Tax Dept. Clarifies Act 221 Standards

DoTax Director Kurt Kawafuchi

At a luncheon hosted by the Hawaii Science & Technology Council and the Hawaii Venture Capital Association yesterday, Hawaii's Director of Taxation Kurt Kawafuchi presented some revised standards for Act 221 (investment tax credit) claims.

Sometime in the next few weeks, the Dept. of Taxation (DoTax) will issue a new Tax Information Release (TIR) to formalize these standards, which clarify what investors in QHTBs (qualified high technology businesses, which include film and television production companies) must do to prove that their investments are genuine, or, as DoTax puts it, have "economic substance and business purpose," and are not made for the primary purpose of claiming Act 221 credits.

There are certain instances in which investors are automatically in the clear with regard to their investments having "economic substance and business purpose"--these guys get what DoTax likes to call the "safe harbor" treatment (as in, phew! we're safe, DoTax won't challenge us on our credit claim, yay!). In order to wade in the the calm warm waters of the "safe harbor," 2 of 3 tests must be satisfied:

1. No frontloading of credits - Get your credits back at the prescribed sequential annual rates-- 35% in year 1, 25% in year 2, 20% in year 3, and 10% in each of years 4 and 5--and no sooner.

2. Reduction in economic value - In year 1, the investor will get back credits with an after-tax value of 50% of his/her actual investment. This proves that the investor is taking a real risk with his/her money by putting it into a Hawaii QHTB.

3. Limited equity shifting - The investor must keep at least 50% of the equity interest in the investment in the QHTB in exchange for a higher share of tax credits--in other words, only up to half of the equity may be shifted from one investor to another.

Is this gobbledygook to you? Well, check back for a post on the actual final TIR in the next few weeks. (Then watch your head really spin!)

Also at the luncheon, according to the Star-Bulletin (I had to duck out early), it was announced that between 2001 and 2004, the state certified $184.5 million in tax credits (claimable over 5 years), and of that sum, $74.9 million has been actually claimed so far.

>> State agency liberalizes high-tech tax credits [Hnl Star-Bulletin, 9/29/06]

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