LINDA LINGLEKURT KAWAFUCHIGOVERNORDIRECTOR OF TAXATIONJAMES R. AIONA, JR.

STANLEY SHIRAKILT. GOVERNOR

DEPUTY DIRECTOR

STATE OF HAWAII

DEPARTMENT OF TAXATIONP.O. BOX 259
HONOLULU, HAWAII 96809

PHONE NO: (808) 587-1510
FAX NO: (808) 587-1560

December 17, 2009

DEPARTMENT OF TAXATION ANNOUNCEMENT NO. 2009-34
RE:Imposition of general excise tax and use tax with regard to imported services orcontracting; "whipsaw" assessments

A "whipsaw" occurs when the Department is forced to treat both sides of a transactionconsistently where the facts or application of law to those facts are in dispute, and assess only
one of two taxpayers based on one view of the facts or law, and allow the statute of limitations
on assessment against the other taxpayer to expire before the Department can change its position
to conform to a judicial ruling against it on its initial position. To prevent such a whipsaw effect,
the department must issue assessments to both taxpayers on inconsistent theories to toll thestatute of limitations until the matter is resolved by the courts. However, the Department intends
to collect 100% of the proper tax only once, whether it is all from one of the taxpayers or a
combination of taxpayers.
The Department has become aware of situations where two or more persons involved in asale of services or contracting are each claiming that the other is responsible for paying the tax
on the services or contracting imported into Hawaii, the tax in question being the general excise
tax or its companion tax, the use tax. The "whipsaw" in this context may occur as a result ofcompeting legal theories or disagreement as to the facts and circumstances surrounding thetransaction.
With regard to competing legal theories, Tax Information Release 2009-02, issued June15, 2009, states the Department's position that the proper test for sourcing a sale of services orcontracting is the "used or consumed" test, as opposed to an alternative test based upon the"place of performance." See Acts 70 and 71, 1999 Session Laws of Hawaii; and Haw. Rev. Stat.
§ 237-8.6 and Haw. Admin. Rules §§ 18-237-8.6-01, et seq. Where an out-of-state person
selling services or contracting to an in-state person takes the position that a "place ofperformance" test applies for general excise tax sourcing purposes, a whipsaw situation may
arise, and the Department may assess the in-state persons purchasing the services or contracting
for use tax even though the Department is pursuing the out-of-state service provider for thegeneral excise tax. Even if all persons agree to the "used or consumed" sourcing test, if thepersons disagree about the facts and circumstances surrounding the transaction, a whipsaw
situation may arise. Although only one sourcing test or one characterization of the facts should
logically succeed, if the Department does not assess both persons for the full amount of tax
owed, for jurisdictional or procedural reasons, first one and then the other taxpayer may prevail
against the Department, thereby denying the Department the ability to collect the full amount ofDepartment of Taxation Announcement 2009-34
Page 2 of 3

tax owed as a result of the sale (whether it be general excise tax, use tax, or a combination ofboth).
ExampleTaxpayer A performs a service for Taxpayer B in return for $1,000, resulting in a
total excise tax (either general excise tax and/or use tax) and county surcharge
assessment of $45. The place of performance of the service is 30% in Hawaii and70% outside of Hawaii. However, Taxpayer B uses and consumes all of theservice in Hawaii. Both Taxpayer A and Taxpayer B have nexus with Hawaii.
If Taxpayer A were to take the position that place of performance is the method
for sourcing gross receipts for purposes of Hawaii's general excise tax, thenTaxpayer A would report 70% of the receipts outside of Hawaii, leaving Taxpayer
A to report and pay general excise tax on 30% of the $1,000, which would be$13.50 in Oahu. If the place of performance test applied to Taxpayer A, thenTaxpayer B would be liable for use tax on the 70% sourced outside of Hawaii forgeneral excise tax purposes, as imported services, which would be $31.50. Thus,
Taxpayer A and Taxpayer B would collectively pay $45 (i.e., $13.50 + $31.50).
However, if the proper sourcing standard were the used and consumed test (whichis the Department's position), then it would be Taxpayer A who would owe
general excise tax on 100% of the $1,000, or $45, because all of the services wereused and consumed in Hawaii and Taxpayer B would owe no use tax.
Because of the competing sourcing theories (i.e., place of performance or whereused or consumed), transactions such as the one in this example are highly likely
to result in litigation. Until a court resolves which test, the one based on place ofperformance or the one based on use and consumption, is the proper standard forgeneral excise sourcing purposes, assessing only one of the taxpayers in a mannerconsistent with only one of the two possible legal theories could lead to a situation
where the entire tax is not collected. If a court concluded that the sourcing
standard should be the place of performance test, then an assessment of only
Taxpayer A for general excise tax could lead to less than 100% of the proper tax
being collected. If a court decision based on the place of performance test wasaffirmed, this means that the Department should have also assessed Taxpayer B
for use tax. If the statute of limitations to assess Taxpayer B for the use tax hadexpired during the time that the court was resolving Taxpayer A's tax liability,
then the Department would not be permitted to assess Taxpayer B, and the entire
amount of proper tax would not be collected on the transaction even though it wasclear from the start that tax was due on $1,000 transaction, whether it is all from
Taxpayer A or a combination of Taxpayer A and Taxpayer B.
Whipsaw assessments have long been accepted with regard to the administration of thefederal income tax, as affirmed in many federal court cases. See e.g., Goodall's Estate v.

Department of Taxation Announcement 2009-34
Page 3 of 3Commissioner, 391 F.2d 775 (8th Cir. 1968); Wiles v. Commissioner, 499 F.2d 255 (10th Cir.
1974); Centel Communications Co. v. Commissioner, 920 F.2d 1335 (7th Cir. 1990); Bouterie v.
Commissioner, 36 F.3d 1361 (5th Cir. 1994); Fayeghi v. Commissioner, 211 F.3d 504 (9th Cir.
2000); Preston v. Commissioner, 209 F.3d 1281 (11th Cir. 2000); In re Indian Motocycle Co.,
Inc., 452 F.3d 25 (1st Cir. 2006). As the United States Court of Appeals for the Eighth Circuitnoted in 1968 in Goodall's Estate:
These are, after all, tax cases. Substantial sums are involved. TheCommissioner is charged with the protection of the revenues.
While these factors might be viewed as pragmatic, it would be
unseemly, we feel, to force the Commissioner, in the performanceof his administrative duties, to make an awesome choice of thiskind at his peril. Taxes are not a game. Of course, theCommissioner, and the government itself, in this court is no moreand no less than just another litigant. But we are aware of every
person's tax responsibilities and we are not inclined to let therealization of revenues stand or fall on so technical a base as
impeccable consistency. Consistency is desirable but its virtue haslimits. Good faith inconsistency buttressed by acceptableargument, when considered in the framework of theCommissioner's responsibilities, cannot be regarded as an offense
which provides a bar to bona fide tax litigation.
Where the facts or application of law to those facts are in dispute with regard to services
or contracting, the Department intends to assess all persons party to the transaction in order toprotect the statute of limitations until the dispute is resolved by the courts. However, theDepartment intends to collect 100% of the proper tax only once, whether it is all from one of thetaxpayers or a combination of taxpayers.
For more information regarding this Announcement, please contact the Technical Section
at 808-587-1577.

KURT KAWAFUCHI
Director of Taxation