax lawyer, I worry whether I am generating some unknown tax liability that could come back to bite me in the butt. I did some research.
Earlier this year, Citibank sent out 1099’s to customers who received American Airlines miles bonuses for signing up for a checking account. Curiously no 1099’s were issued for those who sign up for credit cards. Whew! I have two AA Citibank cards myself!
IRS Announcement 2002-18 states the IRS position that it will not tax “frequent flyer miles or other in-kind promotional benefits.” That is federal income tax. What about the other taxes?
Hawaii’s general excise tax imposes a 4% tax (4.5% in Honolulu) on “gross income” from business, which includes “all activities (personal, professional, or corporate), engaged in or caused to be engaged in with the object of gain or economic benefit either direct or indirect, but does not include casual sales.” The Hawaii Supreme Court has said that the GET can cover “virtually every economic activity imaginable.”
The casual sale exception might exempt people who open one or two cards a year. What about someone like me that opened 8 cards potentially worth $4,000 in travel ($500 x 8)? Did I somehow start a points and miles credit card business that is subject to the GET?
Considering the definition of “engaged in,” the Hawaii Supreme Court in Pratt v. Kondo offered an example of when one’s side activities cross the line into a taxable business activity: “We would not think, for instance, that a house painter who serves as an executor of one or perhaps two small estates over a period of years has ‘engaged’ in the business of settling estates. On the other hand, a person who settles one substantial estate could be found to have ‘engaged’ in such a business.” When I read this, I think of two things, (1) frequency of the activity and (2) substantiality of engagement.
I am a tax lawyer that has applied for 8 credit cards (more than one or two) that each potentially pay out $500 in travel points or miles after I jump through some minimum spending hoops. So, although it is not my primary occpation, the frequency of my credit card applications/transactions could potentially give rise to a taxable business. On the other hand, the substantiality of my engagement with this purported business may be low because all I do is sign up for the card, use it to make purchases up to the minimum spending requirement for a bonus, and repeat for the next card.
Compare my activity with the person who receives 1% cash back on all credit card purchases and is presumably not subejct to GET on those earnings. That person’s activities are very frequent (daily purchases) but the earnings are insubstantial compared with the purchase, $1 in cash for $100 in purchases. My activities are less frequent but the earnings are far more substantial, i.e. $500 in travel for making $3000 in purchases, 16.7%. Of course, if I continue to use the card, the rewards to purchases percentage falls closer to the 1%.
Hopefully, my situation is similar enough to the every day points and miles card user that I do not need to be worried about incurring GET liability. Even if I do need to pay the tax, 4.5% of $4000 is not a big deal. But this example goes to show how activity that is not taxed by the IRS could easily be subject to Hawaii’s GET.