$20M in Act 221 tax credits audited by state

By Sean Hao
Advertiser Staff Writer

The Act 221 tax credits were designed to encourage investment in technology-related companies and have been credited with creating 600 technology jobs in 2002. However, some of the credits were used to write off millions of dollars pumped into projects that did not create permanent jobs, such as movie and TV productions.

To ensure that the credits are not abused, the state Department of Taxation is auditing 23 taxpayers that claimed a total of $19.95 million worth of credits, according to a response to The Advertiser's request for records under the state's Uniform Information Practices Act. Any potential misuse of tax credits would come at a time when the state is strapped for money to pay for raises for state workers, upgrade its education system and maintain roads.

"We've had cases where we don't think they're entitled to the claim," said tax Director Kurt Kawafuchi. "We've had cases where people have made a claim and we go in and audit and they reduce the figure."

This year state lawmakers passed a bill to extend the program through 2010, but removed a provision that the act be "liberally" construed by tax officials and tightened the granting of credits in other ways. The bill is awaiting Gov. Linda Lingle's signature.

The stricter qualifications would save the state an estimated $65.4 million over the next two years, according to the Department of Taxation. However, those changes won't take effect until July 1. Act 221 is expected to cost the state $48.4 million in fiscal 2003 and $64.7 million in the current fiscal year, according to the department.

The state first said it was auditing the Act 221 credits in March 2003. Kawafuchi shocked lawmakers this spring when he said at least 20 percent of all claims for Act 221 credits have potential problems.

Kawafuchi said last week that an unspecified number of claims have been denied, though the state has yet to announce any cases of criminal or civil penalties. The audits have not been completed, he added.

Jeff Au, managing director for Honolulu venture capital firm PacifiCap Group LLC and a supporter of the Act 221 credits, said the large number of claims being audited doesn't prove the credits are being abused.

"I would say there is a burden on the tax department to substantiate the claims (of abuse), whatever they are," Au said. "There's a distinction between a claim being selected for audit and a claim that's been denied and the finding of violations of civil or criminal law."

The new audit figures are more than double the $8.7 million in audited claims reported in October of last year. At that time the tax department said it was only auditing 2001 claims for tax credits available under Act 221 and denied four claims valued at $134,000.

The department has said the audits are hampered by language in Act 221 requiring that the law be interpreted liberally.

Lowell Kalapa, president of the nonprofit Tax Foundation of Hawai'i, said the audits have served one purpose — reducing claims. Claims for research tax credits dipped from $14.5 million in 2001 to $9.2 million in 2002.

"I think it's sending a message — that's what it is," Kalapa said. "Going out to audit really put a pall on activity."

Kalapa also said the audits should not be taking this long.

"It shouldn't take more than a year at most before you can say 'you cheated,'" he said.

Kawafuchi could not specify when the audits would be completed. He said three auditors are working on Act 221 claims part-time.

"We're trying to do the best we can," Kawafuchi said. "We're trying to be fair and careful and give people a chance to prove their case."

Along with the request for information on the audits, The Advertiser asked the tax department on March 31 to provide other information, including:

• The estimated cost of Act 221 and other tax credits in future years.
• The identities of companies certified to claim Act 221 credits.
• Information on Act 221 companies provided to other state agencies to determine the economic impact of the program.
• Details of the advice from the state attorney general to the tax department concerning what information on the program can be shared with the public and outside agencies.

The tax department refused, saying it could not legally provide much of the requested information or was entitled by law to keep the information confidential.

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