New guidelines limit uses of Act 221 for tax credit

By Sean Hao
Advertiser Staff Writer

Facing mounting concerns about Act 221, the state tax department yesterday issued new guidelines that will narrow how Hawai'i's high-technology investment tax credit can be used and said specifically that it cannot be used to underwrite movie productions that "do not contribute to Hawai'i's economy on an ongoing basis."

In its first acknowledgement of questionable uses of the credits, the Department of Taxation said it would audit some of the claims submitted under Act 221, which was created in 2001 to attract investment in high-technology enterprises in Hawai'i.

While the law has been credited with attracting capital to the state, an unintended consequence has been its use by investors who have been able to write off millions pumped into projects such as the production of the movies "Blue Crush" and "The Big Bounce." Tax officials also have said the amounts being claimed by investors dramatically exceeded expectations, reducing the state's tax collections.

Interim Tax Director Kurt Kawafuchi said the department is firming up the rules for claiming the credit because of claims that violated the provision's intent to stimulate investment in technology businesses in the state.

Instead, Kawafuchi said credits in some cases are being claimed under complicated transactions designed specifically to avoid taxes rather than for legitimate business purposes.

Among the reported abuses cited by the tax department were:

• Tax credits for one-shot movie deals that don't create permanent jobs or contribute to the economy on an ongoing basis.
• Tax credits claimed for investments that are repaid for services rendered.
• Claims for tax credits based on related party transactions, such as receiving ownership in a company and getting a contract for services in exchange for the investment.

"Act 221 is very generous by design, but some investors have pushed it beyond what was intended," Kawafuchi said. "With the issuance of this release, we hope to eliminate any doubt in people's minds about whether Act 221 allows the kinds of abuses being reported. It does not."

Last week, the tax department disclosed that the act generated $46 million in income tax credits during its first year. Investors claim the tax credits over five years.

In addition to clarifying how Act 221 should be applied, the tax department is developing an audit designed to target "abusive" claims as well as forms requiring information from investors about the number of jobs created.

The department also plans to draft new rules governing how the act is applied. The process requires public hearings.

Marilyn Niwao, president of Niwao & Roberts Certified Public Accountants in Wailuku, Maui, said the tax department's announcement should help steer the credits toward their intended use.

"This is a step in the right direction as far as getting a handle on this law," she said.

Niwao was a member of the state tax commission that earlier this year criticized Act 221 as overly generous and lacking accountability. The state does not have figures on jobs, tax revenues or other benefits created by the credits.

Even under the clarifications announced yesterday, identifying which transactions qualify for the credits will remain a matter of discretion, Niwao said. The state should fix that by amending the law to specifically preclude certain types of investing schemes, she added.

"Then it's kind of black and white," Niwao said. "There's no two ways about it."

Reach Sean Hao at shao@honoluluadvertiser.com or 525-8093.