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Study Of Tax Credits In Hawaii Is Critical Of VC Incentives

by Mike Godfrey, Tax-News.com, Washington

03 December 2009


Hawaii's high-technology tax credits, the most generous technology tax credits of any US state, have recently been the subject of a study by three University of Hawaii economists, who concluded that the tax credit program needed better monitoring by public agencies and disclosures of how public funds were being used by recipients.

Hawaii has had a longstanding objective of building up environmentally friendly, high-technology industry to reduce its dependency on tourism. The state's remote location, with poorer access to capital markets seemed to justify a strategy, introduced in 1999, that involved offering investment tax credits for investments in select high-technology industries as an expedient way to induce growth.

These tax credits, referred to as Act 221 incentives, allow investors to claim 100% of their investment against Hawaiian taxes over a five-year period. Tax credits are also available to filmmakers and to projects in the performing arts sector.

The study suggested that a 100% tax credit may have had the effect of:

  • Inducing "entrance of low-quality ventures with little chance of success";
  • Raising "the risk of fraud, both by owners of firms receiving the credits and by tax department officials"; and
  • Promoting "opportunistic manipulation of the law’s provisions inconsistent with the purpose of the law".

According to the study, high technology tax credits were modelled on the federal government’s LIHTC (Low Income Housing Tax Credit) tax credit program, but the Hawaiian legislation did not include many of the safeguards while still providing generous tax credits.

Such safeguards included, according to the study, state and federal agency checks to verify applicant information; public disclosure of the details of funded projects, including the value of credits received and contact information; and "powerful clawback features" to prevent "cheating and opportunistic manipulation of the law’s provisions".

Prior to 2009 the Study noted that incentives for equity in the tax credit allocation allowed partnership deals to be sold to non-Hawaii investors while the Hawaii investors retained all tax credits.

Control shifted to investors outside of Hawaii, and it was "not surprising to see firms relocate to other states". The study admitted that this might still have made sense for the State of Hawaii if there was a "substantial spillover of ideas to other firms more firmly anchored in Hawaii".

The Study indicated that the absence of close monitoring procedures made it difficult to determine precisely how much investment was attracted into local high technology firms, or how many jobs were created from the estimated USD657.5m of tax credits.

It recommended, in conclusion, that a "targeted, smaller investment tax credit could well be one ingredient in the correct public policy mix for retaining new innovative businesses".

A comprehensive report in our Intelligence Report series examining tax-sheltering arrangements for investors, including Venture Capital, Forest Finance and Film Finance in a number of key jurisdictions, is available in the Lowtax Library at http://www.lowtaxlibrary.com/asp/subs_reports.asp and a description of the report can be seen at http://www.lowtaxlibrary.com/asp/description_report5.asp

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