Individual Income Tax Insights: Will Puerto Rico’s Potential Value Added Tax Fall Flat Before It Is Even Implemented?

Puerto Rico’s legislature is in the process of holding public hearings before deciding whether to adopt the governor’s proposed bill, H.B. 2329, which would replace the sales and use tax with a value added tax (VAT) on April 1.

The proposed VAT is a 16 percent tax imposed at each step of the supply chain, starting when a taxable item is imported and ending with the final customer’s consumption of the good or service. Certified merchants would then be allowed a credit for 100 percent of taxes paid on the resale of taxable items. The proposed VAT rate is an increase from the current 7 percent sales tax rate.

Puerto Rico’s economy has struggled in recent years, and one of the reasons is lost revenue, partly resulting from low compliance with its sales tax. Puerto Rico’s governor, Alejandro Garcia Padilla, thinks replacing the sales tax with a VAT would increase compliance and boost revenue.

Retailers, however, are unsure that Governor Padilla’s optimism will play out as expected. Rachelle Bernstein, vice president and tax counsel for the National Retail Federation, the world’s largest retail trade association, testified March 4 on behalf of retailers before Puerto Rico’s House Committee on the Treasury and Public Finances.

During her testimony, Bernstein presented a variety of studies that highlight how VATs adversely affect economies. Many of the studies’ results showed how economic growth would decline for a significant period of time, while employment rates and retail spending would permanently deteriorate, if a VAT is adopted.

The obligation and incentive for merchants to keep track of VAT along the supply chain makes it a self-administered tax that is intended to be efficient and consistent. Retailers are doubtful and instead worry that a VAT would be onerous. To underscore retailers’ concerns, Bernstein cited another study showing that compliance would require 26 percent more hours than complying with corporate income tax laws, according to the Caribbean Business article.

While Bernstein was in Puerto Rico, she spoke with various government leaders and discovered a trend – the result of higher tax rates is lower compliance. “The compliance rate is better for the local governments that only need to collect one percent than it is for the [Commonwealth] that needs to collect the additional six percent,” Bernstein told Bloomberg BNA March 9. “I can only imagine that compliance gap being so much bigger if [Puerto Rico] goes to a 16 percent tax,” she added.

With April 1 right around the corner, a great deal of uncertainty remains as Puerto Rico’s House and Senate Committees continue to hear conflicting input from the public. In the meantime, taxpayers can visit the online calculator provided by Puerto Rico’s Department of Finance to determine how the proposed VAT could impact them financially.

Continue the conversation on Bloomberg BNA’s State Tax Group’s LinkedIn page: Will a VAT boost or hamper economic growth in Puerto Rico?

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