Impact / February 15, 2009
By Larry Luxner
A decision by Diageo PLC to transfer production of its Captain Morgan rum brand from Puerto Rico to the U.S. Virgin Islands could cost the Puerto Rican government more than $100 million in federal rum tax rebates — with some local politicians warning it could put the entire rum tax rebate program at risk.
On Jan. 9, the British drinks conglomerate announced it would construct a $165 million distillery on 26 acres of land belonging to the St. Croix Renaissance Group. The lease agreement is for an initial 11-year term, with five 10-year renewal options.
When completed, the facility will have the capacity to produce 20 million proof gallons of rum annually. Myron Allick, Renaissance's vice-president of operations, said Diageo should begin producing rum there next fall, with sales of locally produced Captain Morgan rum beginning in 2012.
"I think this will make a serious difference in our economy," Allick told a local newspaper. "It's already an industrial zone, we have a deep-water port, and we have affordable energy."
The deal follows legislation passed last July and signed into law by USVI Gov. John de Jongh that gives Diageo a series of tax incentives and subsidies in exchange for Diageoís guarantee that it will produce all its U.S. distribution of Captain Morgan from the new St. Croix distillery for 30 years.
As part of the package, the Virgin Islands Public Finance Authority has authorized the issuance of up to $50 million in short-term financing to fund early-stage development costs. This is part of an overall $250 million financing arrangement, under which the PFA will float bonds to finance construction of the distillery. Those bonds will be paid back with federal excise rum tax rebates — currently $13.25 per proof gallon of rum exported to the U.S. mainland.
Kenneth McClintock, Puerto Rico's secretary of state and lieutenant-governor, said the loss of over $100 million a year in rum tax rebate revenues by fiscal 2011 is a "major hole caused by the inaction of the previous administration" of Gov. Anibal Acevedo Vila.
"Historically, the reason for these rebates has been to improve the lives of people in the territories, [not] simply a conduit for giving back taxpayer money for the benefit of a major alcoholic beverage producer," he told Impact.
McClintock noted that Puerto Rico already faces a record $3 billion fiscal deficit, and that Captain Morgan's departure will only make things worse. "We must create a more positive environment for investment here," he said. "Our main economic strategy is to get the economy moving again."
Various Puerto Rican media outlets have reported that Diageo will get — as part of the agreement — a 90% reduction of corporate income taxes and 100% exemption from property taxes, gross receipt taxes and excise taxes for construction, equipment and supplies for the distillery. The Virgin Islands will also give 35% of annual excise tax rebates from the sale of Captain Morgan rum for marketing, an additional 8% of excise tax rebates to be used for any purpose, and help cover its raw material costs through a molasses subsidy.
In return, Diageo promised invest at least $150 million in the project, and employ at least 40 people, 80% of which must be Virgin Islanders.
"Diageo, therefore, will be awarded at least close to or 50% of the total rebates in consideration of its sourcing of its Captain Morgan Flavored Rum requirements from the U.S. Virgin Islands instead of its present Puerto Rico source," said Rep. Antonio Silva, chairman of the Puerto Rico House Treasury, in a letter to Usie Raymond Richards, president of the Virgin Islands Senate.
That means the deal could put the rebates at risk not only for the Virgin Islands but for all U.S. possessions including Puerto Rico.
"It's a major change in the way you use the money that could raise some eyebrows in Congress," McClintock told Impact. "There have been years in which the rum tax rebate has not been appropriated by Congress and later they play catch-up. So it's not automatic. You have to be careful not to rock the boat too much."
Diageo currently sources rum stocks for Captain Morgan from a third-party distillery, Serralles, in the Puerto Rican city of Ponce. The brand has been made by Serralles since 1985, making it (along with Bacardi and Ron Castillo) among the top-selling U.S. rums manufactured in Puerto Rico, with worldwide sales of over 7.5 million cases annually.
Yet Diageo could not reach an accord with Serralles, and as a result Puerto Rico will cease to earn $112 million a year generated by taxes on Captain Morgan rum once Diageo's contract with Serralles expires on Dec. 31, 2011, and production is shifted to the new distillery on St. Croix.
"The USVI-Diageo agreement goes against the spirit of the rum tax rebate law because it uses federal funds to pit two U.S. jurisdictions against each other in a bidding war," said Boris Jaskille, executive director of the Puerto Rico Industrial Development Company, which oversees the Rums of Puerto Rico office. "Our goal is clear: to retain Captain Morgan and effectively position other brands, to strengthen our leadership as the rum capital of the world."
Rums of Puerto Rico had given Diageo close to $25 million — an average of $3.5 million a year — in marketing for Captain Morgan over the past seven years. Yet the Virgin Islands is offering Diageo $35 million a year in marketing funds, backed by the federal rum tax rebates.
"The USVI offer is truly profitable for them, but Diageo's relationship with Puerto Rico has always been excellent and the brand has grown with us," said Karen Garnik, chief marketing officer for Rums of Puerto Rico.
Assuming Rums of Puerto Rico loses its battle to keep Captain Morgan in the family, the agency already has a Plan B: it'll work with other brands like Bacardí, Don Q, Ron Barrilito, Ron Reserva Añeja and Ron Llave.
"We can reallocate the $3.5 million we would have given Diageo annually to help these brands penetrate more markets," said Jaskille.
For example, Don Q rum sales in the United States jumped by over 80% in 2007 and 45% in the first half of 2008. ìIf Don Q continues to grow like this, it could make up for what Captain Morgan generates if it were to leave Puerto Rico," said Garnik.
Rums of Puerto Rico is also working to attract new brands to the market by researching when contracts with their manufacturers expire, in an effort to bring lure their production to Puerto Rico and further compensate for the loss of Captain Morgan.