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The Honolulu Advertiser
Posted on: Sunday, February 22, 2004

Insurers among investors that got Act 221 breaks

By Jim Dooley
Advertiser Staff Writer

Eleven Hawai'i insurance companies, including one closely tied to the state's two largest public employee unions, avoided paying $19 million in state taxes in 2001 and 2002 by investing in high technology ventures, including the "Blue Crush" teen surf movie.

The state won't identify the firms or reveal full details of their investments because of Tax Department secrecy laws now being questioned by some in Gov. Linda Lingle's administration and the state Legislature.

But government records, court documents and a local insurance executive identify the Royal State Insurance group of firms as a central player in a hui that invested in the Blue Crush production in 2001, generating millions in controversial state tax credits.

Repeated attempts to reach Royal State chief executive Melvin Higa for comment were unsuccessful. Russell Okata, head of the 40,000-member Hawaii Government Employees Association and chairman of the board of directors of Royal State Corp., declined to comment other than to say through a spokesman that he "had nothing to do with any Royal State business decisions regarding investments."

Documents contained in a state court lawsuit over distribution of the "Blue Crush" tax credits provide glimpses into the deals worked out in government and business circles over a bonanza of tax breaks available to Hawai'i investors under the 2001 law commonly called Act 221.

These details raise further questions about the public benefit of the tax credits, which cost the state's general fund $21.9 million in 2001 and are expected to cost $48.4 million this fiscal year and $76.7 million in fiscal 2005, according to state estimates.

The law says every dollar invested in qualifying high technology ventures, including film and television productions, can be used to reduce state tax obligations by $1. The tax credits are spread over a five-year period and are capped at $2 million per investment.

Proponents of Act 221 argue that the credits are a valuable economic tool for promoting business growth and creating new jobs in a state overly dependent on tourism and military dollars. Act 221 supporters also argue that disclosure of who benefits from the credits would be detrimental to the program.

State Rep. Brian Schatz said exposing the identities of investors receiving Act 221 tax credits could discourage further investment.

"I just don't see the need to know the name. I need to know the numbers," he said. "I think there are some legitimate reasons that certain investors wouldn't want their names out there, and it's not simply a matter of them wanting to hide."

Critics say the credits are overly generous, have failed to produce tangible economic benefits for the state and have been shrouded in secrecy preventing public accountability.

State Sen. Colleen Hanabusa, D-21st (Nanakuli, Makaha), who opposed passage of Act 221, said she was "stunned and fascinated" by the identification of union-affiliated Royal State as a "Blue Crush" investor.

"That's the kind of information the public should have," she said. "I believe if you receive a tax credit from the state of Hawai'i then Hawai'i taxpayers should know who you are."

Lowell Kalapa of the Hawaii Tax Foundation, said it was ironic that Royal State Insurance, with its connections to Hawai'i's public worker unions, is reducing its state taxes by investing in a venture like the "Blue Crush" film.

Public workers are paid from state tax collections. "It's like these guys are sucking their own well dry," Kalapa said.

The identities of some of the "Blue Crush" investors are contained in an Act 221 tax credit lawsuit filed in 2002 by April Masini, a film and television industry figure active in Hollywood and Hawai'i, against the prominent Hawai'i law firm Cades Schutte Fleming & Wright and a partner in the firm, Vito Galati, who had helped draw in investors for "Blue Crush."

(The firm regularly provides legal representation to The Advertiser but was not involved in the preparation or review of this story.)

Masini claims that she was wrongfully denied "Blue Crush"-generated tax credits after she worked in 2001 to convince Universal Studios to film the movie in Hawai'i.

Masini said she worked with Gov. Ben Cayetano and his high technology adviser, Joseph Blanco, to obtain tax credit approvals for the project and searched for local investors willing to put money into the production.

The law firm and Galati deny any wrongdoing.

Masini said in her suit that she helped pitch the movie tax credit proposal to Hawai'i land-holding giant Damon Estate and two local banks with "high net worth clients" who would be interested in substantially reducing their state taxes.

In one proposal, heirs of the Damon Estate, which at the time owned more than 116,000 acres of property on O'ahu and the Big Island and 13 percent of First Hawaiian Bank, were to receive $11.2 million in tax credits after investing $8.5 million in the "Blue Crush" production, according to court records.

Making a profit in tax credits is one of the controversial aspects of Act 221. The law allows out-of-state investors, who don't need Hawai'i tax credits, to give, sell or otherwise transfer their credits to Hawai'i taxpayers.

The law also may have created an underground market in the secrecy-shrouded credits, according to paperwork filed in the Masini suit.

The proposal to Damon Estate contained a provision that Masini and a Mainland partner had the right to purchase tax credits from the estate "for resale to third parties."

Masini's lawsuit said the estate and banks eventually turned down the "Blue Crush" proposal and the ultimate investors were "insurance companies" brought in by Galati, the Cades law firm partner.

The insurance companies are not identified in the court case because of state tax laws prohibiting public release of "taxpayer information," according to paperwork filed by Masini's lawyer, Philip Brown.

However, the Masini suit does list a number of local insurance companies and executives as witnesses to be called — if and when the case goes to trial. A trial date has been tentatively set for next year.

Companies identified

Among the witnesses listed by both the plaintiff and defendants in the suit are executives of four Royal State-affiliated companies, including the Performing Arts Investors and Royal Management that were formed in mid-December 2001 when the Blue Crush investment was being finalized.

According to state business records, HGEA's Okata was chairman of the board of Royal State at the time the Blue Crush investments were made.

Royal State is listed as the parent company of Royal State Investment Corp., which in turn is listed as the agent for Performing Arts Investors and Royal Management.

Also on the Royal State board with Okata at the time of the "Blue Crush" investment was Gary Rodrigues, then head of the 12,000-member United Public Workers Union, which represents mostly blue-collar state and county employees.

Rodrigues was sentenced last year to more than five years in federal prison in a union fraud and embezzlement case that involved Royal State and a related firm called Voluntary Employees Benefit Association of Hawaii. Both Rodrigues and HGEA's Okata were on the board of trustees of VEBAH.

Rodrigues is no longer affiliated with UPW. Acting union administrator Liz Ho could not be reached for comment.

Another local insurance company executive listed as a witness in the case is Colbert Matsumoto, chief executive of Island Insurance Co. Ltd. Matsumoto wouldn't discuss many details of his company's investments, but acknowledged that Island Insurance has made "several investments" in high technology ventures, including the "Blue Crush" production.

Matsumoto said "an investment entity" was formed to receive money from various insurance companies for the "Blue Crush" venture. Asked if the investment entity was Performing Arts Investors, the limited liability company operating from Royal State Corp.'s Beretania Street offices, Matsumoto said: "That sounds right."

Other executives of insurance companies listed as witnesses in the Masini suit did not respond to repeated requests for comment on "Blue Crush" investments.

The companies include Zephyr Insurance, supplier of much of the hurricane insurance coverage written in Hawai'i, Pacific Guardian Life Insurance, and DTRIC Insurance. Royal State owns a partial interest in the DTRIC insurance business in Hawai'i, according to state business records.

First Insurance Co. of Hawaii was invited to participate in the "Blue Crush" venture but declined, said company spokesman Steve Tabussi.

"We had a look at the proposal," Tabussi said. "It didn't fit our investment needs."

According to figures compiled by state Insurance Commissioner J.P Schmidt, some local insurance companies quickly took advantage of Act 221 tax credits.

A chart prepared by Schmidt for The Advertiser shows nine insurance companies claimed $6 million in Act 221 tax credits in 2001, the first year the credits were available. The following year, 11 companies reduced their state taxes by $13 million using the credits, a 117 percent increase.

Schmidt said he couldn't reveal the names of the companies because of Tax Department confidentiality laws. But the numbers make clear that some insurance companies made multiple Act 221 investments or acquired extra credits from other sources in 2001-2002.

Under an annual percentage formula set in Act 221, the maximum allowable tax credit per investment each year is $700,000. But three companies claimed between $890,000 and $1.3 million in credits for the 2001 tax year, showing that they invested in more than one project or bought or otherwise acquired additional credits from other sources.

In 2002, two insurers reduced their state tax bills by more than $2 million each and another three companies avoided more than $1 million in state taxes apiece through Act 221 investments.

Changes to law sought

The state Tax Review Commission, which reviews state tax policies every five years, has called for changes to Act 221.

In a report last year, the commission said: "Every business receiving $2 million in high-tech investment (credits) should report back to the Legislature to justify the investment costs upon which the credit is based, account for all the credits taken, and demonstrate that the cost-benefit has been achieved."

Kalapa of the Hawaii Tax Foundation said Act 221 credits have left the public with little means of judging their effectiveness.

"We're all left to wonder if jobs are being created. We don't know who's getting the credits so there's no real way to measure the economic benefits," he said.

State Tax Director Kurt Kawafuchi said his department is still studying the economic effects of Act 221 and audits of companies that claimed the tax credits in 2001 to 2002 may be under way.

But the law says that Act 221's provisions must be "liberally construed" by the tax department. Even if audits determine that tax credits were improperly received by Act 221 investors, the law says only 10 percent of previously awarded credits can be "recaptured" by the state.

Information about any recaptures would be confidential, according to Kawafuchi.

Bills to tighten Act 221 eligibility criteria and extend the program another five years beyond its present 2005 expiration date are pending at the Legislature. Provisions that would publicly identify tax-credit recipients have been dropped from the measures.

Ted Liu, director of the state Department of Business, Economic Development and Tourism favors disclosure. "Sunshine is the best disinfectant," Liu said. Tax Director Kawafuchi, however, said he sees good arguments on both sides of the secrecy issue and is looking for a "middle ground" solution.

Reach Jim Dooley at jdooley@honoluluadvertiser.com or 535-2447.

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