Tax credits may cost state millions
The Oklahoman, April 17, 2006
By Randy Ellis
Wealthy investors are being told they can obtain $2 in state tax credits for every $1 invested under a controversial program being used to help finance a new Altus aircraft manufacturer.
-------------More info side bar ------------ State credit offsets taxes An Oklahoma income tax credit allows a state taxpayer to reduce the amount of taxes owed by the amount of the credit. For example, if a wealthy Oklahoman owed the state $3 million in taxes and had a $2 million tax credit, the person would only have to pay the state $1 million in taxes. Tax credits granted under the Rural Venture Capital Formation Incentive Act or Small Business Capital Formation Act can be used to offset taxes for up to 10 years. Some types of tax credits are transferable, but these are not. Randy Ellis -------------More info side bar ------------
Tax credits stemming from the most recent financing of the Quartz Mountain Aerospace project could cost the state treasury more than $64 million if it is fully funded, documents reveal.
Paul Doughty, president of First State Bank of Altus, said strong financial incentives such as this are necessary to attract economic development to rural Oklahoma. Doughty is president of a limited liability company that is managing investments in the aerospace project.State Treasurer Scott Meacham said he has no idea how many similar tax credit projects there are in Oklahoma, but he fears there could be enough to jeopardize the state's future ability to build roads, pay teacher salary increases and cover the other costs of state government.
"It is a serious financial threat to the state," he said.
Meacham said he is not opposed to the state offering financial incentives such as tax credits for economic development, but the benefits to the state need to exceed the costs and risk.
Programs such as the one in Altus take advantage of a legal loophole that enables investors to claim extra state tax credits based on borrowed money that goes into venture capital projects, Meacham said.
Lawmakers are working to close the loophole.
Meanwhile, potential investors in the Altus aerospace project are warned in confidential marketing material that the IRS may reclassify the transaction as a "sham" if it finds investors entered into the deal "for predominantly tax reduction motives rather than for the production of income or profit motive."
An unfavorable IRS ruling could subject investors to severe financial penalties, the documents state.
Only sophisticated investors such as securities brokers, insurance companies, people with net worths of more than $1 million and people with incomes in excess of $200,000 are allowed to invest in the Altus deal.
The names of investors are not public information.
Meacham compares the state situation with what happened nationally two decades ago when wealthy Americans were using tax shelters to avoid paying income taxes.
The federal government cracked down on tax shelters during the Reagan administration, he said.
The controversy in Oklahoma focuses on two programs -- the Rural Venture Capital Formation Incentive Act and the Small Business Capital Formation Act.
The first was written to offer 30 percent state tax credits to people who indirectly invest in new or expanding businesses in rural areas. The second was written to offer 20 percent state income tax credits to people who indirectly invest in such businesses in metropolitan areas.
The Altus project involves the rural tax credit program, but instead of investors being offered a 30-cent state tax credit on every $1 invested, a loophole is being used so they can be offered a $2 credit for every $1 invested.
Here's how it works
Investors are asked to invest $32 million in the airplane manufacturing plant. The plant will then take out a $189 million bank loan. The two numbers are added together for the purpose of calculating the 30 percent tax credits, which go entirely to the investors who put up the $32 million.
Investors who put $32 million into the deal are projected to receive a little more than $64 million in tax credits, after fees and commissions are taken out. The investors can profit, even if the business fails.
The bank loan is only to be used for credit financing when airplanes are sold. This allows the manufacturer to finance its own airplane sales, similar to a person taking out a loan from a car manufacturer to buy an automobile and putting the car up as collateral. The Altus bank loan is not used to finance construction or equipping the plant, so risks to the bank are minimized.
Risk is shifted to the state treasury, which not only will be indirectly providing the plant with working capital, but actually will be giving up $64 million for $32 million worth of work if the deal goes as planned.
Capital West Securities of Oklahoma City is marketing and selling investment units in the project.
State Sen. Ted Fisher, D-Sapulpa, author of the tax credit laws, says they have been "corrupted," and has vowed to "shed my last drop of blood" trying to halt the abuse.
Meacham said a number of Oklahoma financial firms have told him they have refused to get involved in these kinds of deals because "they felt it wasn't in the best interest of the state."
Robert O. McDonald, chief executive officer of Capital West, countered that the state Legislature wouldn't have enacted the tax credit laws if it thought they were bad for the state.
McDonald said Capital West has cleared every tax credit deal it has done with the Tax Commission in advance to make sure they are legal.
"These things are aggressive, there's no question," he said. "We like to seek out products that are of benefit to our clients."
Capital West is far from alone in taking advantage of the tax loophole, and some companies have been even more aggressive.
Meacham said he has heard reports of projects that involve huge loans taken out solely to inflate the value of tax credits.
The loan money sits in a bank drawing interest and is not used on the project.
Doughty, the Altus banker, said he thinks that would be wrong, but he thinks the Altus aerospace project is not only legal, but a good use of the program.
Doughty said he understands the fears of state officials, because nobody seems to know how many tax credit deals are out there or their potential effect on the treasury.
It's like walking into a cave with a flashlight, he said.
"There may not be a bear in it when you turn the light on, but they don't know that," he said.
Doughty said he doesn't expect all the tax credits to be used on the Altus aerospace project, although several million have already been granted on previous financings done for the manufacturer's benefit.
Attracting new manufacturers to rural Oklahoma is "absolutely impossible," he said. "And it's probably worse than that, really."
The Rural Venture Capital Formation Act has succeeded where other economic incentives have failed, he said.
If the Quartz Mountain Aerospace project succeeds, it could bring 300 jobs and a multi-million dollar payroll to a part of the state starved for new industries, he said.
Not only that, but several other projects also are in the works that use the act, albeit on a smaller scale, he said.
"This is critical to rural Oklahoma," he said.