Hotels as Renters

by Tom Yamachika, President, Tax Foundation Hawaii

One of the many unique things about Hawaii is its land ownership structure. Because we used to be a kingdom and the royals controlled most of the land, it turns out that we have a small amount of large landowners. They tend not to sell but to lease large pieces of it, whereupon the lessees then sublease smaller pieces of it to businesses and homeowners.

That type of structure brings a unique tax problem. Sales taxes in most states leave rent alone, but our General Excise Tax (GET) taxes it. Before the late 1990’s, both the lessor and the sublessor had to pay the full retail tax amount on the rent they respectively received, meaning that although there was only one tenant on the particular piece of property, sometimes a homeowner, sometimes a small business, 4% tax was imposed several times: when the tenant paid his landlord, when that landlord paid the person it was renting from, and so on up the chain up to the ultimate owner. (By the way, even if the owner is a charity – a church or a school, for example – GET is still imposed.)

To deal with this problem, a "Sublease Deduction" was enacted in 1997. It says that if a person is both renting real property from a landlord and then subleasing it, then the person, although paying 4% tax on the rent received, gets a deduction worth 3.5% of the rent paid. The lessor further up the chain pays 4% of that rent, making the effective tax rate on the first tier rent 0.5%, the same GET rate we normally apply to wholesale sales. The law now applies to written leases of real property.

This legislative session, a couple of bills would explicitly provide that this sublease deduction will be allowed even if the "sublessor" is a hotel. Certainly the hotel is being paid for the use of its real property; the guests need to rest their heads somewhere at night. But there is also a significant service element; hotel guests receive front desk services, housekeeping, and other amenities that typical rentals don't come with. The issue is whether that should matter. If the philosophy behind the 1997 act is to prevent retail rate GET from applying to the same use of the same real property, the proposal is consistent with that philosophy. Hoteliers have to pay GET on what they get for their room nights just like any other renters. If the hotel happens to be leasing its space from a large landowner, why should the state be allowed a second bite at the proverbial apple? Interestingly, the issue of wholesale services in general was examined by the 1987-1989 Tax Review Commission, at a time when the 0.5% rate applied to very few wholesale services. The Commission recommended adopting the 0.5% rate for more wholesale service transactions (which actually happened in 2000), and also recommended that the wholesale services concept should be extended to the leasing of real property. It certainly looks like that Commission would have had no problem with treating transient accommodation rentals the same as other rentals.

Technical issues exist, of course. It may be argued that a hotelier shouldn’t be allowed the sublease deduction to the extent that its rooms are vacant, which makes sense, and no hotelier has 100% occupancy. But that argument should not be morphed into a reason for disallowing the deduction altogether. We have retail rate GET being piled on top of retail rate GET for occupying the same piece of real estate, and that screams for at least some relief. Hopefully, the stakeholders involved can agree upon, or our lawmakers can come up with, reasonable means for achieving it.

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