On June 12, 2019, Hawaii Governor David Y. Ige signed Senate Bill 394, enacting market-based sourcing for purposes of the Hawaii income tax. The new sourcing provisions apply to taxable years beginning after Dec. 31, 2019.
Currently, Hawaii deems sales other than sales of tangible personal property in the state if the taxpayer performs the income producing activity in the state, or the taxpayer performs the income-producing activity both in and outside the state with a greater proportion of the activity performed in Hawaii than any other state, based on the costs of performance.
The amended 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.
Over half of the states have adopted a market-based sourcing approach and single-sales factor apportionment over the last dozen years. While not a component of the final bill, single-sales factor apportionment was the subject of the first version of the bill. Testimony from the Director of the Hawaii Department of Taxation noted that single-sales factor apportionment would not properly reflect taxpayers’ activity in the state as well the current three-factor formula because it would not take into account property and payroll as the basic inputs of production.
Further testimony from the department indicated three primary reasons to adopt marked-based sourcing. First, a modern economy based more on intangibles than tangible personal property has distorted the tax base; many items formerly delivered as tangible personal property are now intangible, and many taxpayers provide services remotely. Second, market-based sourcing will enhance the sales factor as a measure of a taxpayer’s market by taking into account where the sales are taking place. Finally, the transition will match the sourcing law and rules under the state’s general excise tax, creating uniformity and lessening the burden of administration.
It is anticipated that the state will update its sourcing regulations to comport with the new law. Taxpayers doing business in Hawaii should consider how the new provisions may impact their apportionment and reach out to their tax advisers with questions.