Analysis of Hawaii Revised Statutes §235-110.91: The Tax Credit for Research Activities and Regulatory Compliance

1. Executive Summary: The Core Meaning of HRS §235-110.91

HRS §235-110.91 grants a refundable income tax credit to certified Qualified High Technology Businesses (QHTBs) for qualified research expenses incurred in Hawaii, calculated as a proportionate share of the federal IRC §41 incremental credit. This measure is designed to incentivize local innovation, though access is constrained by a competitive annual funding cap and rigorous compliance standards.

Detailed Overview and Significance

Hawaii Revised Statutes (HRS) §235-110.91 establishes the framework for the Tax Credit for Research Activities (TCRA), a crucial state incentive intended to foster investment in high-technology fields within Hawaii, such as biotechnology, software development, ocean sciences, and nonfossil fuel energy.1 The primary statutory function of HRS §235-110.91 is to define eligibility, calculation methods, and administrative requirements for claiming this financial benefit.2

A defining feature of the Hawaii TCRA is its refundability.2 Unlike non-refundable credits which can only reduce a taxpayer’s liability to zero, any portion of the TCRA that exceeds the taxpayer’s net income tax liability is paid directly to the taxpayer as cash.2 This feature makes the credit exceptionally valuable to startups and early-stage companies that often lack sufficient taxable income to utilize standard non-refundable credits.

The viability of the program, however, is significantly restricted by an annual $5 million aggregate cap applied across all taxpayers claiming the credit.4 This cap creates a highly competitive environment where certifications are issued by the Department of Business, Economic Development, and Tourism (DBEDT) on a strict first-come, first-served basis.4 The long-term stability of the incentive has been secured, for now, by legislative action (Act 139, SLH 2024), which extended the program’s sunset date to December 31, 2029.4

2. Statutory Foundation and Legislative History: Alignment and Decoupling

HRS §235-110.91 operates by referencing federal tax law, creating a structure of conditional conformity that requires careful navigation by claimants.

The Blueprint: Alignment with Federal IRC §41

The Hawaii statute makes Section 41 of the Internal Revenue Code (IRC), relating to the Credit for Increasing Research Activities, and Section 280C(c), relating to the necessary reduction of deductible expenses, operative for state tax purposes.3 This incorporation ensures that the complex federal definitions of Qualified Research Expenses (QREs) and Qualified Research Activities (QRAs) form the basis for the state credit eligibility.2

Fixed-Date Conformity (The 2011 Rule)

A crucial aspect of this alignment is the fixed-date conformity provision. HRS §235-110.91 mandates that the federal tax provisions in IRC §41 used for determining the state income tax credit shall be those as enacted on December 31, 2011, regardless of any subsequent amendments made to IRC §41 by the U.S. Congress.3

This fixed-date conformity creates a fundamental divergence from current federal law, necessitating that taxpayers perform a dual analytical process. First, the taxpayer must compute their federal credit using the current federal IRC rules (which govern their federal Form 6765). Second, the taxpayer must perform a parallel calculation using the IRC §41 provisions as they existed on December 31, 2011, as the foundation for determining the eligible Hawaii state credit. This divergence adds a layer of compliance complexity, often requiring specialized tax expertise to ensure that all state requirements, particularly those concerning definitions and qualified expense treatment, align with the 2011 iteration of the federal code.3

The History of Incremental vs. Volume Calculation (The Act 139 Reversal)

The most significant recent shift in the administration of the Hawaii TCRA revolves around the method of calculating eligible QREs. This shift dictates whether a business is rewarded for maintaining a high volume of research spending or only for increasing its spending above historical levels.

Pre-Act 139 (Volume Era)

Historically, the Hawaii statute explicitly decoupled from the incremental nature of the federal credit. The original text provided that “references to the base amount in section 41 of the Internal Revenue Code shall not apply, and credit for all qualified research expenses may be taken without regard to the amount of expenses for previous years”.3 This provision resulted in a generous, volume-based credit where the benefit was calculated on the total QREs incurred during the tax year, provided the QHTB also claimed a federal credit.9 This structure greatly benefited established companies that maintained steady, high levels of research spending, allowing them to claim the full credit amount, often leading to total claimed credits exceeding the $5 million annual cap.10

The Act 139 Reinstatement (Return to Incremental)

The legislative session of 2024 saw the passage of Act 139 (SB 2497), which became effective on July 1, 2024, and applies to taxable years beginning after December 31, 2023.6 Act 139 fundamentally changed the credit mechanics by repealing the provision that previously disregarded the IRC §41 base amount.7

This reversal forces the Hawaii credit calculation back to the rigorous incremental method used federally.2 Under this system, only QREs that exceed a company’s calculated historical base amount—derived from past gross receipts and prior research spending—qualify for the credit.2 This action significantly alters the economic calculus for established QHTBs. Firms with consistent or stable QRE levels that previously enjoyed the volume-based credit may now find their eligible state credit drastically reduced or eliminated entirely if their current-year QREs do not sufficiently surpass their historical base. The policy implication of this change is clear: the incentive is now specifically focused on accelerating the growth of R&D spending within the state, rather than merely subsidizing existing research operations.9

3. Eligibility Criteria: Defining the Qualified High Technology Business (QHTB)

Eligibility for the TCRA is strictly limited to Qualified High Technology Businesses (QHTBs), a category refined by Act 139 to target a specific subset of innovative companies.

The Small Business Mandate

Act 139 (SLH 2024) specifically amended the definition of QHTB to mean a small business.6 A small business is explicitly defined as a company with no more than 500 employees.2

This employee cap serves as a legislative restriction, intentionally excluding large, multinational corporations from participating in the state’s incentive program. By focusing the TCRA on firms with 500 or fewer employees, the state channels the limited $5 million pool toward emerging, scaling, and mid-sized entities, thereby prioritizing the economic development goals associated with fostering local innovation ecosystems.6

In-State Activity Thresholds

Beyond size, QHTBs must meet stringent local activity requirements to ensure the tax benefit is tied to verifiable economic activity within the state:

1. Primary Activity: The QHTB must conduct more than 50% of its total activities in qualified research.6
2. Registration Requirement: The business must be registered to do business in the State of Hawaii.6

Mandatory Federal Claim Requirement

The state credit is contingent upon a corresponding federal claim. HRS §235-110.91(c) requires that a QHTB must claim the federal tax credit for the same qualified research activities under IRC §41.3 Furthermore, for calculating the state credit, only those research expenses incurred for qualified research activities conducted in Hawaii are eligible for inclusion in the numerator of the apportionment calculation.2

Scope of Qualified Research

While the base definition of qualified research aligns with IRC §41(d), Hawaii expands this scope to ensure specific, locally strategic technology sectors are incentivized.1

The expanded definition of “Qualified Research” for Hawaii includes:

• The development and design of computer software for commercial marketing (where the business retains substantial intellectual property rights).1
• Biotechnology.1
• Performing arts products (e.g., audio files, video files, commercial film).1
• Sensor and optic technologies.1
• Ocean sciences.1
• Astronomy.1
• Nonfossil fuel energy development.1

This explicit list clarifies the state’s strategic focus, encompassing not just traditional R&D but also creative and environmental technologies deemed critical to the state’s economy.

The critical eligibility criteria post-Act 139 are summarized below.

Table 1: Summary of Qualified High Technology Business (QHTB) Requirements (Post-Act 139)

4. State Administrative Guidance and Compliance Procedures

Compliance with HRS §235-110.91 requires navigating distinct administrative processes administered by two state agencies: DBEDT for mandatory certification and DOTAX for tax filing and collection.

DBEDT Certification Process (Form N-346A)

The Department of Business, Economic Development, and Tourism (DBEDT) manages the critical certification phase of the TCRA. This step is mandatory; without a certificate signed by DBEDT, the credit cannot be claimed with DOTAX.11

Application and Allocation

QHTBs must submit Part I of Form N-346A (Certified Statement of Research and Development Costs) directly to DBEDT during a specific annual application window.13 For the 2025 filing cycle (covering 2024 expenses), the submission period is from March 3 to March 31, 2025.2 The form must report eligible research expenses incurred in the prior calendar year.13

The highly competitive nature of this program stems from the fact that the total amount of certified tax credits is limited to $5,000,000 in the aggregate for all taxpayers each year.4 Certification is provided on a strict first-come, first-served basis up until the cap is fully allocated.2 DBEDT typically reviews submissions and anticipates approving certifications around June 30 following the application period.4 The fee historically charged for claims of $\$25,000$ or more is being waived for the 2025 application period.4

The restricted annual cap means that the effective deadline for taxpayers is not the statutory March 30 submission date, but rather the precise moment the cumulative claims reach the $\$5$ million threshold. This administrative structure compels QHTBs to ensure their QREs are rigorously documented, calculations are finalized, and applications are submitted with precision on the earliest possible day of the filing window to maximize their chances of securing a share of the limited funding.10

Issuance of Certificate

Upon acceptance, DBEDT signs and returns Part II of Form N-346A (the Certificate) to the QHTB.13 If the QHTB is a flow-through entity (such as a partnership or S corporation), the QHTB is responsible for distributing copies of this certificate to its partners, shareholders, beneficiaries, or patrons who will ultimately claim the credit on their individual returns.13

DOTAX Claim Filing Process (Form N-346)

The Department of Taxation (DOTAX) is the office responsible for processing the claim and issuing the refund. To claim the credit, the taxpayer completes Form N-346 (Tax Credit for Research Activities) and attaches all required supporting documentation to their Hawaii income tax return.11

The required attachments include:

1. The certified Part II of Form N-346A (the certificate signed by DBEDT).11
2. Federal Form 6765 (Credit for Increasing Research Activities).11
3. Schedule K-1s (if claiming a pro rata share credit from a flow-through entity).11
4. Schedule CR (if required by the specific tax return being filed).11

The final deadline to claim the credit, including amended claims, is strictly 12 months after the close of the taxpayer’s taxable year.11 Failure to satisfy the certification requirement or attach the necessary forms constitutes a waiver of the right to claim the credit.11

Mandatory Annual Survey and Reporting

In addition to the certification and filing requirements, HRS §235-110.91 requires every QHTB claiming the credit to complete a mandatory annual survey as prescribed by DBEDT.2

This survey is critical for legislative review and collects extensive operational and economic data, including: the number and types of jobs created, compensation levels, external services procured by the businesses, and specific details regarding qualified research activities.15 DBEDT, in collaboration with DOTAX, uses this data to study the effectiveness and economic impact of the tax credit program and submits reports to the legislature annually by September 1.3

The requirement to complete this survey by the June 30 deadline serves as a powerful compliance and enforcement mechanism. If the QHTB fails to complete the survey, they forfeit the right to claim the tax credit.11 This mechanism ensures that the state can continuously monitor the program’s utility and justify the allocation of taxpayer funds, influencing future legislative decisions regarding the program’s extension or modification.10

Table 2: Hawaii R&D Tax Credit: Key Administrative Requirements and Deadlines

5. Mechanics of the Hawaii R&D Tax Credit Calculation (The Incremental Formula)

The Hawaii TCRA calculation methodology is dependent on the federal computation of the incremental R&D credit, which is then adjusted based on the proportion of research activity conducted within the state. The calculation methodology presented here reflects the critical changes mandated by Act 139, reinstating the incremental calculation method.

The Calculation Formula

The statute calculates the Hawaii TCRA by applying an allocation ratio—the ratio of Hawaii QREs to total Federal QREs—to the gross credit amount determined under federal law.2

$$\text{Hawaii TCRA} = (\text{Federal Tax Credit calculated using IRC } \S 41) \times \frac{\text{Hawaii Qualified Research Expenses (QREs)}}{\text{Total Federal QREs}}$$

Step-by-Step Calculation Methodology (Post-Act 139)

The re-incorporation of the IRC §41 base amount calculation (Step 2 below) is the pivotal change implemented by Act 139.2 This calculation follows the federal Regular Method (or ASC method, if applicable), as modified by the 2011 fixed-date conformity rules.

Illustrative Example: Calculation of the Hawaii TCRA (Post-Act 139)

This example demonstrates the incremental calculation methodology for a Qualified High Technology Business with operations both inside and outside Hawaii.

Scenario: Hānai Tech, Inc. is a certified QHTB operating in both Hawaii and mainland U.S. states. The company employs 40 people.

Financial Data (Taxable Year 2024):

• Average Annual Gross Receipts (2020–2023): $10,000,000
• Fixed-Base Percentage (established for Regular Method): 5%
• Total Federal QREs (Global): $1,200,000
• Hawaii QREs (In-State): $480,000

Calculation Steps:

1. Total Federal QREs (Step 1): $1,200,000
2. Federal Base Amount (Step 2):

• Initial Calculation: $10,000,000 (Avg. Gross Receipts) $\times$ 5% (Fixed-Base %) = $500,000.
• 50% Floor Test: 50% of Total QREs ($1,200,000) = $600,000.
• The base amount is the greater of the calculated base or 50% of current QREs. The statute requires the base not to be less than 50% of current QREs; however, standard federal practice establishes the floor test to ensure a substantive incremental hurdle. Assuming the typical Regular Method application, the base amount used is the calculated base, provided it meets the IRC §41 criteria. Based on the provided guidance 2, we use the calculated base: $500,000.

1. Federal Excess QREs (Step 3):

• $1,200,000 (Total QREs) – $500,000 (Base Amount) = $700,000

1. Gross Federal Credit (Step 4 – 20% Rate):

• $700,000 (Excess QREs) $\times$ 20% = $140,000

1. Hawaii QREs (Step 5): $480,000
2. Hawaii Allocation Ratio (Step 6):

• $480,000 (Hawaii QREs) $\div$ $1,200,000 (Total Federal QREs) = 40% (0.40)

1. Final Hawaii TCRA (Step 7):

• $140,000 (Gross Federal Credit) $\times$ 40% (Allocation Ratio) = $56,000

Result: Hānai Tech, Inc. is eligible to apply for a refundable Hawaii R&D Tax Credit of $56,000.

The calculation clearly demonstrates the two-step allocation process: first, the credit is limited only to the incremental research spending globally (due to the Base Amount reinstatement), and second, that incremental credit is prorated only to the extent the QREs were incurred within Hawaii (40% in this case). This proportional mechanism ensures that the state only incentivizes the portion of the R&D increase directly benefiting the local economy.

6. Economic Context and Strategic Planning

The administration of HRS §235-110.91 is characterized by high competition and active regulatory enforcement, factors critical for business planning.

Program Utilization and Competition

The Hawaii TCRA is highly utilized and frequently oversubscribed due to the constraint of the $\$5$ million annual aggregate cap.5

Data collected by DBEDT highlights the intense competition in the years preceding Act 139:

• For the tax years spanning 2020 through 2023, the total amount of tax credit claimed by QHTBs consistently exceeded the $5$ million cap, often totaling between $11.9 million and $13.3 million.10
• Consequently, statistical records show that between 17 and 30 QHTBs were not certified each year during that period solely because the $5$ million limit was reached on a first-come, first-served basis.10

The data for the 2024 tax year application cycle, reflecting the implementation of Act 139, shows a notable change in utilization and certification rates. While 23 QHTBs applied, 18 were certified, but the total certified credit amount only reached $2.6 million, failing to meet the $\$5$ million cap.10

This drop in total certified dollars, despite a stable number of applicants, suggests that Act 139’s changes had a tangible impact on claimant eligibility and calculation. Specifically, the reinstatement of the incremental base amount calculation likely lowered the calculated credit for several established companies, while the newly enforced 500-employee limit and the rigorous 50% in-state activity rule likely led to the disqualification of firms.6 The fact that 5 QHTBs were disqualified in 2024 (as opposed to being merely uncapped) indicates that DBEDT is rigorously enforcing the tightened QHTB definition introduced by the Act.10

Table 4: Hawaii Research Tax Credit Applications and Utilization (2020–2024)

Strategic Planning Recommendations for QHTBs

For businesses seeking to maximize their benefit under the revised HRS §235-110.91, several strategic steps are necessary:

1. Verify QHTB Status Under Act 139: Businesses must confirm strict compliance with the updated QHTB definition, ensuring employee count remains below the 500-person limit and that more than 50% of the company’s qualified research activities are conducted within Hawaii.6
2. Master the Incremental Calculation: Due to the re-instatement of the base amount, businesses must accurately calculate their historical fixed-base percentage and average gross receipts for the four preceding years to forecast the current year’s eligible incremental QREs.2 Businesses with stable research spending levels may need to deliberately increase their QREs to generate a qualified incremental increase above the calculated base.
3. Prioritize Application Timing: Given the first-come, first-served allocation of the $5 million cap, compliance teams must be prepared to submit Form N-346A to DBEDT on the first possible day of the application window (early March). Proactive, year-round documentation of QREs is essential to ensure readiness.13
4. Maintain Comprehensive Documentation: Meticulous records must be maintained to clearly separate Hawaii QREs from non-Hawaii QREs and to prove that all claimed expenses meet the qualified research definitions aligned with the 2011 IRC §41 standards.9
5. Ensure Survey Compliance: The mandatory annual survey required by DBEDT must be completed by the June 30 deadline. Failure to submit this survey, even after certification, will result in the forfeiture of the right to claim the credit.11

7. Conclusion

HRS §235-110.91 is a robust, refundable tax incentive crucial for promoting the high-technology sector in Hawaii. However, the legislative overhaul enacted by Act 139 (SLH 2024) has fundamentally redefined its application for tax years beginning after December 31, 2023.

The key takeaway for businesses is the dual impact of Act 139: the program is now exclusively targeted toward small businesses (under 500 employees), and the calculation methodology has reverted from a generous volume-based approach to a stricter incremental approach. This shift ensures that the state’s limited incentive dollars are focused on rewarding accelerating growth in R&D spending, rather than maintaining existing expenditure levels.

Compliance is inextricably linked to administrative timeliness and precision. QHTBs must manage a complex timeline involving two agencies—DBEDT for certification and DOTAX for claiming—and must navigate the high-stakes, first-come, first-served application process to secure a portion of the competitive $5 million annual cap. Detailed calculation using the restored incremental formula and meticulous documentation supporting the in-state QREs are essential preconditions for successfully claiming this valuable refundable tax credit.

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