Richer high tech investment credit (new provisions years 2001 through 2005)
Act 221 provides for a richer high tech investment credit. Structured as a 100% return on cash investments in a qualified high tech business (QHTB) on a front-loaded basis over 5 years—35% credit in the year of investment, 25% in the following year, 20% in the second year following, then 10% each in the third and fourth year following. The credit is designed to give a full 100% return for investments up to $2 million per year per QHTB. If the QHTB fails to qualify as such or if the investment is sold or withdrawn, in any year during the 5-year period, there will be a recapture of 10% of the total tax credit claimed in the preceding two taxable years. Note that this credit is nonrefundable (applied against Hawaii income tax liability only). The credit can be taken not only by individuals and corporations paying Hawaii income tax, but also by banks and insurance companies against their franchise and insurance premium tax, respectively.
Hawaii continues to have a shortage of local angel investment, and a more generous credit is necessary to attract interest in Hawaii-based technology companies. The modest recapture of tax credits if the business ceases to be a QHTB is designed to encourage investors to maintain interest in the viability of the company. Although many other states offer tax incentives as a means of encouraging high-technology firms to expand, or to spur the growth of new industries, Hawaii’s investment tax credit is by far the most progressive in the nation. The 100% return for investment up to $2 million is unmatched anywhere on the mainland. According to the National Conference of State Legislatures website, Hawaii is the only state with this impressive level of tax credit. Many states have between 5 and 15 percent tax credits. And only a few states, such as Maine, Vermont and West Virginia, even come close to Hawaii’s credit with up to a 50% tax credit. This new provision is unprecedented and shows Hawaii’s commitment to fostering the growth of the technology industry.
This credit significantly reduces the risk profile of an angel investment so that more Hawaii individuals will consider investing in tech companies for the first time. For active angels, the credit will return funds that could be made available for second or third round investments. Combined with the lower valuations prevalent in today’s market, the credit will permit investors to fund less money for the same return. Out-of-state investors will have more confidence in Hawaii companies when they see higher participation by local investors.
More tech companies now qualify for the tax incentives--QHTB definitions expanded (new provisions eff. 2001—any sunset depends on specific provisions)
Many of the tax incentives apply with respect to a QHTB, which is defined as a business that conducts more than 50% of its total activities in “qualified research” (for the investment credit, more than 75% of its qualified research must be done in Hawaii). “Qualified research” is a defined term and includes research & development (R&D) work, computer software programming, and biotechnology. This list is now expanded to include sensor and optic technologies, ocean sciences, astronomy, non fossil fuel energy-related technology, as well as performing arts products. The added activities play on Hawaii’s unique geography, natural resources, and culture. Encouraging growth in these sectors helps to strengthen and diversify our economy in a way that need not threaten Hawaii’s environment or way of life.
Note: The State’s current interpretation of these provisions should be solicited. As with any tax provision, general principles of economic substance, substance over form, etc. should control any Act 221 structuring.
Most generous R&D refundable income tax credit (new provisions eff. 2001 through 2005)
Hawaii’s 20% refundable credit on top of the federal 20% credit is already generous but does it one better by being refundable. Nevertheless, due to their smaller scale of operations, most Hawaii technology companies are limited in the amount of the credit that can be taken. This is because federal rules limit the 20% credit to increased R&D expenditures year over year. This year’s legislation decouples Hawaii’s version of the R&D credit from the federal limitations so that all qualifying expenses each year will count toward the credit, not just the incremental increase.
For this credit, QHTB status is not required so long as the research work is in Hawaii and is expended for a activities that constitute the carrying on of a trade or business.
The combined Hawaii and federal credit work to make an investment in Hawaii companies devoted to research work less risky. It encourages our non-technical companies to commit a greater portion of their budget to research work.
Note: This is an evolving area of the law, i.e., recent case law and the issuance IRS proposed regulations, such that qualification for this credit must be based on current interpretation of the law by the courts, IRS, and State.
NOL sale provisions improved (new provisions eff. 2001 through 2003)
Act 221 makes technical corrections to net operating loss (NOL) sale provisions. QHTBs can sell up to $500,000 of unused NOLs per year accumulated up to two prior years, subject to a minimum sale price of 75% of the tax benefit sold. The intent is to increase the cash flow of startup technology companies by giving the company the benefit of its NOLs currently rather than await years in which the NOL can be used against income. The NOL sale provisions were clarified to address various technical issues.
Creates technology infrastructure renovation income tax credit (years 2001 through 2005)
Act 221 provides a 4% nonrefundable income tax credit for renovation work on office buildings that support high tech tenants by providing high volume digital or analog telecommunications, physical security systems, environmental systems, and backup power systems. Many existing office buildings do not have the necessary infrastructure to attract and support technology tenants. This provision provides an incentive to renovate existing buildings with improved cable and fiber access, telecommunications connectivity, backup power and environmental systems.
GET and PSC exemption for public IDCs (for income received 7/1/01 through 12/31/05)
Act 221 exempts public Internet Data Centers (IDCs) from the general excise tax (GET) and public service company (PSC) tax. IDCs are defined as facilities designed to house data centers, operate continuously, have redundant utility systems, and provide Internet-related data and complex web hosting services.
Expands GET related party exemption (eff. 7/1/01; no sunset)
The legislation expands the general excise tax related party exemption to include IT services, use of software and hardware, and database management services. To effect economies of scale, one entity in a group of related entities often incurs the cost of technology for its entire group. The value of these inter-company services will no longer be subject to the GET.
Expands stock option income tax exclusion (new provisions eff. 2001; no sunset)
The stock option income tax exemption is expanded to include stock options issued by the holding company of a QHTB, and to include equity interests in entities other than corporations. Startup technology companies use stock options to attract and retain qualified personnel. This provision takes away the income tax as a barrier to entry for those with such options, and helps to retain that talent in Hawaii.
Royalty income tax exclusion (new provisions eff. 2001; no sunset)
No major changes here except technical ones to ensure that the exclusion conforms to IP arrangements for performing arts products. The performing arts products activity previously limited to the royalty exclusion is now expanded to include all QHTB tax incentives.
