Matthew DeMello:
One of the bigger state-level trends impacting R&D currently is the establishment of “innovation zones” or “districts of innovation”. To stick with that term for right now, what exactly are innovation zones and what states have them?
Lydia Clowney:
To define them is going to be tough. There’s really no definition or no one definition of innovation zones. They’re going to be different state to state, jurisdiction to jurisdiction. So we’re going to have to talk about them in a little bit of a loose way. The terms used to denote a region. Typically it’s a geographic region, but that’s not always the case.
So basically an innovation zone is a place where the rules are different. And what rules? It depends on the innovation zone. So states with innovation zone programs of some kind adds a lot of them. Yeah. Arkansas, Colorado, Georgia, Idaho, Kentucky, Mississippi… I could go on about half the states in the country have them. And weirdly, [there’s] a lack of them in the west coast states. Although actually Nevada has proposed one. That’s very controversial that I think we’re going to be able to get into a little bit later.
Matthew DeMello:
Yes. But just as a term, it really is kind of denoting how these innovation zones are exceptions that prove the rule, and of course that’s what we’re talking about today. Starting to examine the states with the more notable innovation zone programs starting with New Jersey, because that state’s programs intersects with a tax certificate program that’s very interesting. Tell us about what’s going on in New Jersey.
Lydia Clowney:
Yes, the New Jersey innovation zone program intersects with the tax certificate program and that has an impact to their R&D program. So this is one state where these initiatives kind of do go hand in hand with tax credits, and that’s not always the case. As we said in the beginning, it’s kind of going to be different depending on the particular rules. But in New Jersey, it actually does have an impact on R&D tax credits. So the New Jersey economic development authority put this into place and deadline actually just passed to submit for 2021. But this is something that companies do on an annual basis. Essentially, it enables qualified unprofitable, New Jersey based technology or biotech companies to sell a percentage of their net operating losses, their NOLs, or their research and development credits to unrelated but profitable companies.
So there are some certain restrictions on this. You have to have fewer than 225 US employees and that does include at related companies like parent company subsidiaries. There’s also a minimum employment threshold for companies that want to make a sale like this. But if you qualify, you are allowed to sell instead of carrying forward your NOLs until whenever you’re profitable and applying them against tax, you can actually sell those NOLs and those R&D tax credits.
Now they have to be sold for at least 80 percent of their value. And companies are limited to a maximum lifetime benefit of $20 million per business. But companies are doing this though, there was a recent example of a company selling $1.3 million of its available tax credits to a company. We don’t know what company it was. It was an unrelated, profitable New Jersey company. And so a company would want to buy a tax credit like this because maybe they’re not doing their own research and development, they have tax to offset, and essentially they can get those credits for less than they’re worth. The selling company has to sell them for at least 80 percent of their value. But you know, there’s some space between 80 percent and 100 percent. So the company that’s buying is making a little bit of money on that. They’re gaining more value than they have paid out.
Matthew DeMello:
So let’s start examining states with the more notable innovation zone programs starting with New Jersey, because that state’s program intersects with a tax certificate program that’s very interesting. Tell us what’s going on in New Jersey.
Lydia Clowney:
So New Jersey’s cool because they allow companies to sell unused R&D tax credits, and actually NOLs as well, on an open market for money. And so let’s imagine you’ve been doing research and development activities but your company isn’t paying tax in New Jersey. Well, what do you do with that tax credit at that point? If you’re not paying tax because you’re in losses, then you might have a large NOL carry forward as well.
And [if or likely] you’re a startup, you’re probably looking at that and saying, “Well, what good is this to me if I can’t use it for years?”
So when New Jersey allows you to do is sell those credits to someone else, to an interested, unrelated third party that has tax liability and would like to offset it. So a company that has these losses, they can sell them. They have to sell them for at least 80 percent of their value.
And there is a maximum lifetime benefit of $20 million per business. I’ll say too, it’s only certain companies that are going to be allowed to use this program. There are limits both from a minimum threshold and a maximum threshold with regard to the number of employees you have to have. [There are] a couple other requirements as well, but it is a way that you can turn unused, NOLs, and tax credits into capital immediately, as opposed to waiting for when you have tax liability.
Now only technology and biotech companies can take advantage of this program. You have to have filed for, or have a license to use protected intellectual property. Again, a lot of restrictions, but if you fall into this area, then you get to monetize those credits immediately. And on the other side, a company that is profitable and has New Jersey tax liability can, can buy those credits and can take advantage of them where otherwise they might go on you. So the program is capped at a certain dollar value per year for these sales, $75 million annually, but $10 million of that is set aside for businesses that are within innovation zones. So their preference in a certain way. And that’s how you get that intersection between innovation zone and the tax credit program.
Matthew DeMello:
I’m assuming then that these NOLs and R&D tax credits can only be sold to other companies that are paying tax in New Jersey.
Lydia Clowney:
To use a tax credit, you have to have tax liability. So I can’t imagine the company would want to buy them if they weren’t paying tax in New Jersey,.
Matthew DeMello:
Which brings us to Nevada as we were prophesizing before Nevada doesn’t have innovation zones currently, but the governor has proposed them albeit in a controversial form that received some pushback. What can you tell us about Nevada’s innovation zones and how they would compare to New Jersey’s?
Lydia Clowney:
I think this is such an interesting comparison because they really have nothing to do with one another. And I think that highlights how different these, programs are from state to state, from jurisdiction to jurisdiction. In Nevada – and to be clear this is only a proposal and it, like you said, it did get a heck of a lot of pushback. So I don’t know if we can expect to see this go into effect anytime soon, if at all, but, but interesting to see what people are thinking about and conceptualizing as potential ways of encouraging research and development or innovation more broadly.
So basically Nevada’s proposal says that a company and there, of course there are going to be a lot of restrictions on what kind of company and who can do this, but a company could essentially set up its own sub government self-governing political subdivision within Nevada that is administratively separate from the county that it otherwise would be a part of. So the big name here in terms of the company that was kind of the poster child for this program, or this proposal is a company called Blockchains LLC. And by the name, you can probably tell what they do. They are trying to push forward blockchain technology and certain other softwares that kind of intersect with that.
So the requirement is that a company have at least 50,000 acres of vacant land within a single county. Um, so blockchains LLC, they bought like 67,000 acres of land in Storey County, $170 million in 2018. And the county starts out with control over everything in the innovation zone. It, so they still have control over the public services, they receive the taxes, et cetera, but eventually control over the administration of this area, including even school districts, not to mention taxes, public services, even utilities would go to a newly set up government within this area.
So it’s, it’s really interesting. It’s almost … well actually Stephen Colbert called it “neofeudalist” in a pretty interesting YouTube clip there. [Matt and Lydia laugh.] You know, there are things, there are rules that the proposal contained, like there have to be commitments to invest certain dollar amounts in the area. Maybe there would be employment regulations saying you have to create so many jobs, or this or that. And certainly there are a lot of promises being made by companies like Blockchains to say that they will make certain investments and create jobs, but there’s a lot of backlash. I mean, we call it neofeudalist for a reason. It’s taking control away from the government and giving it to an oddly set up sub government that in some ways seems to approximate a company town like in kind of the old days of gold rush days.
Matthew DeMello:
Indeed. So what’s your opinion on Nevada’s version of innovation zones? What do you think they could do to make it a more palatable proposal?
Lydia Clowney:
[Laughs.] To ask what to do to make it more palatable implies that it is not palatable? And if I’m completely honest, I.. it’s not to my taste. I think we’ve seen a lot of promises over the years of think about, well, I’m in the Midwest. So think about the Foxcon plant. And that was promised in Wisconsin, they were going to invest billions and billions of dollars that are to create tens of thousands of jobs. And, you know, here we are five years later, nothing has materialized. So we’ve seen this kind of promise before, and I’m truly skeptical that a government could be set up essentially to serve a single company and not end up with the result of really serving that single company to the exclusion of others within that region.
I’m not sure what you do to make it more palatable. To me, I’d probably scrap the whole thing and try again.
Matthew DeMello:
Rip it up and start again as the song goes. So what do you think Nevada wants to get out of this kind of proposal?
Lydia Clowney:
Yeah, I think Nevada is trying to encourage these large companies to come into their state. I think that they think that something will come from that, whether it’s excitement about the state. Maybe they think that people with high tech degrees will move to the state to work for these companies. You remember when Amazon was looking for a new headquarters, why was any state trying to woo Amazon to build a headquarters there? It’s going to be similar justifications by state and local governments in terms of trying to incentivize these companies to move into their areas. Now, whether that’s foolish or smart… that’s an open question.
Matthew DeMello:
So innovation zones are along the lines of certain patent box regimes we’ve seen all over the world in recent years where countries are trying to get companies to set up technology headquarters in places other than say Silicon Valley… is sort of what I’m getting from this.
Lydia Clowney:
Yeah, I think there’s probably some truth there. I think there are reasons why people live in a place like San Francisco, for instance and you mentioned Silicon Valley. And it’s not just because those companies are there. The companies are there in a large sense because the people are there and why are the people there? It’s because San Francisco’s a really cool city. There are certain mechanisms that companies have that, that state and local governments have to push through. Some of these initiatives try to get the companies to move. But if you don’t have the people, if you don’t have the intellectual resources, it’s probably not going to work out well. So to me, it seems like a better plan to kind of encourage that would be to actually invest in infrastructure and resources throughout the country. I mean, if we don’t have like working excellent internet in the whole country, then no company is going to go to a place without it.
Matthew DeMello:
But there is sort of a chicken and egg question as well, right? As in, do the companies come first or do the people come first? Do the companies come because of the people or do the people come because of the company because of the job opportunities.
So this is straying a bit from our state level R&D subject, but as US R&D initiatives are so tied up with the economic competition with China, we’d be remiss to overlook the innovation zone initiatives in that country as well. What can you tell us about China’s innovation zones and how they’re contributing to the intense overall R&D project initiated there?
Lydia Clowney:
China is basically hitting every lever that they can in terms of encouraging R&D, encouraging high-tech innovation, and related initiatives. So absolutely: They are trying to lead the world in AI by 2030. And their innovation zones and those programs date back to the 1980s, so they’ve been around for a while. They’ve been especially focused on AI development and really we’ve seen a lot of advancements in the areas that they’ve targeted.
So at this point there are a number of innovations zones and they are scattered across the country. There were recently about five new ones instituted, and again, they are all over. So they are in Beijing, they’re in Tianjin, Zhejiang… really a number of cities and provinces. And they’re looking at accelerating R&D. They’re looking at algorithms, software, hardware – again, definitely focusing in a lot on AI and that kind of future of technology.
There are some differences I will say there are some differences to the US state-level level zone initiatives, probably really aren’t many parallels when we look at the Chinese initiatives and the US states. But on the other hand, we do have some federal programs that are a little bit more similar, a better comparison to the Chinese innovation zones is probably with the recent US Innovation and Competition Act. So this kind of built on the Endless Frontier Act. We’ve talked about it a little bit in some other podcasts, but it’s really focused on improving R&D and it institutes regional technology hubs. And I would almost think about the regional technology hubs as more akin to the Chinese innovation zones. And this bill also focuses on robotics, semiconductors, AI cybersecurity — so really hitting all those same things that the Chinese innovation zones are focused on.
Matthew DeMello:
Indeed. And checking back in with the US to close this discussion, are you aware of any other state level R&D initiatives similar to innovation zones that exist currently or are being proposed?
Lydia Clowney:
I like when we were talking about with China, probably nothing from the state level… Maybe the closest thing is, again, that US Innovation and Competition Act. We also have another concept kind of related to the innovation zones called opportunity zones. And I’d say those are maybe a little bit more similar. These would be geographic areas within states that are preferenced for some of these items. Now, the difference is that the opportunity zones are in distressed areas as opposed to being in advantaged areas like the Chinese initiatives, but they are provided for by a federal statute. And they provide for benefits that you wouldn’t be able to get if you were outside of that region. So that’s probably the closest thing.
