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The Honolulu Advertiser
Posted on: Sunday, February 1, 2009

List revealed of firms benefiting from Hawaii's Act 221

By Sean Hao
Advertiser Staff Writer

QUALIFYING FOR INVESTMENT TAX CREDITS

Investors can claim the credit if the business they invest in is designated a Qualified High Technology Business.

To qualify, a business must meet the following criteria:

More than half of its activities are "qualified research," as defined by federal guidelines, and more than 75 percent of that research is done in Hawai'i.

It also qualifies if more than 75 percent of its income is derived from qualified research and that income comes from locally produced products and services.

A business also can qualify if it does no research, but more than half of its business activity (or more than 75 percent of income) involves software development, biotechnology, performing arts, sensor and optical technology, ocean sciences, astronomy or nonfossil fuel energy-related technology.

Not disqualified for tax credits

A review of the 83 qualifying technology businesses listed by the state showed:

12 of the companies were not in good standing with the state's business registration division.

1 firm didn't have a general excise tax license.

9 businesses benefiting from the credits have a principle business address that's either out of state or at a local post office box.

The state Department of Taxation said lack of a valid Hawai'i business license doesn't affect the eligibility of these companies for the tax credit program. The department said it had audited 44 cases of tax credits claimed for research activities and high-technology investment as of Jan. 22. Six companies seeking to benefit from the program were deemed ineligible for the credits.

'DROP-DOWN' SUBSIDIARIES

Among the businesses benefitting from Act 221 is First Hawaiian Bank, which owns KIC Technology 1 Inc.

KIC Technology received investments eligible for technology tax credits last year.

The bank would not discuss KIC Technology 1, but did provide the following written statement: "The company is engaged in software research and integration with a focus on new and innovative ways to deliver financial services."

First Hawaiian Bank also has two similar subsidiaries participating in the tax credit program KIC Technology 2 and KIC Technology 3. All three subsidiaries share the same address as First Hawaiian Bank and none of the subsidiaries has its own Web site.

First Hawaiian Bank isn't the only nonhigh-tech company to create what's sometimes referred to as a "drop-down" subsidiary. Insurer AIG Hawaii and graphic company Honblue Inc. have placed a portion of their information technology operations into subsidiaries that qualify for technology tax credits.

Some question whether such a strategy stretches the intent of the program by shifting employees into a subsidiary that provides similar services or sells services primarily to the parent company. That could allow a parent company to get investment tax credits on what otherwise would be operating expenses.

Part of the concern is that these subsidiaries and other businesses based on tax credits won't grow into large, independent businesses before the tax credit program sunsets in 2010.

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Seven years after launching the Act 221 high-technology tax credits, the state has released the first list of companies benefiting from the program.

Many such as biotechnology firm Nanopoint Inc., tissue engineering company Tissue Genesis Inc. and digital media developer Blue Lava Technologies are the type of innovative companies that can spur the growth of a high-tech industry. Many others, however, do not fit the typical high-tech mold.

A former guava farm, a major bank, a timber grower and an O'ahu exporter of deep-sea water are on a list of 83 companies that have benefited from the tax credits. The list also includes a noni fruit grower, a company that sells swimming lessons on DVD and the producer of Andy Bumatai's TV talk show.

The list points to the successes of the tax credits, but also highlights concerns that the program, in some cases, has missed the mark and may need tightening, especially given the nearly $1 billion budget deficit the state is facing.

The state Legislature is considering at least six bills, including two from Gov. Linda Lingle's office, to limit the tax credits.

The state Department of Taxation released the names of 83 companies benefiting from Act 221 last year as required by a law passed two years ago. In all, 333 companies have benefited from the credits but only those receiving taxpayer-subsidized investments after June 30, 2007, needed to go public.

Information released by the state so far is also limited to the 83 company names and excludes details such as what each business does, how many people it employs and how much money it raised. That makes it difficult to discern if these companies are sowing seeds needed to make the state a future tech haven.

"An air of mystery surrounds several of the 83 companies on the Department of Taxation's list," said Bruce Bird, a professor of accounting at the University of West Georgia's business college. Bird co-authored a 2006 report on the tax credits. "I can find more information on the Web on witness relocation programs in Hawai'i than I can find on a few of these companies."

"A few of the companies on the Department of Taxation's list don't even have a basic Web page. It's not hard to build a Web page."

CUTBACK CONSIDERED

The incentives, which were created in 1999 and significantly expanded in 2001, provide a 100 percent tax credit to Hawai'i residents investing in local technology companies and another 20 percent research tax credit. They were created with the goal of boosting Hawai'i's economy and moving it away from dependency on tourism.

The program cost an estimated $747 million through 2007, according to a recent study by the state. That year, the 177 companies that reported benefiting from tax-credit-generated investments created 2,245 direct jobs. There is no public record of the total number of jobs created since the start of the tax credit.

Nearly 79 percent of companies participating in the program in 2007 were not profitable and needed investment capital, according to the state tax department.

Advocates for the credits say the economic activity generated by the program offsets its cost. They say the tax credit generates much-needed investment capital for local businesses. Still, a slowing economy is forcing the state to wrestle with a projected revenue shortfall and budget deficit.

One cost-cutting option proposed by Lingle is to cut technology tax credit costs by 10 percent in the coming fiscal year and by about 25 percent the following year, which could lead to a potential savings of about $65 million over a two-year period. Those cuts would be made by narrowing the definition of what constitutes a high-technology company and possibly cutting performing-arts companies from eligibility.

Tech industry leaders strongly advocate against any such changes.

"We have not heard a fine-tune proposal yet that makes sense to us and solves any real problems," said David Watumull, chief executive officer of 'Aiea-based Cardax Pharmaceuticals.

"Are we trying to actually decrease the amount of economic stimulus that's there?"

Watumull said the tax credits are a more effective way to boost the economy than large construction projects that the state and city are considering. High-tech jobs pay more and do more to diversify the economy, he added.

RANGE OF COMPANIES

Although qualifications for Act 221 of 2001 were tightened in 2004 under Act 215, the credits are still considered generous compared with those offered by other states.

The credits have been criticized as being overly generous, failing to produce tangible economic benefits, being shrouded in secrecy and, in some cases, creating only temporary movie industry jobs.

That list of companies benefiting from the program, which was released in September, includes many obscure businesses that exhibit few outward signs of life. Other businesses benefiting from the credits don't seem to fit the high-tech mold or don't seem viable in the long run.

Investments in Waterproof Kids LLC, which sells swimming lessons on DVD, qualify for tax credits. Investors in NightTime Productions LLC, which produces the Andy Bumatai evening talk show, also can get tax credits, as can financial backers of the Ocean Network TV channel.

Also benefiting from the program are the companies behind interior design Web site RSVPstyle.com and SeeTheBook LLC, which creates visual representations of literature.

Shan Steinmark, founder of consultant Strategic Transitions Research Inc. and a supporter of Act 221, said that despite some anomalies, most businesses benefiting from the credits are actively trying to build legitimate high-tech businesses.

"If you want to find dirt, you can find dirt," Steinmark said. "That's the frustration we have. The idea is to look at the whole picture at what we're really trying to do and what's being accomplished."

To be sure, there are many recognized high-tech firms in the list of 83, including biotech firm Cardax Pharmaceuticals, software company Avatar Reality Inc. and Hawaii Biotech.

Overall, companies benefiting from the program report raising $1.2 billion and spending $1.4 billion locally. Companies benefiting from the credits create more than 4,000 jobs, including those employed by subcontractors, according to tax department figures.

Still University of Hawai'i economics professor Sumner La Croix said the state should suspend the program because the costs far exceed the benefits.

"During these tough times this is the perfect place for the state to be cutting back," said La Croix, who's working on a study of the credits for the UH Economic Research Organization. "Yes we would lose a few more jobs, but these are jobs that are incredibly expensive. After looking at the companies that are receiving the (benefits of the) credit, I don't see the spillover benefits on the rest of the community."

Unfortunately, many companies now benefiting from the credits may not be sustainable without them, La Croix said.

"This is an industry that's being built on foundations of sand," he said.

AGRICULTURE INCLUDED

Included on the list of businesses benefiting from the tax credits are timber company Hawaiian Mahogany Inc., power company Makila Hydro LLC, Sustainable Design LLC and noni fruit grower and researcher Pacific Biotech LLC.

Sustainable Design LLC is owned by entrepreneur Chris Jaeb, who recently purchased the former Guava Kai Plantation on Kaua'i. His goal is to turn the former guava farm, which is now called Common Ground, into a sustainable resource center for people wanting to learn how to grow organic food in a sustainable way.

Similarly, Hawaiian Mahogany, also on Kaua'i, is focused on sustainable agricultural processes. Bill Cowern, president of Hawaiian Mahogany, said the company is researching ways to produce crops and livestock feed without using fertilizers, pesticides and other imported items.

On Maui the tax credits are helping produce renewable energy from a low-tech source -river water.

Makila Hydro LLC, which is owned by the West Maui Land Company, has spent about $1 million refurbishing the Kauaula Hydroelectric plant.

Some businesses benefiting from the program are in industries that likely would experience growth even without the credits. For example, Hawai'i's deep-sea water industry, which sprang up about four years ago, has tapped Act 221.

Much of that sales increase is attributable to the boom in desalinated deep-sea drinking water and its expanding market in Japan, where it is marketed as a nutrient-rich, pathogen-free, natural product. Hawai'i now ranks as the second-biggest water export state in the country, just behind California.

DSH International Inc. is one of several local companies that export desalinated deep-sea water.

Rich Treadway, executive vice president of DSH, said the Act 221 credits were key to attracting Hawai'i investors early on.

"I think we would have gathered investment as we have off-island anyway" without the credits, he said. But, "I think it would have taken longer certainly initially," Treadway said. "If we had not had (the tax credit program) ... would we have had more difficulty? Probably at first, yes."

Reach Sean Hao at shao@honoluluadvertiser.com.

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