Film tax credit abused, audit finds

The tax breaks the state of Hawaii offers to lure Hollywood productions to the islands are probably sweeter than they should be under state law, according to a report released Tuesday by the state auditor.

What’s more, flawed oversight of the film tax credit has likely increased the cost of the credit to taxpayers while overstating the economic benefits to the state, the audit said.

Both the state Department of Taxation and the Hawaii Film Office got dinged in the report, which noted that the auditor’s office wasn’t even able to confirm that the film credit is providing a net benefit to the state.

“What we do know is that (the Department of Taxation) and the film office need to be more accountable for the administration and oversight of the film tax credit,” the report declared.

Department of Taxation spokeswoman Mallory Fujitani said the agency disagrees with the audit. She said the department has been following the law and offering the film office the appropriate guidance in administering the tax credit.

The film office couldn’t be reached for comment Tuesday, but a formal response within the report from the state Department of Business, Economic Development and Tourism, its parent agency, expressed both concurrence and dissent with the auditor’s findings.

The film tax credit was created by the state Legislature in 2006 to give tax incentives to motion picture, digital media and film production companies in an effort to stimulate the economy, create well-paying jobs in a clean industry and generate exposure for the islands as a prime filming and visitor destination.

According to Tuesday’s report, however, the Department of Taxation has allowed the tax credit to be stretched to include out-of-state expenses as qualified production costs.

That’s inconsistent with the language of the statute and the Legislature’s aim to stimulate economic growth in the state, the audit said.

“For example, expenditures paid to out-of-state businesses and service providers do not provide income for local residents; they do not create local jobs,” the report said.

Additionally, the department should adopt administrative rules to fully implement the tax credit, the report said.

Without a clear definition of the law that created the incentive, the film office is left with limited guidance in administering the credit, and film companies might be uncertain about their obligations to qualify for the tax credit, according to the audit.

There is, for example, no requirement that production costs be independently verified as qualifying for the tax credit, the report said, nor are there rules to help the film office enforce deadlines and other filing requirements.

“We don’t agree with the auditor that the lack of administrative rules makes it difficult to administer the tax credit,” Fujitani said.

Fujitani said the department’s occasional “Tax Information Releases” updates have provided sufficient guidance to the film office.

“We’ve been working with them for 10 years, and they never said they had a problem,” she said.

Fujitani said the department expanded the qualified production costs to out-of-state expenditures on the advice of the state Attorney General’s Office, which advised that to not do so was likely unconstitutional and could be subject to a court challenge.

As for the film office, the auditor found that its economic-impact analysis of the film tax credit data uses “incomplete and overstated data” and therefore fails to measure its true costs.

For instance, the office’s analysis includes an unknown amount of expenditures and wages paid to nonresidents, including amounts for highly paid producers, directors, actors and crew members who are often residents outside of Hawaii, according to the audit.

While these crew members might spend some of their salary or wages here, it is “very unlikely” that a significant percentage of their Hawaii-earned income flows into the local economy, the report said.

“Including these salaries and other out-of-state expenditures in the calculation of benefits to the state significantly over-inflates the film tax credit’s economic impacts,” the report said.

The film office should instead report to the Legislature on the quality of the jobs generated by film productions, according to the auditor. Currently, the film office collects this type of information from production firms applying for the tax credit, the auditor said, but it does not track or report on it.

In the report, the Department of Business, Economic Development and Tourism agreed that internal controls and administration could be improved to offer lawmakers more accurate and meaningful information on the productions benefiting from the credits.

DBEDT also agreed that a third party should review information to verify the costs of sizable productions that qualify for the tax credit.

The department, however, disagreed with the assertion that out-of-state expenditures inflate the credit’s economic impacts. Film productions usually buy goods and services from out-of-state vendors only when they are not available in Hawaii, the department argued.

The film tax credit is scheduled to expire at the end of 2018, at which time lawmakers will need to decide whether the benefits of the program justify its continuing costs, according to the report.

“Unfortunately, the film office cannot provide the Legislature with the relevant, accurate, and timely data necessary to make this determination,” the report said.