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Sticker shock

Hefty taxes on automobiles will cost Puerto Rico consumers $700 million in fiscal 2006

By Jose L. Carmona of Caribbean Business

August 11, 2005
Copyright © 2005 CARIBBEAN BUSINESS. All Rights Reserved.

Government carjacks auto buyers

For the second time in four years, the commonwealth government strikes yet another blow to consumers and auto distributors, making the price of cars in Puerto Rico 30% to 40% higher than on the U.S. mainland

As if having to deal with carjackings, traffic jams, potholes and caved-in streets, increased toll fees, and sky-high gas prices weren’t enough already, local car owners soon will be slammed with yet another hit, one that surely will put a deeper dent in their already cash-stricken wallets. Car buyers in Puerto Rico already pay 30% to 40% more for new automobiles in Puerto Rico than consumers on the U.S. mainland.

Now, in addition to the $60 million in vehicle license fees and $585 million in excise taxes Puerto Rico car owners will pay this year, the government wants to drain an additional $17 million from their pockets by substantially increasing the vehicle-registration fee, known locally as the marbete, or registration sticker. For fiscal 2006, car buyers in Puerto Rico are expected to pay $691 million in excise taxes and registration fees, which excludes an additional property tax paid on vehicles the distributors and dealers have on inventory.

House Bill (H.B.) 1578, which amends Law 22 of Jan. 7, 2000 (Puerto Rico Vehicle & Traffic Law), seeks to increase the price car owners pay for their marbetes. It is part of several measures proposed by the administration of Aníbal Acevedo Vilá to bring in additional revenue in an effort to fix an inherited government deficit of almost $2 billion, which has left the government desperate for new funding resources.

Had Gov. Acevedo Vilá and Popular Democratic Party representatives gotten away with H.B. 1578 as originally presented May 9 in the House of Representatives, owners of vehicles with a price tag of $40,000 or higher (excise tax included) would have paid an additional $30 million a year to get their vehicle-registration fee or marbete. Instead of the usual $40 annual fee, starting in fiscal 2006, owners of new vehicles would have been required each year to shell out an additional $166 to $4,056 per vehicle to drive legally on Puerto Rico’s roadways.

The bill later was amended by New Progressive Party Rep. Antonio Silva, chairman of the House Treasury & Financial Affairs Committee. The amended version of H.B. 1578 still increases the registration fee, through a progressive-tax concept, on new vehicles priced $40,000 and higher, but reduces the scale, which now will start at $280 and go up to $1,000. Under a progressive-tax concept, the more expensive the vehicle, the more must be paid in taxes. This measure is expected to collect $17 million in fiscal 2006.

Targeting the auto industry

Lacking a reliable and functional public transportation system, families in Puerto Rico are forced to own at least one vehicle to drive to work, take their children to school, attend doctor visits, or carry out simple but necessary errands such as grocery shopping.

This fact has made the auto industry a favorite and easy target for government collections. It is consumers, however, who end up paying the added taxes and fees, suffering the consequences of the government’s fixation on the auto industry, which makes vehicle prices on the island 30% to 40% higher than on the mainland U.S. The difference in costs between Puerto Rico and the mainland is the excessive amount in excise taxes the commonwealth government imposes on vehicles arriving to the island. The situation is further aggravated when the discrepancy in per capita income is considered. Puerto Rico’s per capita income is about one-third that of the U.S. mainland.

Figures released by the Puerto Rico Transportation & Public Works Department (DTOP by its Spanish acronym) indicate there were 2.5 million registered vehicles on the island in 2004. This number includes all motor vehicles, public and private. Last year, some 134,541 new motor vehicles were sold in Puerto Rico, generating $550 million in excise taxes when they entered the island. It is estimated the government raked in as much as $585 million in excise taxes from new vehicles in fiscal 2005, which ended June 30. The Puerto Rico Treasury Department estimates collections from vehicle excise taxes in fiscal 2006 will reach $614 million, up from $406 million in 2001. This means consumers have been forced to pay over $200 million more in excise taxes in just three years.

Triple taxation

Vehicles in Puerto Rico are subject to a triple tax. First, dealers pay an excise tax on vehicles that arrive on the island, which immediately increases the price of the car, even before it leaves the port of arrival. Then, the distributors and dealers pay a property tax on the price of the vehicle with the excise tax included, which can be as high as 6.5% in some municipalities. Eventually, the distributors or dealers pay a patente (municipal tax). All these taxes are passed on to Puerto Rico consumers.

Furthermore, the government-levied property tax on the vehicle isn’t on the initial cost of the car before taxes are imposed, but on the cost of the vehicle plus its corresponding excise tax, so it becomes a tax on top of another tax. Once the vehicle is sold, a patente must be paid. The patente is computed on the sale price of the car, which includes excise and property taxes, thus becoming a tax on a tax on a tax–a triple whammy.

Consumers on the island are additionally impacted if we consider that most car buyers don’t have the cash in the bank when they purchase a vehicle. Consequently, they end up financing most of the cost, paying interest not only on the car’s purchase price, but on the taxes imposed on the vehicle as well. Auto loans in Puerto Rico’s banking system, as of March, stood at $2.3 billion.

The government also influences consumer decisions and behaviors by implementing an increasingly progressive excise tax that goes up as the list price of the vehicle increases. In other words, they want you to drive a cheaper vehicle. If you decide to buy a more expensive vehicle, you will pay more to the government in taxes–both absolutely and proportionally.

Not the first time

With threats of much higher water rates and already sky-high electric bills, it is easy to forget it was just three summers ago (in 2002) that the commonwealth government, under the Sila Calderón administration, decided car owners had to pay more in excise taxes for new-vehicle purchases. Law 70 also changed the definition of sport utility vehicles (SUVs), reclassifying them in the same tax bracket as cars. As a result, customers who wanted or needed an SUV for such simple reasons as the type of work they do, family size, or because it made them feel safer, had to pay higher taxes to the Commonwealth.

Needless to say, sales of SUVs declined 6.3 percentage points immediately after the excise-tax increase (from 55.4% to 49.1%) and haven’t recovered since. In fact, SUVs–which include light trucks and minivans–accounted for only 46.8% of all vehicles sold as of June this year.

"It must be noted that as early as May 2002, the Puerto Rico Legislature increased the excise tax by an additional 10% on vehicles with a suggested retail price of $43,170 and on sport utility vehicles across the board," Puerto Rico Automobile Distributors Association (Prada) President Carlos Quiñones told CARIBBEAN BUSINESS. "Once again, we see the government targeting the auto industry to balance the budget."

Prada, which represents 22 local auto distributors and dealers that import and distribute vehicles directly from manufacturers, is extremely concerned about the tax burdens frequently imposed on motor vehicle owners, which impacts auto sales and, even more so, consumers’ pockets, Quiñones added.

In addition to having to pay the vehicle’s excise tax before it is sold, with the increased marbete fee, distributors and dealers will have to shell out even more money before the sale is closed, which increases the cost of doing business. These costs are passed on to the consumer.

"There also is concern in the industry about the effect the increased price for marbetes will have on auto sales, since H.B. 1578 adds a cost to vehicles acquired by dealers before the law went into effect, without taking account of the increase," Quiñones said.

H.B. 1578 considered flawed

Prada Legal Counsel Luis Correa-Márquez explained the marbete or licensing fee traditionally was a fixed, single rate for everyone, regardless of the vehicle’s list price, because car owners basically were paying for the right to use public roads. This concept, however, has been misused by the commonwealth government and turned into a progressive tax based on the price of the vehicle, including all taxes, he stated.

In other words, the owner of a more expensive car pays more to use the roads than the owner of a less expensive car, independent of road use, turning the marbete into a progressive tax, as is the excise tax. The right to use Puerto Rico’s public roads also has become a progressive burden, which is based not on use, but on the price of the vehicle.

"Under current law, this annual licensing fee applies to all public and private vehicles, regardless of their list price. The concept of a progressive fee is used for the excise-tax calculation when the vehicle arrives at the pier, but shouldn’t be used for the right to use the roadways because you already paid, progressively, the excise tax," commented Correa-Márquez. "The right to use the roadways should be based on a fixed fee, not on the value of the vehicle, which makes no sense."

The Commonwealth also has been inconsistent when defining "luxury vehicles" in Puerto Rico. For example, in 2002, when the Legislature increased the excise taxes, a luxury vehicle was defined as one with a manufacturer’s suggested retail price (MSRP) of $43,170 (excluding excise taxes). In 2005, when the cost increase for marbetes was considered, a luxury vehicle was defined as one costing $40,000 with the excise taxes included.

In other words, according to the government, the luxury-vehicle concept has dropped in value from $43,170 MSRP in 2002, to just over $20,000. The lesser value is the price of an average middle-class vehicle which, when excise taxes are added to the MSRP, ends up costing about $40,000. Not much has been said about this situation, but it is certainly abusive, Correa-Márquez stated.

"The bill [H.B. 1578] bases its progressive fee on the luxury concept, but luxury has a different definition depending on who you ask," Correa-Márquez further commented. "There is a big discrepancy between the definition of luxury in 2002 and the one being used in 2005."

Not a temporary measure

Unlike other revenue-increasing measures proposed by Acevedo Vilá, H.B. 1578 doesn’t establish it as a temporary, two-year measure to assist the commonwealth government with its fiscal crisis while tax reform is implemented; therefore, it could become permanent. In a document sent to investors by the Government Development Bank explaining the governor’s budget veto, the expected $17 million in revenue through H.B. 1578 is described as "recurrent."

Another problem with H.B. 1578 is that it doesn’t provide for depreciation in the price of the marbete, since car owners must pay what the bill establishes in the tax table. This means if buyers purchase a vehicle with a marbete costing $1,000, they will be stuck paying the same registration fee for the rest of the car’s useful life, without considering the depreciation in the vehicle’s value. Buyers also could be stuck with the car for the long haul since it could become extremely difficult to sell, as few buyers would want to purchase a used car with a $1,000 license fee. Correa-Márquez says this means people will be forced to stick to their cars longer, which could further affect Puerto Rico’s new-auto market.

What is more, the bill authorizes the DTOP secretary to revise the model years applicable to the measure every July 1 and to establish the necessary regulation for the calculation and collection process for the annual fee.

Another issue to deal with

As if dealing with H.B. 1578 weren’t enough already for the local auto industry, earlier this year, auto distributors in Puerto Rico faced another legislative dilemma–Senate Bill 11, which amended Article 6 of Law 7 of September 1999, commonly known as the Motor Vehicle Warranty Law. The bill now is known as Law 6 of Jan. 2, 2005.

Law 6 basically requires local distributors and dealers to provide new-car buyers with the best warranty the auto manufacturers provide anywhere in the world, not just on the U.S. mainland or in its country of origin. In other words, if the auto manufacturer offers a better warranty than it currently provides in the U.S., Japan, or Korea, it will have to offer that same warranty in Puerto Rico.

Although Law 6 applies to all auto manufacturers doing business in Puerto Rico through their respective distributors and dealership networks, it affects Japanese and Korean automakers the most–ironically, the brands that offer the largest number of models below $20,000, which are the most affordable for the general population.

"This law changes the concept of warranty for the U.S. mainland or other country of manufacture and adds the phrase anywhere in the world," noted Correa-Márquez, "and we ask ourselves how a distributor is going to know that? There are 160 auto markets worldwide."

Auto manufacturers in those 160 markets have different arrangements, according to the specifics of each market, about what type of warranty they will provide in those markets. A distributor in Puerto Rico has no way of knowing in which markets the manufacturer operates has the best warranty so it can be applied here, Correa-Márquez pointed out. "If the warranty in Puerto Rico has to be the same as auto manufacturers provide on the U.S. mainland, then there is a good reference point. As a distributor, however, how do you know what warranty the manufacturer has in another country? Auto distributors have no control over that."

The end result is the Senate bill was approved and became effective immediately, without providing local auto distributors with a transition period to adjust to the new law. Needless to say, local distributors have thousands of vehicles in their inventory whose warranties were negotiated and paid under the old warranty law.

Consumers pay more

What this means is that the added cost to equip these vehicles with the extra warranty will be passed on to consumers, who now will pay more for vehicles (transfer of risk). By increasing a vehicle’s list price, consumers and distributors will have to shell out more to pay excise taxes.

"The added costs will have an impact on the distributor in Puerto Rico and the manufacturer on the U.S. mainland, in Korea, and Japan. Obviously, this is something you can’t negotiate in a matter of days. This type of negotiation between manufacturers and distributors can take months. This is a law that affects previous contractual relationships," said Correa-Márquez.

Eduardo Mayoral, president & CEO of local distributor Hyundai de Puerto Rico, said the main purpose of Law 6 is healthy because it tries to provide consumers with an adequate and comparable warranty from the ones manufacturers offer in other countries.

Although dealers haven’t had sufficient time to determine the specific cost of extending to Puerto Rico the same warranties available on the U.S. mainland–assuming it is the best warranty available worldwide–on a preliminary basis, they anticipate it would cost $700 to $1,000 more per unit. "If we take the number of vehicles already in Puerto Rico affected under Law 6, the cost is in the millions. If we add to that the vehicles en route to the island, the cost grows even more," Mayoral said.

He further pointed out that units sold by the distributor to dealers before Law 6 came into effect would represent a financial loss to the company and the manufacturer. Likewise, units that are part of the distributor’s inventory also will be affected because these will have to be redeclared with the Treasury Department and additional excise taxes paid as a result of Law 6’s new price structure.

Additional complications

In addition, by extending the warranty in the middle of the year, the programming of the complex computer systems used by distributors and dealers to process claims will have to be reprogrammed to recognize the new warranty under Law 6 while warranties under the old law are still active.

Furthermore, it will be necessary to print new warranty certificates and manuals, both in Spanish and English, so they reflect the improved warranty demanded by Law 6. These books and certificates will have to go through detailed scrutiny, first by the manufacturers and later by the distributors, to ensure these are correct and meet technical and legal requirements. "This process can take weeks, if not months," Mayoral indicated.

"In practical terms, the vehicles imported to Puerto Rico are essentially the same as those imported to the mainland U.S. and have to comply with the exact same federal requirements," Mayoral noted.

Auto buyers should get a tax break when purchasing a hybrid vehicle

Although local interest in gas-electric hybrid vehicles is strong since nearly 500 units were sold last year, the high cost of the technology that makes them so fuel-efficient and earth-friendly, in turn, makes these vehicles much more expensive than a similarly equipped model powered by a regular gasoline engine.

If we add to that the excise taxes imposed on new vehicles sold in Puerto Rico, the price goes even higher, making hybrids even less attainable to average consumers wanting to have one to save on gas or keep the air clean. A hybrid vehicle in Puerto Rico can cost $2,000 to $5,000 more than in the mainland U.S.

Through the use of an advanced and complex computerized system, hybrids combine the use of a gasoline engine with an electric motor and a battery pack to become a super fuel-efficient vehicle with ultralow emissions. During a start or stop-and-go traffic, hybrids use the electric engine or the battery pack, which produce no tailpipe emissions. When more power is needed, hybrids then combine the gas and electric engine to produce more torque while using less fuel and emitting fewer tailpipe emissions than a conventional gasoline-only vehicle. This process is completely transparent to the driver because it is automatically controlled by the advanced computer system.

Honda and Toyota are the only auto manufacturers offering hybrid vehicles in Puerto Rico, although more are on the way. Led by then-senator, Roberto Prats, in 2004, several senators and state representatives presented various legislative bills to promote the use of these energy-efficient and environmentally clean vehicles. The bills proposed incentives such as an income-tax deduction, free use of the tollways, and even an executive order requiring hybrids in the government’s vehicle fleet as ways to save on fuel costs and be more environmentally conscious. Unfortunately, the bills never passed.

"These legislative bills or programs should be reintroduced to motivate consumers into buying highly fuel-efficient vehicles such as hybrids to save on our energy resources while their extremely clean emissions help preserve our environment," commented Carlos López-Lay, president & chief operations officer for local Honda distributor Bella Group. "One way to motivate the purchase of hybrid vehicles locally could be to offer a special deduction in the excise-tax rate that applies to these vehicles."

Federal taxpayers can claim a one-time tax deduction on their federal income-tax return when they buy a hybrid vehicle. The deduction is limited to $2,000 for cars first put into use in 2004 and 2005. The deduction will be limited to $500 for vehicles placed in service in 2006, and no deduction will be allowed after that year.

Excise-tax system too burdensome for auto industry and consumers

Under the current excise-tax system, in which a vehicle’s excise-tax rate is based on the manufacturer’s suggested retail price (MSRP) set by the distributor, Treasury Department (Hacienda) regulations require the repayment of any difference in the excise tax if the vehicle is sold above the suggested retail price. There are no refunds allowed under Hacienda regulations on the excess excise tax paid if the vehicle is sold below the MSRP.

This situation practically acts as a disincentive to distributors and dealers to reduce the price of their vehicles, especially when gas prices are sky high and consumers are looking for more fuel-efficient and cost-effective transportation options.

Ángel Pérez Muñoz, executive director of the Puerto Rico Automobile Distributors Association (Prada), said the organization never has objected to implementing a sales tax in Puerto Rico. In fact, he recalled, when the 1992 automobile excise-tax law (Law 80) was enacted, there was a proposal to implement a sales tax on vehicles.

There were objections to that proposal, and the law ended up as it is today: The dealer or distributor pays the excise tax upfront on the vehicle but collects the tax from the customer at the time of sale, Pérez Muñoz explained.

"A sales tax would be beneficial to the industry because it would remove from distributors and dealers the burden of being taxpayers for every vehicle that comes to Puerto Rico," he said. "The excise tax increases our operational costs; therefore, consumers end up paying more."

Pérez Muñoz said there are Prada dealer members that pay more than $14 million each year in surety bonds for their vehicles, which is several hundreds of thousands of dollars in insurance that they wouldn’t have to pay under a sales-tax system. "There are many reasons a sales tax is more favorable for everyone," Pérez Muñoz added.

With a sales tax, he noted, not only would a vehicle’s price come down in line with those in the States, it would give consumers more options in choosing which vehicle to buy instead of selecting one according to the excise-tax bracket.

"It is unfair that local residents, who have a third of the per capita income of their U.S. mainland counterparts, pay 30% to 40% more for a vehicle just because of the high excise-tax rates on the island," said the Prada executive director.

Additionally, a sales-tax system would make the automobile-sales transaction more transparent, meaning consumers would know upfront the exact cost of the vehicle and the taxes paid. Under the current excise-tax system, it is very hard for auto buyers to decipher the tax table and the amount of the corresponding excise tax, or if there are any other hidden tax charges in the invoice.

In addition, the use of a sales tax would eliminate the gray market and tax-fraud problems at the ports. "Gray market" is the term for transactions that are conducted outside the usual business channels but aren’t illegal. Hacienda loses millions in underreported excise-tax collections by unscrupulous auto dealers, who present bogus sales invoices and bribe tax collectors, creating unfair competition for bona fide distributors and dealers that pay taxes according to the law.

"With a sales tax, everybody wins," Pérez Muñoz said.

When a dealer or distributor files corporate income taxes under the current excise-tax system, the excise tax becomes a cost factor and fewer taxes are paid, he said. "With a sales tax, the government would benefit by collecting more in corporate taxes from dealers and distributors as a result of the added sales," Pérez Muñoz said.

"The key is that if a sales tax is implemented, the government mustn’t use that as an excuse to increase the tax much higher on vehicles than what it already is," he added. "If that happens, the government will kill the goose that lays the golden eggs."

In an exclusive interview with CARIBBEAN BUSINESS, Rep. Antonio Silva, chairman of the House Treasury & Financial Affairs Committee, said he is committed to eliminating the use of the excise-tax system on vehicles and incorporating the auto industry into a sales-tax system as part of a much-needed fiscal reform.

"There should be a three-year transition for the phase-in of a sales-tax system and the phase-out of the excise-tax system since this process can’t be done overnight," said Silva. "The government has to ensure it can collect the revenue it needs, but without affecting consumers or targeting the auto industry."

Motor Vehicle Registration Fee (Marbete)

Under Amended House Bill 1578

List Price: Model Years 2001 / 2002 / 2003 / 2004 / 2005 / 2006

$40,000-$46,750: $180 / $200 / $220 / $240 / $260 / $280

$46,751-$53,500: $300 / $320 / $340 / $360 / $380 / $400

$53,501-$66,430: $420 / $440 / $460 / $480 / $500 / $520

$66,431-$73,430: $540 / $560 / $580 / $600 / $620 / $640

$73,431-$80,430: $660 / $680 / $700 / $720 / $740 / $760

$80,431-87,430: $780 / $800 / $820 / $840 / $860 / $880

More than $87,430: $900 / $920 / $940 / $960 / $980 / $1,000

Source: Puerto Rico House of Representatives

This Caribbean Business article appears courtesy of Casiano Communications.
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