Will state Tax Department stick to its guns on restaurant tax?
from Grassroot Institute of Hawaii, January 20, 2024
Hawaii is notorious for its taxes, covering everything from food to medical services. Now, the state is setting its sights on restaurants that received federal COVID-19 relief funds.
On the latest episode of “Talking Tax” on ThinkTech Hawaii, hosts Mark Coleman and Tom Yamachika interviewed Russell Ryan, chief financial officer and co-owner of the two Highway Inn restaurants, whose company was hit with a surprise tax bill applicable to the financial aid it received under the federal Restaurant Revitalization Fund.
“Our position for the record is: This is unfair,” said Yamachika, president of the Tax Foundation of Hawaii and a tax attorney representing Highway Inn.
Yamachika explained how the federal government created several programs at the start of the COVID-19 lockdowns to assist struggling businesses and individuals, including the Paycheck Protection Program and the Economic Injury Disaster Loan Program,
That same year, in 2020, Hawaii’s Department of Taxation issued an official guidance stating it would not impose the state general excise tax on those federal benefits — “in light of the severity of the economic impact of the COVID-19 pandemic”
The Tax Department is now arguing that its 2020 guidance does not apply to funds distributed by the federal Restaurant Revitalization Fund established in 2021, despite the fact that the fund’s purpose aligns with the rationale behind that original guidance.
Ryan said he was surprised when the department wrote to him demanding that Highway Inn pay taxes on its RRF benefits.
“We’re being asked to pull this money out of just our operating income today,” he said.
And Highway Inn is not alone. Coleman, communications director for the Grassroot Institute of Hawaii, said over 1,100 Hawaii businesses received RRF funding, for an average GET bill of $14,500.
Ryan noted that most restaurants make only between zero to 5% in profits, with 5% being a “once-in-a-blue-moon” occurrence. He said that combined with inflationary pressures and the recent state minimum wage increase, this GET bill is “definitely going to hurt.”
Yamachika said he is willing to take the Tax Department to court, but hopes that those in positions of power will “do the right thing” and drop their demand for GET payments on the RRF funds.
1-16-24 Russell Ryan with hosts Mark Coleman and Tom Yamachika on “Talking Tax”
Mark Coleman: Aloha, everybody. I’m Mark Coleman, your co-host today of “Talking Tax” here on ThinkTech Hawaii. My co-host is Tom Yamachika, president of the Tax Foundation of Hawaii.
And we have a special guest today, Russell Ryan. He’s chief financial officer and co-owner with his lovely wife of Highway Inn, which has two restaurants: one in Kakaako and the other one in Waipahu. And they serve mostly Native Hawaiian foods.
And the reason we’re going to talk to him today is because he was hit with a big tax bill unexpectedly a year ago or so. And we’re going to talk about why that happened and what we can do about it.
He’s one of many who were hit by this surprising request for money by the [state Department of Taxation]. And it goes back to the COVID funding era when the federal government and the state were passing out lots of money to help businesses that were affected by the lockdowns — the COVID lockdowns.
So, Tom wrote an article about this very recently called “Restaurants Getting Cooked.” And that was about how these many restaurants were suddenly surprised by this big bill from the government, state government.
And Tom, why don’t you explain what was going on about that?
Tom Yamachika: Sure. Thanks for that great introduction. What we’ve got today is basically an audit program that was initiated by our state tax department.
They’re going after restaurants of all stripes: big ones, small ones, medium-sized ones. And the key factor in that is that they took advantage of a program from the federal government called the Restaurant Revitalization Fund or “RRF.”
You may recall that in the earlier days of the pandemic in 2020 or so, the feds came up with some different relief programs including the Paycheck Protection Program, or “PPP” for short. So, most businesses were able to take advantage of, you know, some monies from that program.
And in 2021, when we had a new president, it was kind of deemed necessary to help a certain, a segment of the business population out, namely restaurants and, I guess, entertainment venues.
So, they had two new programs in 2021 called RRF, which we just talked about, and the Shuttered Venue Operators Grants, so “SVOG.” And this is for businesses that had to close down because of the pandemic because there were closure orders.
Now, what we’re, what brings us to the problem today is our omnipresent general excise tax, which is pretty much levied on everything. And in 2020, when the first couple of programs came out, the Department of Taxation came up with some official guidance.
This is what it looks like, if you can show the first slide, please.
Yes, this is what’s called “TIR,” or Tax Information Release 2020-06. You know, nice official document. It’s many, many pages long, but let’s kind of cut to the chase here and go right to the section we need on page three, and let’s zoom in on that a little bit.
And it talks about general excise tax treatment, and it says:
The general rule is that amounts received by a business that replace income are subject to GET. Thus, grants or other programs that replace or supplement income are normally subject to GET. However, in light of the severity of the economic impact of the COVID-19 pandemic, GET will not be imposed on payments received under Pandemic Unemployment Assistance, loan amounts forgiven under PPP — which we’ve talked about — and EIDL, I think it’s emergency disaster loans …
Coleman: That’s right. Economic Injury Disaster Loan programs.
Yamachika: Right. I’m getting old here. I forgot what the “I” stands for.
These were all federal programs to lessen the injury from the economic impact of the pandemic.
Coleman: Of the lockdowns.
Yamachika: Yeah. And the lockdowns associated with them.
Okay, so this is kind of the, you know, the rule book that we’re playing with. So, to see kind of how that unfolded, well, let’s kind of note that this particular official statement was issued in 2020. And that was before we had the RRF and the SVOG pass, because those were in 2021 when we had a new president.
Yamachika: So, the guidance doesn’t mention RRF. You can’t, I mean, because it didn’t exist yet. But some of the auditors kind of take that omission as saying, well, you know, we talked about PPP and EIDL; we didn’t mention RRF at all. Therefore, it must be taxable.
And that’s kind of how they have been hitting these different restaurants. And today, we’ve got one concrete example and we have Russell here from Highway Inn to tell us about the on-the-ground impact of what that meant and how the industry is taking this.
What’s been going on Russell?
Russell Ryan: Thanks Mark and Tom for bringing this to everybody’s attention. Truly appreciate it. And thanks for that great explanation there.
As you mentioned, you know, when they came out with that document, RRF didn’t even exist. In 2021, we applied for this additional funds and we received it. And according to the regulations, we spent the money because we were told we had to spend it all. Otherwise, we’d have to give it back.
So, we duly went ahead, got the money and spent the money in the economy. So, all of the people on whom we spent the money, they paid their GET to the state. So, they got a piece of that money that we gave to them. And our employees that benefited from the pay that we gave, they also paid state income tax.
So, we couldn’t believe our eyes. And Mark, it was about a month ago — not a year ago — that I opened this letter. And it says, “Do you remember two and a half years ago when you got that money from the federal government? Now you owe us tax on that.”
We were astonished, of course. We were like, “What, how did that happen?” And of course, with the passage of time, I found Tom obviously on this because we’re pretty disgruntled about it because we weren’t told at the time that there would be tax due on this.
And, of course, coming right now in this time, one time of the year when it came as well. We’re being asked to pull this money out of just our operating income today.
And of course, you know, we’re a small company, but we have budgets, we have all of that stuff and we were never, ever, never, ever made aware in order to budget for this particular tax, which came along.
And the thing which I find interesting looking at how they’ve done it is, they’re saying replacing revenue, and somehow this RRF grant is being seen to be replacing revenue as opposed to paying costs like the PPP and the EIDL was.
So, I don’t know how suddenly, this one grant that’s essentially the same thing is suddenly deemed as being revenue replacement as opposed to costs.
Coleman: Yeah, that’s a good point. I mean, Russell, you were — that’s something that Tom brought up in his article, I believe, that that was the excuse that we haven’t talked about until you just brought it up.
That the prior programs had to do with meeting costs. And then this one, they considered it to be replacing revenue. And so, therefore, they are assuming that it doesn’t have to be exempt.
Yamachika: That happened when one of our local news channels broke, you know, broke the story on this development. You know, they interviewed another Kailua restaurant who was being zapped with the same issue and they said, “Oh my God, we got PPP funds. They said it wasn’t taxable. And now, we get, one year later, additional monies from the federal government for RRF. You know, what’s the difference?”
The state spokesperson on that particular program came up and said, well, PPP was replacement of costs. But I’m not really sure they were aware, but under the RRF federal program, you have to spend the money on approved items. You know, the things that the federal government approves. If you don’t, you have to give the money back.
So, I don’t see how different that is.
Coleman: It should be exempted under the GET, under the spirit of that letter.
Ryan: Right. The only difference I was aware of, having been the one that did all the paperwork on all of these alphabet soup of grants, was with their RRF, it was based upon revenue decline during sort of one reference period to another, and the others were based on cost decline or costs that you experienced in that reference period.
And, you know …
Yamachika: That was only the initial amount of the grant, right?
Ryan: Yeah, well, that was just a means of calculating how much, you know, trying to get a ballpark on who owned what.
Because, you know, a small little restaurant is gonna have less than a big restaurant. And we all know in the restaurant business, revenue pretty much equals costs because of our profit margins so skinny, you know, between zero to 5%. You know, 5% being a once in a once-in-a-blue-moon profit margin that you get in this business.
So, revenue is equal to cost, so it’s pretty much the same thing. And there’s no logic in my mind as to why using, you know, a quick revenue calculation that is very, very easy to observe.
I mean, revenue is much more easy to observe than cost because, you know, we all know from accounting that, you know, costs, the costs can be paid in one period, but accrued in another, or you have depreciation or amortization, You have payment plans, so it’s really hard to determine what cost is exactly in what period.
But revenue is unambiguous. It was like, yeah, did you make, you know, $20,000 in this month in revenue? Yes, I did. You know, whereas costs are a little harder to pin down. So, I don’t, you know, because of the speed with which this came out, we literally had, I think about five or six days to come up with our revenue numbers.
And it was impossible to do that with cost. So, in my mind, the revenue number was just a very quick and dirty way of getting the size of, getting that number, which was, you know, essentially, as I mentioned, a proxy for costs because of the low profit margins. And I don’t think there was any intention on the people who came up with the RRF grant, that it was, it should be treated anything differently than any of the other grants.
Coleman: How did they react when you brought this up? Did they go, “Oh yeah, well …” What was their excuse to you?
Ryan: Oh, well, we were still in process. The only information that I’ve gotten back from our accountant is, you know, they respectfully disagree with your position, essentially.
Coleman: Well, just for the record, Jonathan Helton with the Grassroot Institute, which I work for as well — I’m the managing editor over there. He checked with the Small Business Administration, and apparently, more than 1,100 Hawaii-based businesses received RRF grants for a total of $416.2 million.
And at the excise tax rate of 4%, not counting county surcharges, the state realized about $16.6 million by taxing the locally distributed RRF grants. So, that was an average of …
Yamachika: Yeah, well, that’s what they want.
Coleman: $14,500 an hour per restaurant on average. I don’t know where you fit in on that one, Tom, but that’s a lot of money.
And considering how everybody was so, you know, knocked over by the COVID lockdowns, you would have thought that they might’ve let that one go, but I guess not.
Yamachika: And it’s all back assessments. It’s all back assessments. The assessment is going to be made for the year 2021.
Ryan: And the money’s already in the economy. We spent it, as we were advised to do. And we spent that money and that GET is in the economy. So, they’ve already received their tax from …
Coleman: So, you were operating under the idea that — I mean, if you had known you would have had to pay 4% on the money we’re bringing in from the grants, you would have put that aside probably.
Ryan: Absolutely, yeah. And put it aside and then been like, “OK, well, I got to deal with this.” That’s all on top of the income tax we already spent on it.
Coleman: Well, apparently, Gary — who’s the tax director’s name?
Yamachika: Gary Suganuma.
Coleman: Yeah. Apparently, he — Tom, you probably know this. I mean, I’m sure you know this, but he apparently has the power to unilaterally say, “Okay, we won’t, you know, we’ll give you a refund.”
That’s what you’re seeking right, Tom?
Yamachika: Well, it was actually Gary’s predecessor — Isaac Choi — in that position who came out with that tax information release that we were talking about earlier. It’s an official document. People can rely on it.
Coleman: Right. So, but Gary could extend the spirit of that unilaterally to these RRF grants.
Yamachika: I think he already did. If he wanted to revoke it, he could have done so by now.
Coleman: But what I’m saying is, can he authorize reimbursements or refunds on those tax payments that …
Yamachika: Yeah, he can just tell his auditors, you know, let’s end this. Let’s apply the same principle to RRF and SVOG, which I think is what they should do.
Coleman: Yeah, Jonathan, he said, “Yeah, he could do that. He could just issue new tax information release stating that money received from the SVOG and RRF programs are exempt from the exercise tax.” Boom, just like that.
But barring him doing that, then what? Legislature?
Yamachika: Well, yeah. I mean, one of the, one of the issues that I guess they may be dealing with is that there is no statutory exemption for this.
So, he may feel himself compelled to tax it in the absence of authorization from the Legislature. Well, that didn’t stop his predecessor.
Coleman: Oh yeah. Uh-huh.
Yamachika: It may have been kind of a factor of, or influenced by the fact that in 2020, our Legislature wasn’t in session.
They only, you know, met for maybe a few weeks and then said, “Well, we’re locking down the Capitol too.”
Coleman: That’s a good point. Well, is that a, does that rise to the level of an executive, like an emergency executive order? Did he really have the power to do that even for those other programs?
Yamachika: Uh, I think he did. If it’s an executive decision, you know, they have the power to figure out what laws they’re going to enforce and what laws they’re not going to enforce.
It’s like, you know, cops don’t have to arrest everybody they see jaywalking.
Coleman: Well, yeah, that’s good. Yeah, that’s a good point.
What would you like to see, Russell?
Ryan: Well, I mean, purely from a cash flow perspective, you know, we actually haven’t paid it because we just got the bill a month ago. I know several people have been getting these letters previously to me. And now, there’s going to be obviously other restaurants getting it subsequently.
Coleman: Oh right. So it’s not a refund yet.
Ryan: It’s just like me, but for others, they have paid. I know a couple of other people have taken the position: The amount’s small enough that I’ll pay it and then deal with it another day.
But given our location in the Kakaako location because our Waipahu location didn’t receive a significant amount, but our Kakaako location did because obviously, we’re right here in town.
And that one had a major drop off in revenue in the 80% region during this time. And of course, you know, we still had to pay our landlord and our banks and our employees and all that sort of stuff.
So, we started to pay all that, we started paying in cash. I’d literally like not to have to pay it. I mean, and even more so because just this past week, minimum wage just went up too.
And without going off a tangent on minimum wage, the restaurant business, you know, it’s unfortunate that the gross misunderstanding of how minimum wage works in the restaurant business because our servers are paid minimum wage, but they pull in about between $50 and $90,000 a year.
But they make minimum wage, so we’re increasing their pay at the expense of the backhouse people who are making $17, $18 now already. So we have to go pay the people who are already making the most money, more money for the minimum wage. So, it’s grossly misunderstood.
So, not only do I don’t want to pay that, I’m also suffering about an increase of 4-5% costs on labor as a result of this most recent, this recent minimum wage pass.
So even more so now, do I not want to have to come out of pocket for this money because we’re still adjusting to the new realities of 5% higher costs.
And as I mentioned earlier, our profit margin is, you know, zero to 5% in any particular period. So the minimum wage increase has just evaporated our profit margin for the whole of 2024. So, we have to raise prices and so on and so forth.
Coleman: And then you’ve got inflation, which nobody has any control over around here.
So now, to have our own state tax department coming after us or something, which we view as, you know, as you guys have articulated is just, you know, on the face of it, just completely different from that prior treatment of similar monies.
Coleman: But you’ve challenged that or you’ve asked them to reconsider or what have you done about that?
Ryan: Yes, well I actually, that’s how I know Tom because I reached out to Tom about it.
Coleman: And Tom, what’s your position now on where do you think it should go from here?
Yamachika: I mean, I do, in my day job, represent some clients, including Highway Inn.
Coleman: Including who? Oh, Highway Inn.
Yamachika: Including Highway Inn. Yeah. This is Russell’s company.
And our position for the record is: This is unfair. You can’t do this, tax department. And if you don’t do it, we’ll take you to court.
Mark Coleman: Is there any precedent for something like this? Is this happening around the country, anywhere else in other states?
Yamachika: We are not aware of any state that’s taxing RRF except us.
Coleman: Wow. That’s amazing.
Yamachika: I mean, most states have sales tax. And RRF, as a grant, is not something you sell.
Coleman: So how would that work if you had a sales tax? How would that have worked for a company like Highway Inn? And what would that process have been in terms of putting aside money for it to cover the sales tax or whatever? They wouldn’t even have to worry about that, right?
Yamachika: No, sales tax normally doesn’t apply to stuff like that. It applies to like, of course, the meals that they sell and the, you know, would put a charge on the register to cover the sales tax collected and remitted to the state who wants it. That’s what they do in sales tax states.
They do that here to collect the GET, like pretty much any other business does. So there’s not a whole lot of, a lot of difference in terms of the tax on the revenue from, you know, customer meals.
Coleman: About the other program that’s getting taxed — SVOG one — I’m told that from the figures I have here, that amounted to $144 million in Hawaii that they handed out. Only 78 companies, like Polynesian Cultural Center, that kind of, like those kind of companies, such as Roberts Hawaii PC services.
And that amounted to, meaning the average company was about $1.8 million. And so, their average bill was $73,800.
Have you heard anything from these people complaining about their latest surprise in the mail?
Yamachika: So far, no. But have you heard anything Russell, about SVOG?
Ryan: No. No, I haven’t.
Coleman: They’re just like eating it. Perhaps we ought to look into that for a future episode.
Ryan: Maybe they haven’t had the letter yet.
Coleman: Maybe they haven’t been audited yet — right. Maybe they’re going after their restaurants first.
But Russell, how would this, how is this gonna affect you? I mean, is this gonna run you out of business or?
Ryan: Well, I mean, I’m just going to have to borrow money to pay it, or go on a payment plan and pay it if we lose and we were forced to pay it.
But again, like I say, it just means that we just basically operate in the black or, you know, break even for the next, you know, six months.
Well, I want to say we have to obviously adjust our back accounts, but from a cash flow perspective, we’re just going to have to borrow to — which is going to cost money as well in today’s high interest rate environment — in order to get enough working capital to be able to carry on.
So, yeah. Had this happened not at this time, there may be, you know, by the time we’ve adjusted prices, you know, given the new reality of all the inflation and the wage increases I was talking about.
You know, all restaurateurs are very concerned about cash position and what’s going to happen to the demand with increased prices in 2024. And this is just another unnecessary hurdle we have to cross.
Coleman: Darn right.
Ryan: I don’t think it would put us out of business, but it’s definitely going to hurt.
Coleman: Well, that’s good news. As we know, Hawaii is not known for being a business-friendly state, and a failure to back down on this issue would kind of cement that reputation.
Just so our viewers out there know, Highway Inn, like I said, does serve, it does cater to Native Hawaiian tastes and they ship food to people all over the country.
Mike, I don’t know if you want to show that slide about their business. But let’s give a plug for you to see, you know, how to make people help here.
Ryan: Thank you. That’s some of our vacuum-sealed kalua pig and lau laus there.
Coleman: Yeah. Yeah. Stuff that the Hawaiian community on the mainland, anyone who has sweet feelings for home sweet home. Tom, as we come to a close, is there anything else you’d like to say?
Yamachika: No, we just hope that our lawmakers and our people in, you know, the powers that be do the right thing.
Well, thank you, everybody. I’m Mark Coleman, the co-host with the Grassroot Institute. Tom Yamachika, Tax Foundation Hawaii, and Russell Ryan, CFO for Highway Inn — wonderful restaurant there in Waipahu, Kakaako.
And if you like this program, please hit like and subscribe to ThinkTech Hawaii. Stay tuned for following programs and we’ll see you next time, hopefully, two weeks from now. Aloha.
Dec 31, 2023: Restaurants Getting Cooked