Business praises tax-break guidelines
By John Duchemin and Sean Hao
Advertiser Staff Writers
The state government's decision to impose rules on the controversial tax incentive known as Act 221 was welcomed by both the technology community and lawmakers who for months have debated whether the law was vulnerable to abuse.
The state Department of Taxation issued preliminary guidelines on Monday that tightened its interpretation of Act 221, a law passed in 2001 that lets investors in high-tech companies claim tax credits worth more than 100 percent of their investments.
The law has generated tens of millions of dollars in investments in Hawai'i companies, but critics have claimed that not only is the law worded too broadly, but that the tax department has been too loose in its regulation.
More than 120 businesses have sought to qualify for the tax credits, according to the tax department, and in 2001 the law generated more than $46 million in investments — including a $16 million injection into movie production "Blue Crush," which critics said was a one-time venture that did little to help the state's economy.
In its guidelines, the tax department banned certain types of transactions it deemed "potentially abusive" and promised to subject Act 221 claimants to a more thorough review.
The guidelines are a welcome step toward clarifying the act, several members of the technology community said.
"This is progress," said venture capitalist Barry Weinman, managing partner of Palo Alto, Calif., firm Allegis Capital. "For the first time, the government seems to recognize it's got to do something about this."
Leaders of high-tech Hawai'i, which consists of a small group of start-up companies in several fields, have broadly supported the idea of a tax incentive to help stimulate investments and interest. But opinions are split over the effectiveness of Act 221. Some, including Weinman, want the law to be tightened, while others fear that major changes could scare away potential investors.
Widely sought, however, was greater direction from the tax department, which until Monday had not publicly indicated its stance on major Act 221 sticking points.
"In principle, it's a good thing to have clarity," said Jeff Au, managing partner of PacifiCap, a Honolulu venture capital firm with several million dollars invested in local companies.
Au, who has opposed changes to the language of the act, said he hopes the new rules will be interpreted in a way that keeps the substance of the law intact.
Act 221 allows a half-dozen forms of tax credits, which can be claimed by investors in high-tech companies or by the companies themselves. Not only does Act 221 let investors in a high-tech company claim up to 100 percent of their investment in the form of state tax credits, it allows co-investors to swap their credits for additional equity. In some scenarios, this means certain investors could end up with tax credits worth substantially more than the money they invested.
Given the tighter rules, lawmakers said Act 221 is unlikely to be amended this legislative session, which ends in May.
House Majority Whip Brian Schatz, D-25th (Makiki, Tantalus), said the tax department's stricter stance on Act 221 alleviates any need to rush through changes to the law.
Still, it may be necessary to amend the act to possibly remove a provision directing the tax department to interpret the law liberally, said Schatz, chairman of the House Committee on Economic Development and Business Concerns. Discussions on that issue would likely take place this summer.
"The business community, administration and the Legislature need to sit down and make sure we're all on the same page," Schatz said. "We want to make sure the tax credits produced are for real economic activity."
Among the state agencies that rely on Act 221 as a tool to diversify Hawai'i's economy is the Department of Business, Economic Development and Tourism. DBEDT Director Ted Liu said the new guidelines issued by the tax department won't hurt the ability of companies to use Act 221 to attract investment capital.
"Act 221 has not been substantially affected," he said. "I think it remains a very substantive support for the emerging sectors of our economy."
Liu was involved in Act 221 deals in his prior career with venture capital fund manager PacifiCap Group. He said none of those prior deals would have violated the new guidelines. He also rejected the idea that some people were abusing the tax credits, which the tax department said have been reportedly used in certain cases to finance projects with questionable long-term economic benefits and ties to technology.
"I'm not sure 'abuses' is the right word," Liu said. "There's been some aggressive applications."
Gov. Linda Lingle said she thinks lawyers, accountants and financial advisers are looking at existing laws and "seeing an opportunity to get a windfall for their clients."
"That's their job. But our job is to make certain that when we pass a tax credit, it meets its intended result," she said, which include investments in local, high-tech companies and creation of permanent jobs.
Lingle said she doesn't believe the tax department's changes will discourage legitimate use of the tax credit.
"It's the most generous tax credit in the nation, even after we make those changes," she said.
Advertiser Staff Writer Gordon Pang contributed to this report.
