In order to preserve the status of its only investment grade bond and reduce its outstanding debt, Puerto Rico has increased its sales tax rate and stepped up tax enforcement. Tax is a logical place to begin repairing the territory’s credit status because taxes can reduce Puerto Rico’s ratio of debt to revenue. Additionally, sales tax is a key to bond sales in Puerto Rico. The only Puerto Rican bond to retain an investment grade rating is the Cofina bond, whose revenue is backed by sales tax.
Recent legislation attempts to fight these problems by increasin
g the sales tax to 6 percent and stepping up tax enforcement. Effective as of February 1, 2014, a new sales tax limits the authority of municipalities to tax food and food ingredients. The new law keeps the previous overall rate of 7 percent, but imposes a mandatory 1 percent tax on food and food ingredients. Municipal sales and use taxes are reduced from 1.5 percent to 1 percent, effectively reallocating these funds to the territory level. The reallocation is also part of an effort to create a uniform municipal sales tax. This uniformity is intended to ease Puerto Rico’s efforts to tax remote Internet vendors who sell to consumers in the territory.
In addition to increasing the rate, Puerto Rico is also increasing enforcement. Currently, Puerto Rico’s underground economy makes up 27 to 28 percent of gross domestic product. This is significantly higher than the continental United States, which has an underground economy estimated at 19 percent of GDP. In fact, Puerto Rico only collects 56 cents for every dollar of tax due.
Additional enforcement could result in an additional $391 million in tax revenue, which could significantly reduce Puerto Rico’s outstanding debt and thus increase its credit rating. In order to fight sales tax evasion, Puerto Rico has added a new $20,000 fine for each instance of sales tax evasion, and hired an additional 200 tax enforcement investigators. Further, the territory has introduced legislation to require all businesses engaged in sales to certify sales tax payment systems with the Treasury. Such registrations will provide accountability and reduce the financial incentive for business to evade the sales tax.
The changes to Puerto Rico’s sales tax appear centered on increasing enforcement and creating a uniform tax. Businesses operating in Puerto Rico should be aware of the increased focus on tax collection and the potential for additional efforts to tax remote vendors.