On April 1, 2010, Governor Pawlenty signed into law the Minnesota Small Business Investment Tax Credit (the “Angel Investment Tax Credit”). Vigorously pursued by several investor and trade groups to encourage investment in emerging companies in Minnesota, and passed by an overwhelming majority in both the Minnesota House and Senate, the new law creates a credit against Minnesota income taxes equal to 25% of a taxpayer’s investment in a “qualified small business.” To qualify for the credit the investment must be: 

  • a “qualified investment”;
  • in a “qualified small business”;
  • by a “qualified investor” or “qualified fund.”

In order to be “qualified,” businesses, investors and funds must apply to, and be certified by, the Minnesota Department of Employment and Economic Development (“MNDEED”). Additional application must be made to request the tax credit within 60 days prior to each investment, and it is on the basis of this tax credit request application that credits will be allocated.

The Angel Investment Tax Credit is not unlimited: only $11 million of tax credits will be approved annually for investments made during tax years beginning after December 31, 2009 and before January 1, 2012, and $12 million annually for investments during tax years beginning after December 31, 2011 and before January 1, 2015. Qualifying investments will be approved on a “first come first served” basis, with tax credit applications received on any single day pro rated if they exceed the annual limitation.

Qualified Investment
To be a “qualified investment,” the investment must be:

  • in cash;
  • in exchange for equity securities (including common stock or convertible securities); and
  • for a minimum of $10,000 for a qualified investor, or $30,000 for a qualified fund.

Qualified Small Businesses
To be certified as a qualified small business, MNDEED will require that the business satisfy all of the following conditions:

1. It must be a Minnesota business. The headquarters of the business must be in Minnesota, at least 51% of its employees must be employed in Minnesota, and 51% of its total payroll must be paid or incurred in Minnesota.

2. It must provide innovation in a qualifying industry. The business must engage in, or commit to engage in:

  • research and development for, or use of proprietary technology in, a product, process or service in a qualified high-technology field, including most traditional high-technology industries, and agricultural and greentech industries; or
  • research, development, or production of a new proprietary technology for use in agriculture, tourism, forestry, mining, manufacturing, or transportation.

Specifically ineligible for the credit are investments in businesses engaged in real estate and financial services, most forms of consulting, wholesale or retail trade, professional services, transportation, construction, or ethanol production from corn.

3. It must be small, independent and young. The business must have fewer than 25 employees, not be a member of a unitary group that employs more than 100 employees, and not have been in operation for more than 10 consecutive years.

4. It must not have received significant funding. The business must not have previously received private equity investment of more than $2,000,000.

The aggregate amount of tax credits that will be allocated to any qualifying small business is limited to $1,000,000.

Qualified Investors and Funds
The Angel Investment Tax Credit is available only to investors or investment funds that have applied to MNDEED for each year in which an investment is made and been certified as “qualified investors” or “qualified funds”. To be “qualified,” an investor is required only to certify to MNDEED that his or her investment will be made in a transaction registered under Minnesota’s small corporate offering registration, or exempt from registration under the institutional investor exemption or limited offering exemption. A qualified fund is required to certify that it invests in qualified small businesses, is organized as a pass-through entity, and has at least three separate investors, all of whom are “qualified investors.”

The amount of tax credit that can be claimed by any individual investor, whether as a qualified investor or member of a qualified fund, is limited to $250,000 if the investor is married and files a joint return, and $125,000 for all other investors. Further, a tax credit is unavailable to any investor, or member of an investor’s family, who derives more than 50% of his or her annual gross income from the qualified small business in which he or she proposes to invest.

If the investment is not held by a qualified investor or qualified fund for at least three years, any credit taken by the investor must be repaid, and any unused credits are revoked. The three-year holding period does not apply, however, if the investment becomes worthless; the qualified small business or more than 80% or its assets are sold; or the common stock of the qualified small business begins trading on a public exchange

Certification and Application
Applications for certification as a qualified small business, qualified investor, or qualified fund will be available on MNDEED’s website by August 1, 2010 and will require an application fee. Application is required prior to the date of the investment (or if the investor is not “accredited” under federal securities laws, within 30 days after the investment). MNDEED is required to approve or reject an application, or request additional information, within 30 days of receipt, or the application is deemed rejected and the fee is returned.

Qualified investors and qualified funds must submit another application to “request” the credit when an investment is to be made, and it is on the basis of this application that the MNDEED allocates available credits in any year. The form of this application will be posted by MNDEED on its website and MNDEED must begin accepting applications by September 1, 2010. MNDEED is required to approve or reject this application within 15 days of receipt, and the investment must be made within 60 days of this approval. After investment, the qualified investor or qualified fund must again notify MNDEED of the investment, and MNDEED is required to issue a tax credit certificate for the amount of the credit that it previously approved.

Reporting and Loss of the Credit
The Angel Investment Tax Credit imposes ongoing reporting requirements in addition to the certification and application requirements. Qualified small businesses that receive qualified investments and qualified investors and funds that receive tax credits must submit an annual report (and a $100 fee) affirming that they continue to meet the requirements for the credit, before February 1 of each year. This report must be filed for three years following the investment for qualified investors and qualified funds, and five years for a qualified small business. Failure to file a report results in a fine and revocation of the credit. Further, if a qualified small business can no longer certify that at least 51% of its employees are employed in Minnesota, and 51% of its total payroll is paid in Minnesota, a portion of the credit is revoked and subject to repayment.

Use of the Credit—Out of State Investors
Unlike earlier versions of the legislation, the final Angel Investment Tax Credit does not limit use of the credit to taxpayers who have liability for Minnesota income taxes. An out-of-state investor will be entitled to a refund in the amount of the credit, regardless of the lack of Minnesota taxable income, if the investor files a return in the state.

Clarification: Procedures and Forms
The new Angel Investment Tax Credit provides a much needed tangible benefit for investment in young Minnesota companies that should cause the state to become more competitive with some of its neighbors. Although the legislation is fairly complete, many of the forms and procedures required to obtain the credit are yet to be created. We anticipate that these forms and procedures will clarify some of the ambiguities contained in the new law when they are posted by MNDEED prior to this coming September.