Effective July 1996, Section 103-53, Hawaii Revised Statutes (HRS), was amended to require businesses to obtain a tax clearance certificate from the State Department of Taxation and the Internal Revenue Service (IRS) prior to entering into a contract with the State of Hawaii or any of its four counties. This requirement is in addition to the tax clearance certificate required before final payment is made by the contracting agency upon completion of the contract.  This issue of Tax Facts provides current information on the tax clearance requirement and the application process, and also serves as a general guideline for those businesses, including out-of-state contractors, nonresident individuals and nonprofit organizations, planning to engage in business with the State or any of its four counties.  This Tax Facts 2000-1 supersedes Tax Facts 96-3, issued July 1996.

For those out-of-State businesses not familiar with Hawaii tax laws, Hawaii does not have a sales tax.  Instead, Hawaii imposes a tax, called the general excise tax, on gross income attributable to business and other activities in Hawaii.  The general excise tax is a business privilege tax levied on persons engaged in business at all levels including sales at both wholesale and retail, services, commissions, rental income, and many other business activities.  As distinguished from most sales taxes, the legal incidence of the general excise tax is upon the business rather than the customer.  Therefore, it would be irrelevant that the customer is the State of Hawaii or any other tax-exempt entity; the business must still compute the tax on its gross receipts, which includes any amount of the tax passed on to the customer.  The pass-on of the tax is considered part of the price paid by the customer and deemed a contractual agreement between the business and the customer; it is not a statutory requirement.  Hawaii also imposes a use tax on the landed value (including shipping and handling) of tangible personal property or services imported into Hawaii from anywhere outside Hawaii.

1. What are the tax requirements or obligations  for an entity planning to engage in business with the State of Hawaii or one of its counties?
Under current Hawaii law, any business entity  intending to enter into (or bid on) a contract with an agency of the State of Hawaii or any of its four counties is required to obtain a tax clearance certificate from both the Department of Taxation and the IRS prior to entering into a State or county contract for the furnishing of goods or professional services, as well as upon completion of the contract before final payment is made.  This requirement is applicable not only for local businesses but also for out-of-State nonresident individuals, nonprofit organizations, and other businesses that may or may not have business presence in the State at the time.

Additionally, if the contract creates sufficient business presence in Hawaii (nexus) and is deemed to be taxable for State purposes,  the business is required to apply for a general excise tax license.  (For nonprofit organizations that have received tax-exempt status from the IRS, see Tax Facts  98-3, Tax Issues for Hawaii Nonprofit Organizations, for additional information on applying for exemption from the general excise tax).

2. What is a tax clearance certificate and why is this requirement necessary for contracts with the State or county government?
A tax clearance certificate is issued to certify that the taxpayer has filed all tax returns due, and paid all amounts owed as of  the date the certificate is issued.  Tax clearance certificates are valid for 6 months for bidding purposes or prior to entering into a contract.  However, a tax clearance obtained for final payment is valid for 2 months.

In the past, some businesses were awarded State or county contracts and were paid the contracted amount even though they were delinquent in their taxes.  The 1996 law change fosters compliance with our tax laws, and also helps ensure that all bidders on public contracts take into account their tax obligations when bidding for such work.

3.  Are there any exceptions to these requirements?
Yes, there are.  Two major exceptions are (1) "small purchases" or contracts under $25,000, and (2) "emergency procurements" of goods, services, or construction.  "Small purchases" and "emergency procurements" are terms defined in the State Procurement Code.  Additional exceptions can be found under section 103-53(e), HRS.

4. How do I get a tax clearance from the Department of Taxation and the IRS?
You would apply for a tax clearance certificate by completing and signing one copy of the Tax Clearance Application, Form A-6.  Be sure to check the appropriate box on item #7 of the application to indicate whether the certificate is required for a bid or prior to entering into a State or county contract, or for completion of contract or final payment.

The Tax Clearance Application (revised 3/1998)  is a two-sided form.  Please type or print clearly, since the front page of the application is photocopied and becomes the actual tax clearance certificate when it is stamped and signed by both the Department of Taxation and the IRS.

Submit the completed application by mail, fax or in-person to either the Department of Taxation or the IRS offices in Hawaii.  State district tax offices are open each weekday, except State holidays, for walk-in service.  The IRS is open each weekday on Oahu, except federal holidays, but has very limited office hours on the neighbor islands.  Neighbor island taxpayers are therefore encouraged to mail in their applications to the IRS office on Oahu instead of walking it in.

Upon submission, the first agency and then the other will review your application, and if your records are clear, they will stamp and sign the appropriate box on the front page of the application.  When approved by both agencies, a certified copy bearing a green stamp will be given or mailed to you to submit to the State or County agency before the contract is entered into or before final payment upon completion of the contract.

Application Forms A-6 are available at Department of Taxation and IRS offices in Hawaii (see addresses on last page), and can also be downloaded from  our website (see website address on last page).  Forms also may be requested for by calling the Department of Taxation's 24-hour  Forms Request Code-a-Phone at 587-7572 to have the form either mailed to you or faxed to you anywhere on Oahu.  Neighbor island and mainland callers may call toll-free at 1-800-222-7572 for forms to be mailed, or call (808) 678-0522 from your fax machine for forms to be faxed to you.

5. How long does it take to get a tax clearance?
Applications generally take a total of 10 to 15 working days to be processed by both the Department of Taxation and the IRS, provided that there are no discrepancies.  Again, neighbor island taxpayers are encouraged to mail in their applications as IRS office hours on the neighbor islands are limited.

To avoid delays, be sure that the taxpayer, or a person required to file tax returns for the taxpayer, such as an officer of a corporation or a partner of a partnership,  is available to discuss and resolve any discrepancies that may arise.  Tax return information is confidential, and may only  be released to the taxpayer or a person required to file tax returns for the taxpayer.

If some other individual, such as an accountant or office manager, will be acting on behalf of the taxpayer, attach both the State Power of Attorney, Form N-848, and the IRS Power of Attorney, Form 2848, to your Tax Clearance Application to designate that individual as your authorized representative.  If the State Form N-848 is not available, the IRS Form 2848 may be substituted for the State form, but it must specifically state on the form that it is being used for Hawaii tax clearance purposes and it must reference the appropriate form numbers for the State returns and tax types for State taxes.

6. Tax clearance certificates from the Department of Taxation previously were required before receiving final payments on State and county contracts.  Are tax clearances still required for final payment?
Yes.  A tax clearance is still required prior to final payment on a State or county contract.  However, the law now requires businesses to obtain tax clearances or special letters from both the Department of Taxation and the IRS within 6 months of the notice of final settlement or the completion date of the contract.  If not, the final payment may be assigned to satisfy your tax obligations with the State first, then IRS.  After settlement of your tax obligations, any remaining balance of the final payment amount will be retained by the contracting agency.

If a business submits a tax clearance application for final payment on a contract without a general excise license number (with the assumption that the contract is not taxable),  it is recommended that the name of the State or county agency and contact person from that agency be provided in the space below the Completion/Final Payment box in item #7 of the Tax Clearance Application, Form A-6, to  expedite the tax clearance process. The Department will then be contacting that agency to review  the contract and confirm that the contract is not taxable.

7. What are some of the common reasons for a tax clearance to be rejected or denied?
Other than non-filed or missing returns or delinquencies on the applicant's account, a most common reason for rejection of a tax clearance application is the lack of an "authorized signature".  If someone other than a corporate officer, general partner, or individual (sole proprietor) signs the application form, a power of attorney (State of Hawaii,  Department of Taxation, Form N-848 and the IRS  Form 2848) must be submitted with the application.

Many applications are also rejected because they are filed on the incorrect form.   Due to the many changes in the laws and other requirements for tax clearances, the Department has revised the tax clearance application several times within the past few years.  In order for the application to be processed by the agencies, the most recently revised form, revised 3/1998, must be submitted.

8.  If I bid on 15 government contracts, do I have to complete 15 different tax clearance applications?
No, you can fill out one application and request multiple copies by writing the number of copies you want  in the box in item #5, No. Of Certified Copies Requested.   Since bids require both State and IRS approval, the last agency to approve will make multiple copies of the certificate and certify each copy with a green stamp, which assures the  receiver  that   the  copy  is  acceptable as a substitute for the original tax clearance certificate issued.
NOTE:  A stamped certified copy is an acceptable substitute for the tax clearance certificate required for final payment on a State or county contract; however, a tax clearance used for final payment is only valid for two months, rather than the normal six-month period.

9.  Do I need to submit a tax clearance certificate before I receive each progress payment?
No.  Tax clearances are not required for progress payments.  You are, however, required to submit a tax clearance certificate before receiving your final payment.  See Question 6 for more information on tax clearances for final payments.

10.  I am behind in paying my taxes, but have arranged for a payment plan with that agency.  Can I qualify for any State or county contract?
Yes.  You may still qualify for these contracts if you are on a payment plan and have not defaulted on your payments.  The Department of Taxation and the IRS will issue special letters for you to submit in lieu of a tax clearance certificate and will not have your progress payments assigned to pay your tax obligations as long as you comply with the terms of the installment agreement.

11.  What happens if I become delinquent or default on an installment agreement during the term of the contract?
If you become delinquent or default on an installment agreement during the term of the contract, your progress payments can immediately be assigned to pay your tax obligations, first to the State and then to the IRS.

In addition, your final payment also may be assigned if you do not submit a tax clearance certificate within 6 months of the notice of final settlement or completion date.

12.  Will I be notified before any progress payments are assigned?
Yes.  You will be notified and given an opportunity to resolve the delinquency.

13.  How will the Department of Taxation and IRS know if I become delinquent or default on an installment agreement during the term of the contract?
The applicable records will be checked periodically to see if any new delinquencies have occurred.  If you are on a payment plan, the collector handling your account will ensure that you have not defaulted on your installment agreement.

14.  Are there any other special requirements regarding State or county contracts enacted with the 1996 legislation?
Yes.  If a State or county contract is assigned to another business (e.g., when a contracting firm is acquired by another firm and the contract is assigned to the acquiring firm), then the assignor (transferor or seller)  must file a Report of Bulk Sale or Transfer, Form G-8A, from the Department of Taxation, if required.
A bulk sales report is required whenever a business sells or transfers all or a large part of its business assets or property, other than in the ordinary course of its business.

If a bulk sales report is not required, then the assignor must obtain a tax clearance certificate from both the Department of Taxation and the IRS.

A special letter from the agencies may be submitted instead of the applicable certificate.

15. In general, what types of State or county contracts would be taxable in Hawaii?
In general,  any contract entered into with the State or  any of its counties, by a business that owns property, maintains an office, or has employees in the State would be taxable for general excise as well as a net income tax.  Additionally, any contract entered into by an out-of-state individual or business involving services such as making repairs or providing maintenance to property sold, installation at or after delivery of property, the conducting of training, seminars or the like,  in the State, would be taxable as well.  In all of the situations, sufficient nexus has been established for taxation in Hawaii.

16. Are tax clearances required when both parties to the contract are government agencies?
No.  Tax clearances are NOT required prior to entering into a contract, nor upon completion of the contract prior to receiving final payment, when both parties to the contract are government agencies (pursuant to 103-53(e)(4), HRS).  "Government agencies" includes any government agency, whether domestic or foreign, at any level, including municipal, county, state or federal.  This would also include public universities.

17.  What is the definition of "nexus"?
To have "nexus" with a state, the Due Process Clause of the U.S. Constitution "requires some definite link, some minimum connection between a state and the person, property, or transaction."  One way to establish "nexus" is "in-state physical presence", whereby the activity carried on by the business in the State contributes significantly to the company's ability to establish and maintain a market for its products (or other  business activity) in Hawaii.  "In-state physical presence" includes, but is not limited to, the maintaining of an office, inventory, or employees in the State.

18. For an out-of-State company, when would a contract with the State (or county) be subject to the general excise tax, but not a net income tax?
As a general rule, the only time a contract would be subject to general excise and not a net income tax is when the business activity that is conducted in the State is limited to solicitation of orders of tangible personal property, and activities that support  the solicitation by either an employee or an independent contractor hired by  the out-of-State company (Public Law 86-272).  If there is any other type of activity which supports the company's ability to establish and maintain a market in this State, then sufficient jurisdiction is established for the State to impose a net income tax.  See Tax Information Release No. 95-3 for additional information.

19.  If an out-of-state vendor provides the bulk of its services outside of Hawaii for a State or county agency, but an employee of the company comes to Hawaii for a meeting or presentation of its work, what part, if any, of the contract would be taxable to the out-of-state-vendor?
A portion of the contract would be taxable, and it would be determined by applying the ratio of the Hawaii costs over the total costs to the total contract.  Hawaii costs may include airline fare, hotel, and other living expenses incurred while in Hawaii.

20.  With regard to out-of-state vendors, how will computer software, hardware, maintenance agreements and license agreements be taxed in Hawaii?
A contract involving only the sale of computer software, hardware and other related items by an out-of-state vendor would not be subject to the general excise tax.  However, if the contract also includes any warranty or maintenance agreement, whereby repair services are provided in the State either through an employee or an independent contractor  (third party repair service provider), then sufficient nexus would have been established and the entire contract becomes taxable for general excise, as well as net income tax purposes.  See Tax Information Release No. 96-1, Re: Computer Company's Provision of In-State Repair Services Creates Nexus, for supporting and additional information.

In licensing agreements, which in essence allow the customer in Hawaii the "right to use" the software owned by the company, an out-of-state vendor will establish sufficient nexus for taxation in Hawaii.

21.  If an out-of-state vendor enters into a contract to furnish and install equipment, but hires a local contractor to install the equipment, would the  contract be taxable?
Yes.  Similar to the situation discussed in Question 20, an out-of-state vendor, who hires a local contractor to provide installation services , is purposefully availing itself of the benefits of an economic market in Hawaii.  Therefore, income from the contract would be taxable.

22.  If an out-of-state vendor sells subscriptions for magazines or other periodicals every year to a local government agency, what taxes, if any, would they be subject to?
If an out-of-state vendor has no nexus in Hawaii and sells magazine subscriptions to a purchaser in Hawaii, there would be no tax.  Under the use tax law, any tangible property imported into the State would be taxable, with the exception of newspapers or other periodical publications purchased on the subscription plan and mailed as second class matter (Section 238-1, HRS).

23.  If an out-of-state vendor makes an isolated sale of tangible goods ordinarily sold in the usual course of the vendor's trade or business to the State or county in Hawaii, will this sale be taxable?
No.  If a vendor does not have nexus with Hawaii, under Section 237-22, HRS, the general excise tax is not imposed.  Because this vendor is not required to be licensed in Hawaii, the importation of the tangible goods for consumption would subject the purchaser to the use tax at 4%.  However, if the importer (purchaser) is a government agency, it is not a taxable entity as defined in Section 238-1 of the use tax law and there would be no use tax.   See Tax Information Release No. 95-5, Re: Application of the General Excise and Use Taxes on Sales of Tangible Personal Property by an Out-of-State Seller, Including Drop Shipments, for more information.

24.  We are an out-of-state company bidding on a State contract.  We are not registered for a general excise tax license because presently, we have no employees, office or inventory in the State, nor have we ever had any business income generated in the State.  The contract involves the sale of equipment and the subsequent training of the staff in the State on the use of the equipment.  Is this type of contract taxable in the State of Hawaii for general excise tax purposes?
Yes.  Anytime there are services provided in the State in conjunction with the sale of tangible goods,  the entire contract becomes taxable for general excise tax purposes at the rate of 4%.  In addition, there will be a 0.5% use tax on the importation of the goods into the State, which would include the value of the goods plus shipping and handling.  Therefore, these amounts should be taken into consideration when submitting your bid.

25.  Our nonprofit organization has been recognized by the IRS as a tax-exempt entity under the provisions of section 501(c)(3) of the Internal Revenue Code.  We are planning to enter into a contract with a State agency, which involves providing educational training services in Hawaii.  Are we automatically exempt from all Hawaii taxes, including the general excise tax since we are exempt from federal income taxes?
No.  Nonprofit organizations that have been granted tax-exempt status from the IRS are  automatically exempt from all Hawaii income tax.  However, the income tax exemption by the IRS is not applicable to the Hawaii general excise tax.  To apply for general excise tax exemption, submit Form G-6, Application for Exemption of the General Excise Tax, with copies of the organization's articles of incorporation, by-laws, IRS determination letter, and the $20 registration fee to:

State of Hawaii
Department of Taxation
Technical Section
P.O. Box 259
Honolulu, HI 96809-0259

For more information on nonprofit organizations doing business in Hawaii, see Tax Information Release No. 91-4, Re: Hawaii Tax Obligations of Nonprofit Organizations and Tax Facts 99-4, Parent-Teacher Organizations and Other School-Related Organizations, which also discusses nonprofit organizations in general.

26.  During the 1999 Legislative Session, there was a new law passed as Act 70, whereby imported services will be taxed under a new use tax law.  How would this affect State and county contracts where out-of-state businesses will be providing services outside of Hawaii for the local government agencies in the State?  As an example, our firm does lobbying at the U.S. Congress on behalf of the State in Washington, D.C.; presently, our contracts are not taxable for general excise tax purposes.  Does this change when the new law takes effect in January 2000?
No.  The new use tax law would not affect those contracts involving "imported services" because the importer of the services is a government agency which is a non-taxable entity.

27.  Our company has a contract with the University of Hawaii to design, furnish and install biomedical equipment  at the School of Medicine.  We were told that because this contract qualifies under the definition of "scientific work" and the University is using federal funds to pay for this contract, it qualifies for an exemption from the general excise tax under the exemption for scientific contracts.  Is this correct?
If the University of Hawaii has obtained funding from the federal government for work which qualifies for exemption from the general excise tax under  Section 237-26, HRS, under the definition of "scientific work", and contracts the work to another business, the exemption from the general excise tax "on certain scientific contracts with the United States" would still apply for the contractor.

However, the contractor would still be required to be licensed for general excise tax purposes to do business in Hawaii, report the gross income on the general excise return, and claim an exemption by stating Section 237-26, HRS, as the reason for the exemption.

Additionally, although the contractor may be exempt from the general excise tax, there is no exemption from the State net income tax, so the income tax return is required to be filed with Hawaii.

28.  Our company was recently awarded the bid and  has entered into a construction contract with the State  to build a low-income housing project in Hawaii. We plan to ship some heavy equipment, as well as some of the building materials, from California, to be used in the construction.  We also plan to purchase some of the building materials in Hawaii.  What taxes would we be subject to?
If your company is a contractor for a qualified low or moderate income housing project in the State, your company would be exempt from the general excise tax on the gross income received.  Section 237-29, HRS, provides for an exemption from the general excise tax on the planning, design, financing, construction, sale or lease of a qualified low or moderate income housing project in Hawaii.   The Form G-37 may be submitted to the certifying agency for approval.  See Question 18 of Tax Facts 99-2, Business Tax Incentive, Tax Facts 99-3, Contractors and the General Excise/Use Taxes and Department of Taxation Announcement No. 98-24 for more information.

For use tax purposes, any equipment temporarily brought into the State for use in the project would not be subject to this tax.   Additionally, any materials which will be incorporated into the construction of the project and are imported from out of State are also exempt under Section 238-3(j), HRS.  Moreover, any construction materials purchased in Hawaii for the project would also be exempt from the general excise tax under Section 237-29, HRS.

For income tax purposes, however, as sufficient nexus would have been established in Hawaii, your company would be subject to Hawaii income tax. Additional information about tax clearances is available in the brochure entitled, An Introduction to the Tax Clearance Procedure.  This brochure, as well as other publications, the Hawaii Revised Statutes, and the Tax Clearance Application, Form A-6, may be obtained from any district tax office, and also is available at the Department of Taxation's site on the Internet at: www.state.hi.us/tax.