Posted on: Friday, May 30, 2003

State audits questionable claims for tech tax credits

By Sean Hao
Advertiser Staff Writer

About $10 million — or more than two-thirds — of all research tax credits claimed in Act 221's first year went to non-technology companies, the state's tax department director said yesterday.

Started in 2001, the tax credit program was designed to boost Hawai'i's fledgling high-tech industry. Instead, nearly 69 percent of an estimated $14.5 million in tax credits claimed for research expenses went to nonprofits, tour operators, travel agencies, financial institutions and other non-high tech companies, said Kurt Kawafuchi, director of the Department of Taxation.

"I don't think that that was the law's intent," he said, speaking before a Small Business Hawaii gathering at Ala Moana Center.

After the meeting, Kawafuchi said the department is auditing several suspicious Act 221 claims and sending letters to other companies seeking research tax credits. Even more audits and inquiries could be forthcoming, he said, and cautioned that some questionable claims ultimately may prove legitimate.

The department's ongoing probe into Act 221 tax credits claimed in 2001 returns follows Gov. Linda Lingle administration's unsuccessful attempt to scale-back the 20 percent, refundable tax credit for research and development expenses.

Citing abuses and the unexpectedly large cost of the program, Lingle called for a tightening of the law, but lawmakers rejected her proposals. Supporters said the tax credits are serving their purpose and should be allowed to work as intended.

Although state law prevents disclosure of tax return data for particular individuals and companies seeking the research credits, Kawafuchi said, "If I could tell you the names of those claiming it and how much, you'd be shocked.

"Most of these (refund) checks are for $500,000 to $1 million," Kawafuchi said.

Kawafuchi could not say when the Act 221 inquiry would be completed. "Obviously as more time goes by, we'll have more data," he said.

Earlier this month, the tax department blamed credits such as Act 221 for a drop in April tax collections. Individual income tax collections declined by 56.3 percent or $68.5 million compared with the same period last year and corporate income taxes fell by 36.9 percent or $6.1 million.

Kawafuchi acknowledged that factors other than Act 221 credits also affected April tax collections, including the department's inability to process 2002 tax returns in a timely manner. He also conceded that much of the shortfall attributable to tax credits could be traced to a spike in the 4 percent home construction and remodeling tax credit, not Act 221.

That residential construction and remodeling credit, scheduled to expire July 1, is having an unexpectedly large effect on state revenues. Earlier this month, the Council on Revenues raised its estimate for the cost of the residential tax credit from $40 million to $60 million for the current fiscal year.

At the same time, the council slightly raised its estimate of Act 221 tax credits from $45 million to $48.4 million. Overall, the tax credits mean the state will have millions less this fiscal year to pay for government operations than originally estimated.

Kawafuchi said the administration has focused its efforts on changing Act 221 rather than the residential tax credit because the latter expires this summer. The technology tax credits don't sunset until the end of 2005.

Lingle wants to tighten the research tax credit law so that the credits are no longer refundable, meaning a company could not get a refund if it pays no taxes, which is allowed now. The administration also wants the credit applied only to increases in research expenses rather than to a company's entire research budget.

The state could save $55 million over two years if the proposed changes are implemented, the governor estimates.

Representatives of the state's technology industry feel Act 221 has been unfairly singled out for the state's flagging revenues, especially in light of the revised figures on the effect of residential tax credits.

"They talk about unintended consequences. Well, (the residential tax credit) really is something far more utilized than people expected," said Ann Chung, executive director of the Hawai'i Technology Trade Association.

Chung's group along with the Hawai'i Venture Capital Association are calling on the tax department to release more data on the effects of tax credits. And they also want to know more about how the council generates its forecasts.

The Hawai'i Venture Capital Association made such a request through the Office of Information Practices earlier this month and was still awaiting a reply yesterday.

Kawafuchi also told the small business group that state tax collections are rebounding this month after the sharp drop in April and discussed efforts to collect on $303 million in overdue state tax payments, penalties and interest.

He said Lingle is expected to sign a bill that would allow the department to offer settlements to delinquent taxpayers. Senate Bill 1400 would let the department arrange payments of $50,000 or less without the governor's approval.

The collection effort is significant because what the state is due stood at $303 million at the end of fiscal 2002. The amount is up significantly from $236 million at the end of fiscal 2001, an increase Kawafuchi attributed to the sluggish economy and events of Sept. 11, 2001.