Hawaiian must
pay $23.2M to IRS

The carrier likely will not have
to pay a $40.5 million penalty

Hawaiian Airlines will have to pay the Internal Revenue Service $23.2 million to cover 2 1/2 years of back taxes and interest but likely won't have to pay a $40.5 million penalty sought by the government.

Bankruptcy Judge Robert Faris ruled yesterday in favor of the IRS' claim against Hawaiian for the tax years of 2001, 2002 and the first half of 2003. But Faris said there was enough ambiguity in federal laws to tentatively rule that Hawaiian should not have to pay a penalty for following an airline tax consultant's advice to take fuel excise tax credits for those years. Faris said he will issue written orders on his decisions.

The mixed ruling means Hawaiian Airlines has escaped a major portion of an initial $129 million tax claim that the IRS filed last June.

"We're enormously pleased with the judge's decisions," Hawaiian Airlines trustee Joshua Gotbaum said. "When the IRS filed its claim for $129 million, we said it was grossly overstated and we expected the judge to reduce it substantially. And that is exactly what happened."

Last month, the two sides reached a settlement on several disputed issues that resulted in Hawaiian being liable for taxes on less than $10 million for those items. A hearing also is scheduled next month on two remaining issues involving boarding coupons and the carrying over of operating losses from one year to the next. The IRS is seeking a tax liability on nearly $17.3 million for those issues.

At a corporate tax rate of 35 percent for the combined $27.3 million liability, Hawaiian could face more than $9 million in additional taxes.

The rulings yesterday remove another hurdle that has stood in the way of the airline emerging from its nearly 2-year-old bankruptcy. A hearing is scheduled for Jan. 25 on a reorganization plan that is being jointly proposed by Gotbaum, the airline's unsecured creditors' committee and investment group RC Aviation LLC.

Gotbaum said the company had expected to pay the excise taxes and has been putting aside money.

"We've already reserved for that payment on our books," Gotbaum said.

Attorney Rick Watson, who represented the U.S. Department of Justice in court, declined to comment.

Faris said there was no explicit language in any statute that exempted Hawaiian from paying the fuel-excise tax when Hawaii changed from a U.S. possession to a state in 1959.

Sid Levinson, attorney for Hawaiian trustee Gotbaum, argued that the airline was entitled to a fuel tax credit for its trans-Pacific flights between Hawaii and the mainland because laws written in the 1930s exempted the payment of fuel excise taxes between the United States and any of its possessions. The intent of the laws was to encourage ships and aircraft to purchase fuel refined by domestic producers from imported crude oil, rather than purchasing from foreign producers.

When Congress enacted the Hawaii Omnibus Act of 1960 to deal with Hawaii's statehood, it did not amend the law dealing with fuel tax exemptions between the United States and its possessions. Levinson argued that Congress did not make the change because it recognized the unique geographic location of Hawaii and that impact on transportation costs.

The IRS said that since at least 1944 Treasury regulations have never included either Hawaii or Alaska in its definition of U.S. possessions for excise tax purposes.

Faris said he found irony in the arguments of the two sides.

"The government is arguing that Hawaii should be treated as a state when it wasn't a state and the trustee is arguing that Hawaii should be treated as a possession when it wasn't a possession," Faris said.

Faris said he was tentatively ruling that Hawaiian wouldn't have to pay a $40.5 million penalty because of the ambiguity of the laws. He noted that in taking the credits the airline was following the advice of Heffernan Associates Inc., a firm specializing in evaluating aviation and other excise taxes. On the other hand, he said, the company's accounting firm, Ernst & Young LLP, had raised questions about the credits.