Hawai'i business leaders seek changes to Act 221
By Sean Hao
Advertiser Staff Writer
The state's high-technology tax credit — which generated $112 million in investment in its first two years without an equal impact on the local technology industry — needs to be tightened, business leaders said.
State lawmakers are considering a five-year extension of the controversial Act 221 tax credit, which was set to expire next year. The recent disclosure that the tax credit led to $112 million in investment in 2001 and 2002 has left many business leaders wondering where that money went, given the small size of the state's technology sector.
Many now believe that at most $50 million actually went to companies such as Hoku Scientific, Hoana Medical, Firetide and other high-tech startups intended to benefit from the program.
If all $112 million was pumped into high-tech companies, "I would think it would be a lot more visible," said Mike Fitzgerald, president and chief executive of Enterprise Honolulu. "It just can't be accounted for."
Proponents of Act 221 argue the credits promote business growth and create new jobs in a state dependent on tourism and the military. Critics contend the credits are overly generous, have failed to produce tangible economic benefits for the state and have been shrouded in secrecy that prevents public accountability.
According to the law, every dollar invested in qualifying high-technology ventures can be used to reduce state tax obligations by $1. The tax credits are spread over a five-year period and capped at $2 million per investment
Act 221 cost the state's general fund nearly $60 million in its first two years. The cost to taxpayers is expected to reach $48.4 million this fiscal year and $76.7 million in fiscal 2005, according to state estimates.
Where much of the investments generated by those incentives went is unclear, though it's likely at least a portion went to companies that took advantage of the act by shifting certain technology-related work into subsidiaries that could qualify for the credits. Though legal under the law, such transactions don't necessarily result in new investment or jobs.
"Here's where the critics of Act 221 may be right," Fitzgerald added. "If there's lots of companies that are just shifting things to qualify, that could be the answer as to why it's so high. If that indeed is happening then it is being abused because that is not new research that is happening."
The Lingle administration, the Hawaii Technology Trade Association and others are mulling ways to rein in the act while extending it through 2010. However, just what changes are required is a subject of disagreement as is the level of alleged abuse.
"I'm not saying it isn't (being abused), we just don't know how big of a problem it is," said Ann Chung, executive director of the HTTA. "If there are specific abuses that (the state) alleges are occurring, they should do something about that."
Some industry and state officials said problems with the program are worsened because of the act's liberal language, which could allow businesses not generally considered to be technology companies to qualify as technology companies.
"A lot of existing companies do technology. They do software development, they do (information technology), they do a lot of stuff for themselves," said Ted Liu, director for the Department of Business, Economic Development and Tourism. "I think what happened was technology, but technology liberally defined and liberally construed."
Most business leaders and lawmakers agree Act 221 intended to benefit startup, high-tech companies. The question its application has raised is should other companies qualify as well.
"Intended is always in the eye of the beholder in some ways," said David Watumull, president and chief executive of Hawaii Biotech, which raised as much as $5 million in 2001 and 2002 with help from Act 221. "In some cases these (subsidiaries) are legitimate and in a number of cases they're not."
Among the changes being debated are removing language that requires the act to be liberally construed, capping the amount of credits that can be claimed at 200 percent of the investment and restrictions on related-party transactions such as the creation of subsidiaries.
The most restrictive changes are being proposed by Honolulu corporate attorney Greg Kim, who represents several technology companies, including Hoku, AssistGuide and Hoana. The Lingle administration and HTTA are proposing less-restrictive changes.
"I don't know where that ($112 million) went," Kim said. "It didn't go to our clients. I'd be surprised if it all went into startups."
Kim suspects some of that money went to artificial companies created with the intent of providing tax breaks.
"Those companies aren't really technology companies because they're not going to go commercial," Kim said. "I think a lot of companies have done it."
The concern is some companies took advantage of Act 221 to give investors a two-times or greater return on their money through tax credits without doing much to create technology jobs. That makes it more difficult for traditional technology companies that take a conservative approach to the program, said Dustin Shindo, president of Hoku, which raised $1.6 million in Act 221 investments in 2001 to 2002 and is developing fuel cell technology for Sanyo Electric Co.
"I've seen that there's a lot of those going on, but it's difficult to quantify," Shindo said.
Reach Sean Hao at shao@honoluluadvertiser.com or 525-8093.
