October 2, 1998

DEPARTMENT OF TAXATION ANNOUNCEMENT NO. 98-23


RE:  Adoption of sections 18-237-16.5-01 to 18-237-16.5-07, Hawaii Administrative Rules (HAR),
relating to the application of the general excise tax to written real property leases and the sublease deduction.

The Department of Taxation (Department) has adopted rules implementing Act 353, Session Laws of Hawaii 1997 (Act 353). Act 353 takes effect on October 1, 1998, and has been codified in section 237-16.5, Hawaii Revised Statutes (HRS).

Act 353 reduces the pyramiding of the general excise tax on real property that is subleased by allowing a lessee who leases real property from a lessor a deduction from rental income received when subleasing the same real property to a sublessee. The lessee (i.e., sublessor) is allowed a deduction from rental income received by the lessee from a sublessee of up to 87.5 percent (phased in over seven years) of the amount the lessee pays to the lessor.

The allowable rate to be used in computing the deduction is as follows:

  1. For gross proceeds or gross income paid in the months of October, November, and December, 1998, 12.5 percent;
  2. In calendar year 1999, 25 percent;
  3. In calendar year 2000, 37.5 percent;
  4. In calendar year 2001, 50 percent;
  5. In calendar year 2002, 62.5 percent;
  6. In calendar year 2003, 75 percent; and
  7. In calendar year 2004, and thereafter, 87.5 percent.
The 87.5 percent deduction when fully phased in for the year 2004, removes seven-eighths of the lessee's rent from the four percent general excise tax, which is the functional equivalent of subjecting all of the lease rent to the general excise tax at the 1/2 percent wholesale rate.

The rules clarify the requirements for the sublease deduction, including the requirement for three parties, a lease and sublease in writing, and certification by the lessor. The rules also discuss the phase in of the deduction, the allocation of the rent by the lessee when the lessee leases various real property with different rental values and subsequently subleases the real property, and the allocation of the rent by the lessee based on the percentage of the property subleased and the fair rental value of the property subleased.

Section 18-237-16.5-01, HAR, defines certain terms used in the rules.

Section 18-237-16.5-02, HAR, clarifies the imposition of the four percent general excise tax on the business of leasing real property in the State and the requirements for the sublease deduction. The lessor must submit to the lessee a certificate that certifies that the lessor is licensed and taxable under the general excise tax law; the absence of the certificate shall give rise to a presumption that the lessee is not allowed the sublease deduction. A copy of that certificate is attached to this Announcement.

Section 18-237-16.5-03, HAR, explains the calculation of the sublease deduction, including the allowable rate used to calculate the deduction. The allowable rate for determining the amount of the deduction is 12.5 percent for the months of October through December 1998, and increases by 12.5 percent for each succeeding calendar year with a maximum of 87.5 percent in calendar year 2004, and thereafter. Section 18-237-16.5-03(b) discusses percentage leases where the lease rent is based on a percentage of gross sales or net profits of a business.

Section 18-237-16.5-04, HAR, clarifies the allocation of rent paid by the lessee based upon the percentage of the real property when the lessee subleases less than one hundred percent of the real property which was leased from the lessor.

Section 18-237-16.5-05, HAR, specifies guidelines that are applicable when the lessee leases various real property with different rental values and subsequently subleases the real property.

Section 18-237-16.5-06, HAR, furnishes several factors for allocating the rent paid by the lessee based upon fair rental value where an allocation of rent paid based upon the percentage of the real property subleased is not reasonable under the circumstances. Section 18-237-16.5-07, HAR, specifies that the person claiming the sublease deduction has the burden of proof.

A copy of a worksheet to assist lessees in calculating the sublease deduction is also attached to this announcement.

A copy of the rule and other tax information may be downloaded from the Department's website at http://www.state.hi.us/tax/tax.html. A copy of the rule and other tax information may also be obtained by calling the Department's Forms Request Line at 808-587-7572. Persons who are not calling from Oahu, may call 1-800-222-7572 to receive forms by mail or 808-678-0522 from a fax machine to receive forms by fax.

/s/
RAY K. KAMIKAWA
Director of Taxation
 
Attachments :  G-71 GENERAL EXCISE SUBLEASE DEDUCTION CERTIFICATE
G-72 SUBLEASE DEDUCTION WORKSHEET

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