Subway Real Est. Corp. v. Dir. of Taxation

• Decision Date: 28 February 2006
• Docket Number: No. 26488.,26488.
• Citation: 129 P.3d 528
• Parties: In the Matter of the TAX APPEAL OF SUBWAY REAL ESTATE CORP., Taxpayer-Appellee/Cross-Appellant v. DIRECTOR OF TAXATION, STATE OF HAWAI`I, Appellant/Cross-Appellee.
• Court: Hawaii Supreme Court

129 P.3d 528

In the Matter of the TAX APPEAL OF SUBWAY REAL ESTATE CORP., Taxpayer-Appellee/Cross-Appellant v. DIRECTOR OF TAXATION, STATE OF HAWAI`I, Appellant/Cross-Appellee.

No. 26488.

Supreme Court of Hawai`i.

February 28, 2006.

Hugh R. Jones and Damien A. Elefante, Deputy Attorneys General, State of Hawai`i, on the briefs, for appellant/cross-appellee.

Miki Okumura, Lindalee K. Farm, and Donna H. Kalama (Goodsill Anderson Quinn & Stifel), Honolulu, on the briefs, for taxpayer-appellee/cross-appellant.

MOON, C.J., LEVINSON, NAKAYAMA, ACOBA, and DUFFY, JJ.

Opinion of the Court by ACOBA, J.

We hold in this appeal by Appellant-Cross-Appellee Director of Taxation, State of Hawai`i (the Director) from the March 9, 2004 final judgment of the Tax Appeal Court (the court)<sup>1</sup> that (1) the rule of strict construction of statutes does not apply in this case to Hawai`i Revised Statutes (HRS) § 237-2 (2001 Repl.);² (2) the Director's assessment of Hawai`i general excise taxes (GET) on the subleasing activities of Taxpayer-Appellee-Cross Appellant Subway Real Estate Corp. (Taxpayer) was proper inasmuch as (a) Taxpayer gained or economically benefitted under HRS § 237-2 from said activities, and (b) the substance-over-form doctrine enunciated in In re Tax Appeal of Hawaiian Tel. Co., 57 Haw. 477, 559 P.2d 283 (1977), does not apply to the present case; and (3) the reimbursement provisions of HRS § 237-20 (2001 Repl.)³ do not apply to the present case. Because the court ruled to the contrary as to Taxpayer's GET liability for its subleasing activities, we vacate the court's March 9, 2004 final judgment, and remand with instructions to enter judgment in favor of the Director. With regard to Taxpayer's cross-appeal, we hold the record is insufficient to resolve Taxpayer's GET liability for services. Therefore we also remand to the court for a determination of Taxpayer's GET liability, if any, for services.

I.

A.

Doctor's Associates, Inc. (DAI) is the franchisor of Subway Sandwich shops throughout the United States. According to Taxpayer, Franchise Real Estate Leasing Corporation (FRELC), is an "affiliate" of DAI, and negotiates the master leases and subleases for the locations of the Subway shops on behalf of DAI, the prospective franchisees, and two other companies, Subway Restaurants, Inc. and Subway Sandwich Shops Inc., both nominal holders of certain leases and subleases. Taxpayer, a Delaware corporation, states that, as an affiliate of DAI and a wholly-owned subsidiary of FRELC, it is responsible for signing and maintaining the leases and subleases for each Subway Sandwich shop in the United States. As of December 31, 1991, thirty-nine Subway Sandwich shops were in operation in Hawai`i.

In its Franchise Offering Circular (circular) DAI lists Taxpayer as a corporation that may act as a sublessor of restaurant premises, states that Taxpayer is empowered to terminate the subleases and to require the franchisee to vacate the premises through legal action, and may be involved in litigation in various jurisdictions with respect to certain leases and subleases. In order to establish a Subway Sandwich shop, a franchisee must sign the "Franchise Agreement" (the agreement) with DAI. The pertinent provisions in the agreement relating to Taxpayer's subleasing activities (1) oblige the franchisee to sublease property from Taxpayer; (2) permit Taxpayer to charge the franchisee a higher rent for portions of the property that are not used as a Subway Sandwich shop; and (3) direct the franchisee to indemnify Taxpayer for acts of negligence or fault.

Taxpayer directly leases real property from a landlord through a master lease agreement (lease agreement). Taxpayer then subleases the real property through a sublease agreement to a franchisee to establish a shop. Under the sublease agreement, all sublease rent is paid directly by the franchisee to the landlord rather than to Taxpayer. Section twenty-eight of the lease agreement, entitled "Limitation of Liability of Persons and Entities Affiliated With Tenant," stated that "Landlord recognizes and acknowledges that the [Taxpayer] is a Delaware corporation and that [Taxpayer's] assets consist almost exclusively of leases, subleases, and options to purchase leased premises." Although Taxpayer states that FRELC is responsible for negotiating the leases and subleases, the lease agreement provides that Taxpayer was in the business of "negotiating and drafting leases with a view towards subletting the leased premises to franchisees [or] licensees of [DAI]." (Boldfaced font omitted.)

B.

On November 28, 1998, pursuant to HRS § 237-13(10),⁴ the Director assessed Taxpayer for GET, interest, and penalties in the total amount of $26,805.47 as unreported income arising from Taxpayer's 1992 subleasing activity. According to the Director, the amount assessed was based on four percent of the "gross income" at the rate indicated in the leases and subleases. Taxpayer appealed the assessment to the Board of Review, First Taxation District (Board of Review).

On January 14, 1999, the Board of Review upheld that tax assessment in the amount of $23,092.80 and waived the penalty of $3,712.67. On February 2, 2000, Taxpayer appealed the Board of Review's decision to the court.

On August 10, 2000, Taxpayer moved for summary judgment, arguing that its subleasing activity in Hawai`i was not subject to the GET because (1) there was no object of gain or economic benefit; (2) it did not receive any fee or other consideration; and (3) Taxpayer's primary purpose was to sign leases and subleases for all franchise properties in the United States and nothing else. Alternately, Taxpayer argued, if it was engaged in a business activity subject to the GET, the gross receipts were exempt under HRS § 237-20.⁵

On the same date, the Director moved for summary judgment asserting that Taxpayer's subleasing activity is subject to the GET under HRS §§ 237-13 and 237-2.⁶

On August 28, 2000, during the hearing on the motions for summary judgment, the court indicated that the GET should have been assessed based on the value of services instead of the value of the lease rent amounts.

On October 12, 2000, the court entered two orders. One order granted in part and denied in part the Director's motion for summary judgment as follows:

(1) [T]he Director's Motion for Summary Judgment is GRANTED IN PART with respect to the Director's power to assess [GET] against Taxpayer based upon the value of any services that Taxpayer provided. . . ; and (2) the Director's Motion for Summary Judgment is DENIED IN PART with respect to the Director's assessment of [GET] against Taxpayer based upon the sublease income.

(Some capitalization omitted.) The other order granted in part and denied in part Taxpayer's motion for summary judgment:

(1) [Taxpayer's] Motion for Summary Judgment is granted in part, to the extent that the [Director's] assessment of [GET] based upon the sublease income was not proper, and (2) [Taxpayer's] Motion for Summary Judgment is denied in part, to the extent that . . . the [Director] has the power to assess [GET] against [Taxpayer] based upon the value of services, if any, provided by [Taxpayer].

On October 23, 2000, the Director moved for reconsideration of the court's two orders issued on October 12, 2000.

On April 25, 2001, Taxpayer moved for summary judgment arguing that under In re C. Brewer, 65 Haw. 240, 649 P.2d 1155 (1982), the value of any services provided was no more than $6875.00 and not taxable because the services were performed outside of Hawai`i. The Director opposed the motion, arguing that the facts and evidence did not support Taxpayer's position on the value of services provided and the location of the services performed.

On November 8, 2001, the parties entered into and filed a stipulation. The pertinent parts of the stipulation state as follows:

[F]or the purpose of agreeing on factual issues that remain in controversy, [the parties] stipulate as follows:

1. On October 12, 2000, this [c]ourt entered its Order Granting in Part and Denying in Part [Taxpayer's] Motion for Summary Judgment Filed August 10, 2000 and its Order Granting in Part and Denying in Part [Director's] Motion for Summary Judgment, both of which provide that the Director's assessment of [GET] based upon sublease income was not proper, but that the Director has the power to assess [GET] against [Taxpayer] based upon the value of services, if any, provided by [Taxpayer] pursuant to the Hawaii Supreme Court's decision in [In re C. Brewer];

2. At a hearing held on September 24, 2001, this [c]ourt denied [Taxpayer's] Motion for Summary Judgment Filed April 25, 2001, on the basis that the proper measure of the value of services provided by [Taxpayer] pursuant to the Brewer case might by an issue remaining in dispute. An Order has been lodged with this [c]ourt.

3. For purposes of [Taxpayer's] 1992 tax year, and that tax year alone, [Taxpayer] and the Director stipulate that the value accruing from any benefit conferred by [Taxpayer] on [DAI] was $10,875, although no cost consideration therefore [sic] was received by [Taxpayer].

4. [Taxpayer] does not admit or concede that any services or benefit accruing to DAI were provided or performed by [Taxpayer] within the State of Hawaii.

5. This stipulation is not an admission or concession by the Director that the lease rent paid by DAI's franchisees to the landlord under any master lease agreement executed by [Taxpayer] as the lessee in 1992 was not subject to [GET] as gross income to [Taxpayer], nor an admission or concession by [Taxpayer] that [Taxpayer] earned or otherwise received any rental income taxable to [Taxpayer].

(Emphases added.)

On November 27, 2001, the court denied Taxpayer's motion for summary judgment filed April 25, 2001. On the same date, the court denied the Director's motion for reconsideration filed October 23, 2000.

On December 7, 2001, Taxpayer moved...