For more than five years, one of Hawai'i's largest financial institutions has battled the state over a series of tax bills totalling nearly $10 million.

Central Pacific Bank Inc. claims in appeals filed in state Tax Court that it should be allowed to claim a 70 percent tax deduction on dividend payments it receives from two subsidiary companies, CPB Real Estate and Citibank Properties, Inc.

At the heart of the dispute is a business entity called a Real Estate Investment Trust, or REIT, which enjoys certain tax benefits under federal and state tax laws. REITs themselves don't pay taxes on their earnings if they are paid out to shareholders in the form of dividends.

Separate sections of the federal and state tax codes allow corporations to claim tax deductions for dividends they receive, but the federal law excludes REIT dividend payments from this deduction.

In 2004, the tax department won a similar tax dispute with another local financial institution, American Savings Bank, and its parent company, Hawaiian Electric Industries Diversified Inc.

But that 2004 Tax Court decision was later appealed by HEI Diversified to the Hawai'i Supreme Court and the parties settled the case before the high court ruled on the matter.

Now the same issue is being argued again at the Tax Court level by Central Pacific Bank.

CPB — and Hawaiian Electric before it — argued that state tax does allow corporations to claim a 70 percent tax deduction on dividends it receives from REITS.

Not so, the attorney general's office argued in the Hawaiian Electric case.

"Dividends received by a corporation from a REIT are not deductible from a corporation's gross income," the state said.

HEI Diversified "improperly claimed the dividends received deduction to avoid Hawai'i income tax on $225 million in income it received from its majority-owned real estate investment trust," the attorney general's office argued.

HEI paid the amount in dispute, $16.5 million in taxes and interest, while litigating the issue.

Circuit Judge Gary W.B. Chang, who presides over Tax Court cases, ruled in favor of the state in June 2004.

Now, Central Pacific Bank is demanding refunds of state taxes and interest payments totalling $9,670,779.

The tax assessments are "based on an incorrect, illegal and erroneous interpretation" of state law, tax lawyer Miki Okumura has argued in a series of a tax appeal cases now pending before Judge Chang.

"The Department of Taxation erred in determining that appellants are not entitled under the facts and law to the 70 percent dividends-received deduction claimed for dividends received from Citibank Properties Inc. for each of the tax years in the dispute," Okumura argued.

Hugh Jones, supervising deputy attorney general for the tax department, said the issue in the CPB appeals is the same one already decided by Judge Chang in the earlier Hawaiian Electric case.

"We're waiting for a decision now from the judge," Jones said.

Okumura could not be reached for comment.

Reach Jim Dooley at jdooley@honoluluadvertiser.com.

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