Contacts:
Dana Lance
San Jose
T +1 408 346 4325
Trinh Tran
Los Angeles
T +1 213 596 6718
Jamie C. Yesnowitz
Washington, D.C.
T +1 202 521 1504
Chuck Jones
Chicago
T +1 312 602 8517
Lori Stolly
Cincinnati
T +1 513 345 4540
Patrick Skeehan
Philadelphia
T +1 215 814 1743
Hawaii Gov. David Ige recently signed legislation impacting Hawaii corporate and personal income taxpayers. The legislation creates economic nexus rules for income tax purposes,
1 adopts the use of market-based sourcing for sales other than sales of tangible personal property,
2 and updates Hawaii’s conformity to the Internal Revenue Code (IRC).
3
Economic nexus
Applicable to tax years beginning after Dec. 31, 2019, S.B. 495 creates an income tax economic nexus standard for taxing out-of-state persons on their income earned in Hawaii.
4 A person that lacks physical presence in Hawaii is presumed to be systematically and regularly engaging in business in Hawaii and subject to income tax if, during the current or preceding calendar year: (i) the person engages in 200 or more business transactions with persons within Hawaii;
or (ii) the sum of the value of the person’s gross income attributable to sources within Hawaii equals or exceeds $100,000.
5 For purposes of Hawaii income tax, a “person” includes an individual, trust, estate, partnership, association, company or corporation.
6
Market-based sourcing
S.B. 394, applicable to tax years beginning after Dec. 31, 2019, adopts market-based sourcing for purposes of apportioning income from sales other than sales of tangible personal property.
7 The market-based sourcing law provides that sales of intangible property are sourced to Hawaii to the extent the intangible property is used in the state, or, in the case of a service, to the extent the service is used or consumed in the state.
8
For tax years beginning before Jan. 1, 2020, sales other than sales of tangible personal property are sourced to Hawaii if the taxpayer performs the income-producing activity in the state, or the taxpayer performs the income-producing activity both within and outside the state with a greater proportion of the activity performed in Hawaii than any other state, based on costs of performance.
9
IRC conformity
For tax years beginning after Dec. 31, 2018, S.B. 1130 updates Hawaii’s IRC conformity date to Dec. 31, 2018.
10 Hawaii’s previous IRC conformity date was Feb. 9, 2018, for tax years beginning after Dec. 31, 2017.
11 The statute provides that conformity to the IRC is as of Dec. 31, 2018, as applicable to the determination of gross income, adjusted gross income, ordinary income and loss, and taxable income, except for provisions otherwise inapplicable or limited under Hawaii law.
12
With respect to other IRC conformity issues, the legislation amends the definition of unrelated business taxable income (UBTI) to provide that IRC Sec. 512(a)(7)
13 does not apply.
14 The legislation also provides that Hawaii no longer decouples from Subchapter Z of the IRC, with respect to opportunity zones.
15 Specifically, Subchapter Z is operative, except that for Hawaii income tax purposes, such qualified opportunity zones must be designated by the Chief Executive Officer of Hawaii.
16
Commentary
Hawaii is the first state to enact legislation that applies the economic sales tax nexus thresholds approved by the U.S. Supreme Court in
South Dakota v. Wayfair, Inc.17 to an income tax context. In 2018, Hawaii enacted legislation that applies the
Wayfair thresholds to the state’s general excise tax (GET).
18 Therefore, Hawaii will now have somewhat similar nexus standards for both income tax and GET purposes. However, the income tax statute imposes nexus on out-of-state persons engaging in 200 or more
business transactions with persons within Hawaii. The new law does not provide a definition of “business transactions,” and existing law does not define this term. The corresponding provision in the GET statute imposes nexus if the out-of-state person sold tangible personal property delivered in the state, services used or consumed in the state, or intangible property used in the state in 200 or more separate transactions.
19 On in its face, the income tax statute requires 200 or more
business transactions as opposed to 200 or more
sales transactions. The income tax statute does not necessarily require that the business transactions consist of sales. This broad reading could impose income tax nexus on a remote entity that regularly purchases goods or services from a Hawaii business, conceivably causing an out-of-state business with minimal or even no sales in Hawaii to have nexus with Hawaii. Additional legislation or regulations are needed to clarify the meaning of “business transactions.”
Numerous states have enacted legislation that applies the
Wayfair economic nexus standard to sales tax. There is a possibility that other states may follow Hawaii’s lead and extend the
Wayfair economic nexus thresholds to income tax. Although the new economic nexus standard applies to income tax, remote businesses should continue to receive federally adopted protection from Hawaii income tax under P.L. 86-272 to the extent the activities of such businesses qualify for protection.
20
In replacing the existing cost of performance method for assigning income to the state, the Hawaii legislature noted that as intangible property and services have become a greater part of the economy, states have transitioned to market-based sourcing for intangibles and services.
21 The legislation explains that the transition to market-based sourcing will ensure that Hawaii’s income tax is keeping up with the changing economy and will foster uniformity with states that have also transitioned to market-based sourcing. The change also will reduce inter-state complexity and simplify inter-state compliance.
Additionally, Hawaii’s GET utilizes a version of market-based sourcing,
22 so transitioning the corporation income tax to market-based sourcing could increase consistency and efficiency between the two taxes. However, there may be differences in the application of market-based sourcing between the tax types. For purposes of measuring market-based sourcing under the GET, gross income from services or intangible property generally is sourced to Hawaii in proportion to the benefit received in the state.
23 Hawaii will need to issue regulations to clarify the implementation of market-based sourcing for income tax purposes. If the Hawaii income tax market-based sourcing regulations are based on the extensive model regulations issued by the Multistate Tax Commission (MTC), there may be inconsistencies in market-based sourcing between income tax and the GET. For example, the MTC model regulations generally source income from services according to delivery location as opposed to the location where the benefit is received. The possible differences in market-based sourcing between income tax and the GET should be considered after the income tax market-based sourcing regulations are issued.
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.