 FTZ. I bet you don't know what that means. We're going to tell you what it means. Tom Yamachika, Talking Tax, the Tax Foundation of Hawaii. Today is Thursday and it's 10 o'clock, and that means it's Tom Yamachika talking tax. Hi, Tom. Welcome back to your show. Thanks, Jay. Thank you for having me on your show. It's mutual. So what is an FTZ? Tell us slowly what it is. Sure. There are a number of devices that the feds provide to help exporters. And one of these is an FTZ, which is a foreign trade zone. Let me kind of show you a picture of one. This is foreign trade zone number nine. It's next to Restaurant Row in downtown Honolulu here. And it's probably the biggest and one of the oldest foreign trade zones in the nation. What it is, is this a geographical area, in adjacent to a port of entry. So it's got to be close to, you know, some place where there's international traffic, where commercial merchandise receives the same customs treatment as if it were outside the United States. So what that does is it helps American businesses to be competitive by, you know, if they want to produce goods for export, they can bring those goods in, not have them subject to U.S. tariffs, assemble the goods or otherwise manufacture them, and then send them off for export. So it never enters the United States, never gets subject to U.S. tariffs. And so we have a number of businesses that set up shop in the zone to load on load, handle, store, manipulate, manufacture, and exhibit goods for reshipping by land, water, and or air. And you may have heard about. Let me unpack a little of that. Sure. So this is down on the waterfront. It's a great big warehouse building near the immigration service, as I recall. It's on the water. Linda Lingle, I think, used that for the homeless for a while, that building. There was a steel, or maybe it's next door. There was a steel company in there for a while. But this is foreign trade zone has been there a long time. And I guess I'm really curious as to what, you know, what I'm going to call it, the federalism is, is this a federal facility? Is it a state facility? It's a federal facility. Federal facility. The people who run it are federal managers and the tax exemption and all that, the carve out, so to speak, that's a federal carve out, but it also applies at the state level. I'm confused. Okay. Foreign trade zone is a federal program. So the people who are there and kind of supervising it is from Homeland Security. Okay, it's customs folks. So they're there to basically police the area as if it were outside the United States because it is for, for customs purposes. Ours was established in 1966 at Pier 39. And it's now about 2,600 acres. So it's pretty, pretty big. And it's also very secure. There is a big cyclone fence around it. I'll tell you a short story. I used to go out on weekends with my camera and take pictures of things, you know, just aesthetic experience. And one day I was in the front of that cyclone fence there on the roadway between the foreign trade zone and Alamoana. And I took a picture of the cyclone fence and the building behind it. And the security people came out and told me, no, no, no, no, no. You cannot take a picture of the foreign trade zone. I said, you've got to be kidding me. I won't tell you the rest of the conversation. I thought that was absolutely absurd. Did you leave the free with your camera? No, that was the rest of the conversation. But let me only say that at least some people think this is a highly secured area. How secure is it? Or maybe I should say how secure should it be? Well, it looks like you found out firsthand how secure it actually is. But there are other federal devices that help imports and exports. You may have heard of duty free shops. Before you go to that, you talk about exhibits in that building in the foreign trade zone. She's operated what I think the Department of Commerce has something to do with it because they have a building right next to it. In fact, on that map that you should aerial photo, their building is right there. So my question is, if I want to assemble, if I want to exhibit, as you said, if I want to have some geography in the foreign trade zone, I have to rent it. I have to enter into an agreement with the foreign trade zone and say, well, space SJ67 is mine for a period of time and I pay rent. Am I right? I believe so. Actually, it's under federal authority, but the people who actually run it is D-bed. But they were given a grant of authority and there's actually a foreign trade zones board in Washington DC that has oversight authority over all this stuff. But they're carved out of the state. It's like a special federal enclave, which the federal government controls and I guess has jurisdiction over, but they allow D-bed to come in and manage it. Is that what happens? Yeah. And it's funny you should see enclave because it's not. And that brings us to one of the principal points of dispute that we're going to be talking about later in the show. Okay. I interrupted you. Why don't you go ahead with your conversation? No, I also wanted to mention that there were other federal facilities that we probably all know and love, such as the duty-free shop. Duty-free shop is also an area that's considered outside of the US for customs purposes. So people can go in to a duty-free shop, you know, make a purchase. But the catch is that they will not be allowed to take the, you know, the purchase goods onto Hawaiian soil. Okay. It's given to them after they board the aircraft. That's going to take them home. Okay. So a duty-free shop, like the foreign trade zone, is another instance of areas under special federal controller supervision that are outside the customs territory of the United States. You don't want to say enclave. No, enclave is something different. Okay. And so let's get to that. There is a special provision in the US Constitution that allows the United States to establish enclaves. And we have some enclaves in various places of the country. There are some federal buildings, courthouses, national parks, you know, stuff like that. And some military bases. And the thing is that in federal enclaves, state laws just don't apply. What's probably the most famous federal enclave that everybody talks about every day? Washington, D.C. The whole thing. The whole thing. Yeah, it's carved out of Maryland and Virginia. It was actually bought by the federal government. And it is an area onto itself. I mean, it's not part of Maryland. It's not part of Virginia. None of those state's laws apply. You think it would be helpful if they sold the whole thing back to Maryland and Virginia and, you know, get away with it? No, I think that would be disastrous. I mean, the feds have to have their own space, too. Come on, you know. Anyway, go ahead. But the thing that's different between federal enclaves, federal trade zones, and customs bonded warehouses, which is what a duty-free shop is, is the extent to which state laws apply. Okay. That's a big difference. It's a big difference. In a federal enclave, it's not part of the state, basically. No state laws apply. In a federal trade zone or a customs bonded warehouse, state laws do apply. But some of them are pushed out. Like, for example, if you try to sell merchandise for export in a foreign trade zone or in a duty-free shop, state laws don't apply. So the RGE tax doesn't apply. But the treatment only extends to the particular goods that are getting export treatment. Yeah. Well, okay. I can understand duty-free. And I suppose when you talk about duty-free shoppers, you shouldn't confuse that with the duty-free zone. Duty-free shoppers is a private company that has some sort of license or permit to operate as a duty-free shop. Yes. But it is a private retail organization, like every other retail organization. But to focus on the federal trade zone, the magic word is export. And I'm racking my brain, Tom, to think of exports from Hawaii. I mean, think tech has been advocating for export of bloody everything that could possibly be exported from Hawaii, but there's not a lot being exported from Hawaii. And I wonder if the original intention is being met, the original intention being to incentivize to make a facilitation of Hawaii exports. And certainly the Department of Commerce tries very hard to do that. They even advertise to do that. But query whether there are significant exports leaving our state so as to justify this large piece of property. Well, I mean, I think one of the issues is that maybe the people who should know about it don't know about it. And that's one thing that we're trying to do on this show here, is to educate people what an FTZ is, what the other federal programs are, that how it might help them if they want to do exports. So this is what we're here to do. Pitch me. What's in it for me with these programs and all to try to be an exporter? One of the problems about Hawaii traditionally, and this is especially so in government contracting, is it's complicated. You have to get the regulation book out and read it cover to cover so you don't make a mistake. And it's the same thing with foreign trade zone. It's a follow-up with regulations about export. Complicated. And that's on top of all the other business considerations on selling stuff. So query, why would I go to the trouble of trying to export? Well, if you want to export, if you have contacts or a market in a foreign country, for example, and you have something or can get something, and you have the ability to manufacture it or reassemble it in Hawaii, then what you can do is get your component parts or manufacturing inputs from wherever you need to. It's not going to be subject to U.S. customs duties because it's still outside the United States for customs purposes. Make your stuff and then sell it to the foreign country again without it ever entering either Hawaii or the U.S. for tax purposes. So I avoid customs. You avoid customs and you avoid stuff like the Hawaii use tax. Right. Which runs at the rate of what? Half percent? Half or four, depending on whether there's a four percent sale following it. Now, if you're going to produce goods for sale into the United States, then it really doesn't matter because the duties are going to hit when the stuff enters the country. The foreign trade zone doesn't help you then. Not for imports, for exports. We're only talking about exports. Okay, I have to do a lot of stuff to export, and it is sexy to know that there are markets out there. Say, take Asia, take China, there are billions of people out there or potential customers, I suppose. Really, this is a Hawaii-specific facility. It's a Hawaii-specific export incentive. It's a Hawaii-specific process. It's not Hawaii-specific. It's U.S.-specific. Okay, you can have foreign trade zones in New York or Boston or anywhere that there is a port of entry. I believe foreign trade zone number one is in New York. They had to be the first. Okay, does that mean that the people who rent space in the foreign trade zone here, on the waterfront here, maybe from other states, maybe companies who are simply coming here for the space in the foreign trade zone so they can assemble their manufactured products and sell them overseas? So here's the thing. If a foreign trade zone were a federal enclave, they could do that no problem. Hawaii laws wouldn't apply. You wouldn't have to worry about GE tax. You wouldn't have to worry about US tax. You wouldn't have to worry about Hawaii regulations, which is an issue when you have food products, because you would have to comply with the Department of Health regulations in addition to the federal ones. And there are other regulations that are applicable to other industries that we impose on top of other states. And we have labor laws. Okay. If you were in a federal enclave, you wouldn't have Hawaii workers' comp laws. You wouldn't have Hawaii SUI. All of that would be federally controlled. But if you have an employee in the duty-free shop in Waikiki, yes, Hawaii taxes are being withheld from their wages. Yes, they are paying workers' comp at the same rate as other Hawaii employers of the same size and risk factor. And they are making unemployment contributions into our state funds because foreign trade zones and customs bonded warehouses are not federal enclaves. Now, for a while, our state Department of Taxation got the two confused. They thought, yes, sounds like a federal enclave, so we're going to rule that our taxes don't apply. And they did. I think it was in the 70s, 80s timeframe. They did issue rulings. Then guess what happened in 2021? I'm going to pass on that guess and let you tell us what happened. They had an epiphany. Eureka foreign trade zones are not federal enclaves. And we need the money. And we need the money. So they went after vendors of businesses that did business in the foreign trade zone. Like, you know, if you had a contractor come in to fix the plumbing, or if you had an electrician come in, or if you were a little shy and people needed a payroll service, or get some temporary workers. That sounds completely reasonable to me. Yeah. And the question then becomes, do Hawaii laws apply in the foreign trade zones to that extent because you're not dealing with the goods? Okay. And the answer is, well, yes, it does. Contrary to the department's previous understanding, they now came to the realization that foreign trade zones are not federal enclaves who taxes do apply. So they did what a typical tax agency would do. They sent letters to all the people they thought might be involved and said, give us back taxes for all open years. Oh, no. Oh, no, that's now that's not reasonable in the years. That's not reasonable. And that's not fair. Their epiphany should not permit them to do that. That's what they did. Okay. And a lot of businesses that have provided services to folks in the foreign trade zones are dealing with this issue now. Okay. So we can kind of think about, well, what should the remedy be when you have a tax agency that just makes a mistake? Because they do, you know, they're human, like anybody else. Why do you say it was a mistake? It's a change in policy, wasn't it? No, it's basically a conclusion of law. So the mistake was they should have taxed them before. That's correct. Okay. Yep. Foreign trade zones are not federal enclaves. They never were. And the rulings they gave up to the contrary, we're just wrong as a matter of federal law. Well, it's not as a matter of state law, because the tax we're talking about is state tax. That's true. But the federal law question is whether the state of the state tax law is preemptive and whether it overrides the state law. If it were if a state did not want to collect state tax on a foreign trade zone, it doesn't have to. The federal government is not requiring it to do that. They could legally exempt activity within the foreign trade zone. No problem, right? Yeah, yeah, but they didn't. Yeah. It's their own mistake. It's a mistake. It was a matter of policy kind of mistake. Anyway, I feel that looking at retroactive taxation here is really wrong. But that's what they're doing. I mean, and the question it becomes, okay, when the tax agency makes a mistake. Okay, you keep calling it that. Well, we will assume for purposes of the argument that it was a mistake. Okay. Who bears the consequences of the mistake? Is it the taxpayer who got the unusually favorable ruling or to the expense of the all the people in the state of Hawaii or the other way around? I think the tax for a given period of time, the tax office has to live with its own ruling. I say that the tax office has to live with its own ruling. And if it said it wasn't collecting the tax, it said it wasn't imposing the tax, then no tax. And if that means that the taxpayers of the state have to pay a little more to cover it up and not cover it up, but make it up, then that's the way it is. And there are other examples of the same sort of thing where the tax office has decided not to impose a tax in a given situation. Okay, it made a ruling, finished. Well, but there's a Supreme Court president that goes the other way. What is that president? Go ahead. It's I think American automobile association versus commissioner. It's a US Supreme Court case involving the IRS. IRS had given an organization a ruling saying that it was a tax exempt organization. A few years later, it realized that it made a mistake. It revoked the exemption and said, please give us back taxes. And the company not surprising, we said, this is unfair. And the case one of the Supreme Court and this and the Supreme Court said, it's fair. That's different. I would distinguish that here. This was a ruling covering the foreign trade zone. This was a ruling saying that these contractors and the like could come in and operate without having to pay state tax. Okay, if there was a mistake, it was a conceptual mistake. If there was a mistake, it was a policy decision that they didn't have to make, but they did make and it applied across the board, not to one company or in that case, nonprofit, but to everybody who did business in the facility. The Supreme Court case you talked about involved one company. And I think that that is a true mistake. If you want to use the term mistake, and it differs. There are also Hawaii Supreme Court cases, a couple of them, basically saying, and we can debate the wisdom of this, but what they hold is that if a state worker does something to impede the sovereign taxing power of the state, basically the department is given a get out of jail free card. This happened in the Travelocity litigation with the out of state sellers of tour packages. You know, the Expedia's and Travelocities of the world. They entered into a settlement with the department on hotel rooms. They signed off. They stipulated it to judgment. And then and the state comes back and was, okay, here's round two. Round two is car rentals. And the defendant company said, what? We stipulated to judgment for all of these years. And you're coming after us again. And the Supreme Court said that's okay. Our Supreme Court said that's okay. If somebody signed the stipulated judgments and then was a mistake, we're going to let the state get out of it because that's that was an abridgment of the taxing part of the state. And that shouldn't be allowed just because somebody, you know, screwed up on a couple of documents. I suppose there are other states where the same kind of ruling was handled that handed down, but it strikes me as bad law. If I'm in court, you've been, you know, in this situation, if I'm in court and I'm litigating some issue, and I'm in front of a settlement judge and we argue and we and we take our positions and finally this is involving one one client, so to speak, one specific company involved in that litigation. And we make a deal and we rely to our detriment on that deal. And we either pay money or we in some other way rely on it. I think the state should be bound by that. Yeah, I have a case involving that very issue right now. And of course that's What position do you take? Are you taking? The state's bound to the deal. Should be. Yeah. You can't change their minds. You know, I mean, people went through a lot of aggravation to get to the settlement. You can't undo a settlement because you had a change of mind. You're locked in as far as I can see. I don't know why the state should have any any rights to get out of a settlement beyond the rights of individual parties. They're locked in. Yeah, but apparently the Supreme Court takes differently. So bad law. That's what we have to deal with. Yeah, bad law. Sorry. Not all presidents are correct, as you know. But they are presidents. So we just have to know that they're there and then deal with them. Yeah. Okay. All right. So where are we going with this federal trade zone? So people are unhappy because the state changed its policy. As I said before, I don't think that's unreasonable, but I do think it's unreasonable making it retroactive for all open years. That sounds really unfair to me, particularly because there were rulings. They have the force of law, those rulings, saying this was okay to change the rulings effectively is what they're doing retroactively. These people were doing tax planning in all those years and relying on the rulings. It's the same thing. It's bad law. Right. So maybe it's time for the legislature to do something about it. I mean, they obviously can and perhaps they should. Yeah. We have to do better. And actually, the Supreme Court has to do better. I mean, arguably a lawyer representing one of those contracting companies takes it up and he says, gentlemen, this is bad law. How about changing the president? I know that's a burden, right? Not likely to succeed. Still, somebody had to raise these points of consideration. I mean, and the points, the policy points to me are you have to have confidence in government. You can't enter into a deal and then have the other guy back out when he feels it's to his interest. We need to have... That's the Darth Vader theory of government, right? Right. We do what we like. If you don't like it, you know... I am afraid that I do not alter it further. Well, I hate to see this happening because I don't think this is good for the state. If I'm on Wall Street, right? And I hear about this kind of, we're backing out of a tax ruling. I say to myself, what kind of banana republic are we talking about here, backing out of a tax ruling? Hawaii shouldn't have a reputation like that. It already has a reputation on the regulatory side for it to also have a reputation like that on the tax side. It's not good for our relationship with investors all around the world. The problem with investment in Hawaii, Tom, is that when you step in something and you have a precedent or a ruling or even a point of legislation that dumps on the investor from Wall Street or anywhere else in the world, you A, you have that investor, he's unhappy or she or it, but you never know how many other people hear about this and say to themselves in the privacy of their private clubs, we're never going to invest in Hawaii. Hawaii, it backs up, backs out on its agreements. You never know how many deals you lost. One of the things that's important in the investing community as with everywhere else is credibility. And if you give your word as a state, you should be held to it. So, I mean, yeah, fundamental mistakes or whatever it is. I think the tax office is doing what its mission is. I mean, it's unfair, but it's doing whatever it can to collect the revenue, which is what their job is. And so it's, I think, up to the legislature to kind of reel them in and say, okay, folks, you got to be reasonable here. You guys gave your word and we got to keep it for the benefit of the state. Yeah, but I think the magic word here that overrides all of this is 20, which you said this happened this year, 2021. And that means COVID. That means COVID. And I think people responsible for the public fisk see the state under great pressure. They see this as a financial emergency and it is. And the question is how do we deal with financial emergencies? I mean, granted, it's a financial emergency. It really is. How do we deal with that? This got to be another way. Politically, it's risky to raise taxes, raise the rate of taxes, any kind of tax. You always get pushed back on that politically. And maybe if you're the champion of such a bill, you don't get reelected and so forth. But that's the way that you have to, in my view, the way you deal with an emergency. You don't do this. This is different. And so I can understand why any tax office would want to do this retroactive number because they see it as a source of revenue. And it is, theoretically. And maybe you're into some precedence. It is, but it's not good for us. This has got to be a better way to raise money. Right. And even our laws give the department discretion to specify whether or not rulings are going to have retroactive effect. And if so, how much? And I think this is a good case that discretion should be exercised with a line towards not making taxpayers sort of too unlimited damage. Right. It's damaging. It's damaging to business is what it is. You haven't prepared, you haven't budgeted this, and all of a sudden bang, out of nowhere. Anyway, are you finished with your discussion? Yes. All right. Then I'm going to tell you a story. In my first year of law school, I had this teacher whose name I remember right down to the middle initial. His name was Gerhardt, O.W. Muller. It was German, teaching it at my law school. And he said, the answer to all of these interpretation questions and repealed questions and so forth is that the agency that develops the statute or the rule has to go further. At the end, where it says effective date, you have to say something more. You have to say, you know, on this one, gentlemen, we really mean it. That's what you got to say. And if you really, really mean it, then just before the effective date, you should say, we really, really mean it. And that will tell future generations just how ardent you are about this law or regulation. What do you think, Tom? Well, but that means every law is going to say, and we really, really, really mean it. You're trying to tell me it's implied anyway. So, so query, you know, whether there's this ruling, you know, would have been better if they said, you know, we really made it this time would that have helped? Lord only knows, Lord only knows. I'm Yamachika, President Tax Foundation of Hawaii. Thank you so much for joining us on your show. Thank you for having me on your show. Aloha. Happy Christmas.