Posts Tagged ‘Caribbean Rum Subsidies’

Rum Cover Over Tax

Sunday, March 3rd, 2013

Nearly one hundred years ago the US Congress initiated what has become to be commonly known as the Rum Cover Over tax. Without knowing anything about rum, the reader should understand that something is being covered over and the word tax should tell you that it involves money. If you drink rum in the US, it’s your money.

For the last 80 years or so, no one really talked much about this line in the congressional archives that gave money back to the US Virgin Islands according to the federal tax that was paid in the form of Federal Excise Tax on sugar cane spirits imports from that Caribbean territory.

Currently the Federal Excise Tax, or FET as it is known in the industry, on a 750ml bottle of alcoholic beverages at 80 proof, the standard bottle you’ll find on a liquor store or bar shelf is or 40% alcohol is $2.17. One liter and 1.75 liter bottles are taxed $2.89 and $5.06 respectively. Back in 1917, the US government agreed to give back to the US Virgin Island general fund, most of that tax, which was smaller in those days. Since the money came back to the USVI general fund, it could be used for whatever purpose the local governor thought best served his islands.

About 1957, Puerto Rico appealed to the fine folks in Washington for the same deal. And they confirmed what fine folks they are, by giving Puerto Rico the same benefits that their windward neighbors had been enjoying the previous 40 years. Bacardi was in the process of gearing up production in Puerto Rico and it wan’t long before the tax on that rum sold in the US brought considerable dollars back to the island. The Puerto Rican government recognized that by passing on some of the money that Bacardi and other distilleries on the island were generating to the distillers themselves in the form of marketing assistance that even more money would come south from Washington, D.C. And it did.

The rest of the tax money would go to the Puerto Rican general fund and go to build schools and buy lavish houses and yachts for those elected to disperse that money from the general coffers. In the Virgin Islands, the story is similar but names of the people and companies involved differ.

And then came Diageo. No. That isn’t exactly true. Diageo had been buying rum from Serralles since the late 20th century for their Captain Morgan brand rum after they acquired that brand from Allied Domencq. Historically, Diageo didn’t own their rum distilleries as Seagrams had in the last century. But as the Captain Morgan and other brands grew, Diageo began searching for a place to build a modern rum distillery. They were already buying rum from Venezuela – Pampero and Cacique, and Guatemala – Zacapa, but they wanted to build a distillery so they could more closely manage their production costs in a stable political environment. The decision of where to build was also influenced by the value of the concessions afforded them by the host country. Being a British company and since the British Virgin Islands are too small to accommodate a project of this size, Diageo went to the US Virgin Islands began the conversation about building on St Croix.

Rum production on St Croix dates back centuries, almost to the introduction of sugar cane to the Caribbean by Christopher Columbus to what he called the West Indies in 1493. Well, Chris, didn’t actually carry the sugar cane with his own hands, he was too busy for that, but he was the guy that got the Queen of Spain to finance his trip after successfully returning from a shakedown cruise the previous year. Sugar cane, was one of the plants he brought which he claimed he would use to start a new Spanish colony in the New World. Closer to the truth was that starting a Spanish colony would give the conquistadors a base from which to explore, or more accurately exploit, the riches of the New World.

By the 18th century, St Croix was a patchwork of sugar cane fields. Even today you can see the remains of sugar mills and distilleries from almost anywhere on the largest of the US Virgin Islands. Lacking a protected port like Charlotte Amalie on St Thomas, St Croix didn’t develop as the trading center but rather the agricultural center of the Virgin Islands.

In the last century only two distilleries remained until hurricane Hugo destroyed the Brugal distillery in 1989. Since that time the Cruzan distillery has grown through a number of acquisitions and takeovers as international companies recognized the quality of the rum produced and aged on St Croix. Everything changed a few years ago when the US Virgin Islands governor made a deal with Diageo to build a distillery not too far from Cruzan. But there was going to be a big difference, Diageo would get back half of the rum cover over tax money that it generated. Governments giving industries incentives to invest in their region is nothing new, but in this deal, Diageo would get back more than their cost of production for any sugar cane spirit sold in the US and thence taxed by Uncle Sam, their new favorite uncle.

And there was more, St Croix would help finance the construction of the distillery through bonds guaranteed by the money that would be generated by the new distillery. A match made in political heaven. Not many businesses get back more than their cost of production even before they get paid for their product.

Five hundred years after the Spanish sailed by what are now the Virgin Islands because they didn’t see the golden treasure they were looking for, it seems Diageo has found more than gold.

As you might expect, Puerto Rican rum producers cried foul because by their laws only a small percentage, less than 20% of the rum cover tax received by the Puerto Rican island government could go to the rum producers themselves. Another percentage would go to Rums of Puerto Rico, that promotes all of the rums from that island.

The owners of the Cruzan distillery also felt a bit slighted but were able to negotiate some low cost loans to they could modernize their facility and compete a bit more fairly with their new neighbor. Unlike Diageo, Cruzan depends on aging their rum, a process that ties up a lot of money and resources. But like Diageo, Serralles and Bacardi, Cruzan also sells a fair bit of fresh bulk rum to blenders and bottlers that use it for a myriad of products some of which don’t even have the word rum on the label.

But don’t think for a minute that this is just a local controversy between a couple of neighboring islands over an estimated $30 billion over the next 25 or so years. Almost every rum producer in the Caribbean has cried foul claiming Diageo and other US Caribbean rum producers are enjoying unfair advantages in what is supposed to be free and level market.

Most of the those people have forgotten the $5 million euros the EU spent a few years ago to promote Caribbean rum. But even if Diageo had orchestrated that promotion and paid the entire bill itself, it would have paled in comparison to this deal. There have been rumblings of misconduct by Congressmen, but that’s mostly died down as business as usual as there were more important issues during the last US presidential election. And there has been talk about a suit against the US in the World court. Who will finance such a court battle is yet to be seen. Every rum producer and rum producing country has their own interest and though unity is probably the only way such a challenge could succeed, the reality just isn’t that simple.

The Dominican Republic rum producers claim to be harmed by the Diageo rum cover over tax deal. The reality is that only rum sold for consumption in the US is subject to the rebates. And much of the rum produced on the Dominican Republic, less than 100 miles downwind from Puerto Rico, is distilled on Trinidad or Panama and then blended and bottled in a free trade zone on the south coast of the DR. The next time you pick up a bottle of rum, look for the country of origin of the rum, not just the country where the rum was produced.

The Dominican Republic government receives a lot of aid from Uncle Sam and many influential Americans including the Clintons vacation on the south coast of the DR. Although the blended and bottled rum market is important to the DR for employment, there are little to no alcohol tax paid in that country since the bottling industry operates in a free trade zone and most of those products are not sold on that island.

Historically, the West Indian Rum and Spirits Producers have failed to cooperate as a group to do much of anything. In 2000, they agreed not to adopt any best practices for their industry, so it seems unlikely that they will be capable of uniting on something even this important to them. In the bigger picture, this as an opportunity to differentiate between the rum that is being distilled and bottled by Diageo and that which has decades, if not centuries, of tradition. Certainly the Caribbean rum producers on Barbados, Trinidad, Panama, Jamaica, Antigua, St Lucia and others are justified in feeling that they are at a disadvantage, but they have so much more to sell in terms of authenticity and heritage if they wanted to be more transparent. It should be noted that the tax advantage is greatest for a company that is selling the cheapest, freshest rum. The price of an older, more expensive rum isn’t affected by the cover over tax nearly as much as a young, cheap rum. And as the rum market expands, imbibers are looking for better products with less regard to what even Diageo admits is a high fructose corn, flavored, sugar cane spirit.

There is a lot of uncertainty in the future of this controversy. (Don’t get me started on the corn subsidies that are destroying the health of livestock and the American population. Please). But there is one indisputable fact that is as clear as the words on this page. When everything thing is said and done, there will have been a lot more said than done.

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