20% of high-tech tax credits may be illegal

By Sean Hao
Advertiser Staff Writer

At least 20 percent of all claims for the state's Act 221 high-technology tax credits potentially violate criminal or civil law, and prosecutions of claimants could begin within a year, the state Department of Taxation said yesterday.

Lawmakers, who are considering extending the tax credit program for another five years, said they were surprised by the disclosure which came from state tax director Kurt Kawafuchi.

"You've just said something very alarming," said State Rep. Brian Schatz, D-25th (Makiki, Tantalus), chairman of the House economic development committee. "It's just astonishing that we're at this stage of the legislative session and this is just coming out."

Kawafuchi said, "It's the first time I was asked a specific question" about the scope of Act 221 abuses.

Act 221 was created in 2001 to spur technology investments as a way of diversifying the state's economy away from tourism and the military. Since then the law has come under increasing criticism that the credits are overly generous, have failed to produce tangible economic benefits and have been shrouded in secrecy that prevents public accountability. The law will expire next year unless extended by legislators.

Kawafuchi said the types of questionable transactions involve:

• Drop-down subsidiaries, where companies move information technology operations to a separate business;
• Companies selling slightly altered off-the-shelf software and calling it high technology;
• Other deals that don't result in actual investments or new jobs.

Kawafuchi said there had been no prosecution yet because "we want to be very careful and thorough and make sure it's a solid case."

Schatz said the abuses point to problems in administering the law, as opposed to the way it's written. Schatz said he'll propose providing the tax department an additional five to eight new positions to help police the credits while also giving the tax department greater authority to deny credits that don't result in new jobs or investments.

"If these things are illegal, they shouldn't be allowed," Schatz said. "We need to help them get to the bottom of this."

To tighten Act 221, the Lingle administration is urging lawmakers to make several changes, including striking out a provision stating the law be applied liberally. Kawafuchi said the law's liberal language causes tax filers to take overly aggressive claims on their returns.

Legislators have showed little interest in removing that provision for fear of stifling investments in high-tech companies.

"I think (Kawafuchi) is trying to scare people — not necessarily investors, but legislators," said Lowell Kalapa, president of the nonprofit Tax Foundation of Hawai'i. "That kind of public statement says, they've got to fix this or they'll rob the bank."

So far Act 221 has generated $161 million in total tax credit claims, though the actual cost in the first two years was about $57 million. That's because the tax credits are spread over a five-year period.

According to the law, every dollar invested in qualifying high-technology ventures can be used to reduce state tax obligations by $1. Companies also can claim a 20 percent refundable tax credit for research and development costs.

Among changes to Act 221 being discussed in the Legislature are limiting research credits to high-tech companies and providing guidance meant to curtail investment tax credit returns that in some cases have been higher than intended. There's also debate over disclosing the identities of companies and certain investors that benefit from the program.

Those most opposed to changing Act 221 include the Hawaii Technology Trade Association and the Hawai'i Venture Capital Association. Bill Spencer, president of the HVCA, said despite Kawafuchi's claims, there still are no known examples of abuse that would justify drastic changes to Act 221.

"I just think they haven't done their homework," he said. "These estimates are at best guesstimates."

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