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The Honolulu Advertiser
Posted on: Tuesday, December 31, 2002

Controversy still dogs Act 221 on last day for 2002 investments

By John Duchemin
Advertiser Staff Writer

Hawai'i technology on public radio
Hear The Advertiser's John Duchemin and the latest Hawai'i technology news every Wednesday on Think Tech Hawai'i, 5 to 6 p.m., on HawaiÎi Public Radio KIPO FM 89.3, with hosts Jay Fidell and Gordon Bruce.

TOMORROW: Holiday programming. Think Tech Hawai'i returns to the air Jan. 9.

Rich investors, get out your checkbooks.

It's the last day of 2002, which means it's the last day you can invest in a Hawai'i technology company and apply that money as a credit against this year's state tax bill, thanks to the tax incentive known as Act 221. You'll get 100 percent of your money back over five years in Act 221 refund checks. And you'll hang onto your equity in these promising companies until one of them goes public and you cash out with a 700 percent profit.

OK, that's how Act 221 is supposed to work. It's not proving so easy.

The days after Christmas and before Jan. 1 are supposed to be the busiest of the year for promising Hawai'i technology companies, many of which, armed with the groundbreaking act, have been trying for months to secure multimillion-dollar venture commitments from local and Mainland investors.

Investors are prone to wait until the year's waning hours to invest because they are guaranteed "instant cash back" — the state Department of Taxation will mail refund checks in January for any qualified Act 221 investment made in 2002.

That happened last year. A handful of startups secured about $10 million at the very end of 2001.

But several insiders say the 2002 financing climate is much worse — and the culprit is Act 221 itself. In the past year, fundamental flaws in the act's structure and interpretation have been exposed.

First the movie "Blue Crush" drew unkind attention after investors convinced the state Department of Taxation to grant them "qualified high-technology business" status and reaped at least $18 million in tax credits.

Performing arts businesses are allowed to qualify under the act's extremely broad language. But tech companies cried foul over "Blue Crush" and subsequent 221-qualifying movies, saying that financing one-shot productions was not the intent of the act.

More importantly, tech company officials said, local investors with big Hawai'i tax liabilities were being drawn away from small-scale tech deals by the get-rich-quick allure of movie deals. Mainland film studios have proven willing to "sell" Act 221 tax credits in enormous quantities — the $18 million in "Blue Crush" credits, for example, was more than double the amount raised by tech companies in 2001. As interest from film studios increased, Mainland high-tech venture capitalists had problems finding local partners to buy their relatively small tax credits at a reasonable price.

Then, during this fall's election campaigns, further unhappiness with Act 221 arose. Critics in the government and private sector grumbled that investors were trying to manipulate the law — requiring extraordinary high profits from the purchase of tax credits and setting up spurious companies to reap gains.

These reports have yet to be substantiated. But venture capitalists are correctly afraid that perceptions of abuse could cast a shadow over all Act 221 activities, especially since the act's language doesn't provide many safeguards.

The act requires the Tax Department to construe its language "as liberally as possible" — a huge hole that means the entire regulatory burden is on the back end, as the already understaffed department is forced to chase down abusers. Further, "tightening" language is unlikely to emerge from the Legislature or new Gov. Linda Lingle, as the governor and elected officials such as House Speaker Calvin Say and Democratic Rep. Brian Schatz proclaim their support for leaving the act unamended.

So this leaves Hawai'i's legitimate tech companies with one day left to raise money in 2002 — but struggling to do so under a cloud of concerns.

Act 221 proponents argue that the incentive's positives far outweigh the negatives. If enough investors commit financing to Hawai'i's best startup technology companies, they will be vindicated.

But we won't know for sure until next year.

Reach John Duchemin at 525-8062 or jduchemin@honoluluadvertiser.com.