Foreign Trade Zone Kerfuffle

by Tom Yamachika, President Tax Foundation Hawaii

If you’re in downtown Honolulu and you’re driving past Restaurant Row, you’re likely to see a sign on the makai side saying, “Foreign Trade Zone No. 9.”

In this country, a foreign trade zone (FTZ) is a geographical area, in (or adjacent to) a United States Port of Entry, where commercial merchandise, both domestic and foreign, receives the same Customs treatment as if it were outside the United States.  The zones help American businesses to be competitive in the global economy by reducing tariff burdens on the importation of foreign inputs and on exported finished products. Businesses can set up shop in the zone for loading, unloading, handling, storing, manipulating, manufacturing, and exhibiting goods and for reshipping them by land, water or air.  Merchandise of every description may be held in the zone without being subject to tariffs (customs duties) and other taxes based on the value of the goods. This tariff and tax relief is designed to lower the costs of U.S.-based operations engaged in international trade and thereby create and retain the employment and capital investment opportunities that result from those operations.

The FTZ in Honolulu was established in 1966 at Pier 39 in Honolulu Harbor.  It has since grown to include 13 sites and 2,600 acres.

So, what’s the current problem with the FTZ?  Of course, it has to be a tax problem.  It involves Hawaii General Excise Tax, and the question is whether it applies in an FTZ.

State law, HRS section 212-8, already makes clear that merchandise that is admitted into the zone and that is sold for use or consumption out of state is exempt from GET, Use Tax, fuel tax, liquor tax, and tobacco tax.  (Tax still applies if the merchandise is sold to someone in the state.)  But there has been some confusion over whether other activity performed in the zone is subject to state tax.  For example, a factory in the zone that manufactures products for export breaks down, and a technician comes in to fix the broken machinery.  Is the technician’s fee subject to GET?

For a while, the Department of Taxation was telling folks that the answer is no.  They thought that a FTZ was a “federal enclave,” where the laws of the states just don’t apply.  Washington, DC is one example.  It was carved out of Maryland and Virginia, and neither state’s law applies there. Other federal enclaves include some federal courthouses, military bases, federal buildings, and national forests and parks.

The Department, however, recently had an epiphany. Eureka! FTZ’s are not federal enclaves!

After realizing its mistake, the Department did what a typical tax agency does:  it started telling people it wanted back taxes for all open years. For most businesses that filed returns, the statute of limitations is three years. If a business “substantially omitted” income by failing to declare it even though it was claimed exempt, the Department can go back six years.  If a business didn’t file returns, thinking they didn’t have to, the Department can go back to the beginning of time.

The Department, one can easily imagine, was licking its chops at the thought of millions of additional revenues it could bring in. Potentially affected taxpayers, meanwhile, began losing sleep.

Do we think that this is the kind of issue where the Department should let bygones be bygones and just make sure that the rules are clear going forward?  Or are we all okay with the Department saying, “Well, we screwed up in the past, but our mistake doesn’t matter because the duly enacted laws say you owe the tax”?

Maybe it’s time for the Legislature to step in and run interference between an obviously hungry Department of Taxation and the taxpaying public.