Bill seeks to plug
tax law loophole

A 40-year-old law exempts certain
firms from some state levies

By Craig Gima
Star-Bulletin

When Scott Wallace began his movie theaters in Hawaii in 1992, he started small but expanded quickly.

Today, Wallace says his business has created 254 new jobs with an annual payroll of more than $3.5 million.

His success may be, in part, because Wallace's companies are now exempt from state general excise and income taxes.

Wallace's theaters and 32 other companies, including a hotel, racquetball club, a retail store and a wholesale natural food business, have taken advantage of a little-known, 40-year-old law that allows the businesses to become "business development corporations."

The state Tax Department says the law originally was intended to give tax-exempt status to companies that provide start-up funds for new businesses and is now being abused to exempt some companies from paying from all general excise and income taxes.

"It's outrageous," said Rep. Michael White (D, Lahaina), general manager of a Maui hotel and a member of the House Finance Committee.

The House passed a bill that would allow the state to set up rules for the operation of business development corporations and phase out their tax exemption.

"It's a tax shelter for these companies that have been abusing the BDC laws," said Tax Director Ray Kamikawa. "How do you think Consolidated feels about Mr. Wallace being exempt from all these taxes and competing with him on that basis?"

The Tax Department estimates the state has lost more than $1.6 million in excise tax revenue and $690,000 in hotel room tax revenue because of abuse of the law.

He notes that some businesses, including Wallace Theaters, were paying taxes before reincorporating as a business development corporation and now do not pay taxes.

But Wallace says the law has done what it was intended to do: Stimulate business.

He told lawmakers the tax benefit has helped him expand his theater chain.

"Existing BDCs pay other taxes and have been a proven, successful job creator in Hawaii's stagnant economy," Wallace told lawmakers.

Said Kamikawa, "If we follow that logic, every business should be exempt from tax, period."

Wallace points out his business pays nearly $300,000 in other taxes, including payroll withholding, real estate and unemployment, and he pays the excise tax when buying goods and services.

But Kamikawa argues that the general excise tax passed on by vendors is the responsibility of the vendors.

Under the current proposal, the tax benefits for business development corporations would be phased out by 2005.

Wallace argues that taking the tax benefits away from existing companies would violate the U.S. Constitution. He said his company "shouldn't have the rug pulled out from under us."

White notes that even if the tax benefits are phased out, existing business development corporations could be very valuable. His hotel, he estimates, could save $6.3 million over the seven years of remaining tax benefits -- if he were to buy a business development corporation.

The profit from the sale of a business development corporation is also exempt from state excise and income taxes.

Wallace showed lawmakers a legal opinion that the state cannot take away existing tax benefits.

But the attorney general's office issued an opinion that the tax benefits can be legislated away.

If the measure doesn't pass, Kamikawa said the state may go to court to collect the taxes the state feels it is owed.

"We're not conceding anything, whether or not this legislation goes forward, because we always have our audit powers to contest these companies' interpretation of the law," he said.

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LEGISLATURE UPDATE

A calendar of tomorrow's hearings -- to be held at the state Capitol, 415 S. Beretania St., unless noted:

HOUSE

Human Services and Housing: Hearing with House Health Committee on resolution requesting the Health and Human Services departments to examine ways to eliminate duplication of home and community-based programs and services, 9 a.m., Room 329.

Transportation: Hearing on resolution strongly urging allowing van-pool vehicles, commercial vehicles and vehicles with two or more occupants to use the zipper lane. Decision-making to follow, 10:30 a.m., Room 309.

Higher Education: Hearing on resolutions requesting the University of Hawaii to establish sister relationships with the Sun Yat-Sen University of Medical Sciences and the National Taipei University of Technology. Decision-making to follow, 2 p.m., Room 309.

SENATE

Commerce, Consumer Protection and Information Technology: Hearing on gubernatorial nominees to the State Boxing Commission, Public Utilities Commission, State Board of Public Accountancy, Contractors Licensing Board, Board of Private Detectives and Guards, Real Estate Commission and Board of Electricians and Plumbers. Decision-making to follow if time permits, 9 a.m., Room 016.

Ways and Means: Briefing on state auditor's reports regarding the Child Support Enforcement Agency Information System and the financial audit of the Department of Human Services, 9 a.m., Room 211.

Education: Hearing on gubernatorial nominees to the King Kamehameha Celebration Commission, University of Hawaii Board of Regents and the Education Commission of the States. Decision-making to follow if time permits, 1:30 p.m., Room 224.

Transportation and Intergovernmental Affairs: Briefing on the impact to private shipyards due to reduction of repair work on Navy ships, 1:30 p.m., Room 016.

Hearing at 3 p.m. to follow on resolutions requesting a study on the availability and condition of hurricane-resistant public shelters within each county, Room 016.

Human Resources: Hearing on resolutions requesting a policy for well-being of children, youth and families and requesting state employees use "aloha" as an official greeting when meeting the public or answering the phone. Decision-making to follow if time permits, 2 p.m., Room 225.

Hearing with Senate Transportation Committee at 3:30 p.m. on resolution urging support for Hawaii's congressional delegation effort to amend the Social Security Act to increase Hawaii's federal medical assistance. Decision-making to follow if time permits, Room 225.