Loophole in tax law threatens budget

By Randy Ellis

Published: March 26, 2006

A tax loophole so big it threatens to cripple the state budget has lawmakers scrambling at the state Capitol.

"It's awful," said state Sen. Ted Fisher, who in the 1990s authored the two pieces of venture capital tax credit legislation that are now being abused.

"I wrote these two programs, and I'm sick to my stomach at how they've been corrupted," said Fisher, D-Sapulpa. "I never believed it could be corrupted like this -- but it has -- and I'll shed my last drop of blood trying to stop it."

Fisher said the abuses started after some unknown person "tweaked" the law, and he failed to notice.

Sharp tax attorneys and accountants discovered the loophole and began helping wealthy clients exploit it last year, officials said.

At issue are two laws that for years have provided incentives for people to invest in new and expanding small businesses.

After years of granting from $960,000 to $3 million in tax credits under the programs, the state Tax Commission last year granted pre-approval of proposals that could result in the issuance of $66 million in such credits, said Tony Mastin, director of the commission's tax policy and research division.

There is no requirement for a person to seek pre-approval of an investment plan to obtain the tax credits, so the potential cost to the state could be several times that amount. The cost also could be less if the projects aren't done.

Mastin said it will be the end of the year before the state knows how much it lost from tax credits claimed for 2005. Meanwhile, more projects are being planned every day.

"This is money that could go to roads, bridges and school kids," Fisher said. "This is sucking it right out of the bottom of the general revenue fund."

Abuses to similar programs in other states have had a devastating impact on their state treasuries, he said.

Louisiana discovered its obligations for such credits rose from $17 million to $340 million in one year, prompting an emergency declaration in 1999, officials said.

An audit of a similar program in Missouri found that $140 million in tax credits was generated on projects that only generated $23.6 million in projected revenues while creating an average of 293 projected jobs for 15 years.

Indirect investments
The two tax credit laws creating all the problems are called the Small Business Capital Formation Incentive Act and the Rural Venture Capital Formation Incentive Act.

The first was written to offer 20 percent state tax credits to people who indirectly invest in at least five small businesses in metropolitan areas.

The second was written to offer 30 percent state tax credits to people who indirectly invest in at least four small businesses in rural areas.

The purpose of the laws was to encourage people to risk their money on new or expanding businesses to create jobs and stimulate the state economy, Fisher said.

It worked well for several years, he said.

The problem began when investors figured out they could use a borrowing and investment scheme to obtain tax credits in excess of the amount they were putting at risk.

Fisher provided this hypothetical example:

An investor puts up $5 million to invest in urban small business venture capital projects.

Through a limited liability company, he borrows an additional $95 million. That money doesn't go into the project, but is instead placed in a restricted fund and used to repay the loan.

The investor claims a $20 million tax credit based on his $100 million "investment." No jobs are created off the borrowed portion of the money and the state treasury loses $20 million.

Tax Commission officials said they can't disclose who is taking advantage of the loophole because of tax secrecy laws.

Efforts are under way on several fronts to stop the abuses.

Mastin said during the pre-approval process, the Tax Commission has taken the position it won't issue a positive tax credit recommendation for projects in which all of the money is not committed to actually going into the venture capital businesses.

Mastin said he expects a lot of targeted taxpayer audits will have to be done to sort out abuses of the program, which many experts contend are legal.

Meanwhile, the governor has been asked to call for a suspension or moratorium on the program.

"The governor has concerns about it," said Phil Bacharach, a spokesman for the governor. "We have all our options open and are looking to see what we can do."

Fisher is pushing a bill, SB 1693, that would place a $10 million annual limit on the amount of tax credits that could be granted under each of the two programs. The bill also attempts to close loopholes that allow investors to collect tax credits based on borrowed funds that are not put at risk.

The bill passed the Senate and now is pending before the House, where it is the subject of political intrigue.

John Carey, D-Durant, says he has been removed as House author of the bill and replaced by Odilia Dank, R-Oklahoma City. He won't say why.

Dank says she was asked to assume House authorship of the bill, but won't say who made the request.

"I was just approached to see if I would carry it," Dank said.

"Certainly, if there are problems and abuses, we will look at that," said Kevin Calvey, chairman of the House Revenue and Taxation Committee.

Contributing: Nolan Clay