Richard Woodard

Richard Woodard

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It’s already been christened, in typical journalese, the “Rum Wars”. It’s prompted angry exchanges in the Caribbean, questions on Capitol Hill and, most recently, a vitriolic attack by the world’s biggest drinks company on one of its rivals. So just what is going on with Diageo’s new Captain Morgan distillery? Richard Woodard picks apart Captain Morgan's current adventure.

Right. Let’s start by calming down, forgetting all the name-calling for a moment and setting out, rationally and chronologically, how we got to this point. Are we sitting comfortably? Then I’ll begin…

December 2000: Diageo, along with Pernod Ricard, is the big winner in the Seagram sell-off, securing a cornucopia of drinks brands, among them Captain Morgan, which is number two in the US rum market.

But there’s a snag. Puerto Rican firm Destileria Serralles, which produces Captain Morgan, claims the Seagram shake-down gives it first refusal on the brand. And it wants to sell to Allied Domecq instead.

To avoid a lengthy court battle (and to meet competition requirements in the US), Diageo sells Malibu to Allied and signs a long-term rum supply contract with Serralles for Captain Morgan.

Is everyone happy? Well, sort of. Diageo would rather – much rather – have had direct control over production of Captain Morgan. And you can only wonder how it felt about doing business with a company which had tried to snatch one of Seagram’s biggest brands out of its grasp.

Fast-forward to 2007, and Diageo is looking ahead to the end of the Serralles supply deal in 2012. There are negotiations, but they don’t work out and money – surprise – is the sticking-point. Time, then, for the Captain to set sail into fresh waters.

But where? Diageo says a few locations are considered, including Guatemala, Guyana and Jamaica, where its Myer’s brand is already produced. But, in mid-2008, it announces the construction of a new distillery on St  Croix, one of the US Virgin Islands (USVI). The choice of location is crucial – in more ways than one.

Here’s the nub. Essentially, Diageo chose St Croix because it secured a stunning deal. In return for a 30-year commitment to rum production on the island, the company gets a swanky new free distillery and 30 years of subsidies and tax exemptions, reported to be worth a cool US$2.7bn.

How can an economically fragile US territory afford this? Thanks to the Rum Excise Tax Cover-Over. Under US law, most of the excise tax collected on all rum imported into the US is handed over to Puerto Rico and the USVI, netting them $5.1bn and $1bn respectively between 1990 and 2008. The amounts remitted are linked to the amount of rum each territory produces.

It’s a principle of the relevant legislation, dating back to 1917 for Puerto Rico and 1954 for USVI, that the territories can decide what to do with the money locally, subject to the broad approval of the President. And, in the case of the USVI, they’ve decided to dedicate a large chunk of the revenue to enticing Diageo to St Croix.

This is the point at which Puerto Rico and its rum companies, most notably Serralles and Bacardi, cry foul. How can it be right, they demand, for taxes paid by hard-working, recession-hit US citizens to be diverted into the coffers of a foreign drinks conglomerate?

On one rather superficial level, they’ve got a point. Consider this: Diageo pays excise duty (currently $13.50 per proof gallon) on every bottle of Captain Morgan produced in St Croix and sold in the US. Then the US Treasury sends nearly all the money to the USVI government, which in turn hands a large slice back to Diageo in the form of molasses, production and marketing subsidies. Hmm.

Puerto Rico does a similar thing, but claims it is on a much smaller scale (no figures are publicly available), devoting only 6% of its cover-over revenues to directly promoting rum. Mind you, it’s still a tidy sum: an average of $23m a year for the last five years, and a total of $324m between 1990 and 2008.

So, it’s not the principle of subsidising rum production with taxpayer dollars which is being contested, but the extent of it. Proposed legislation, backed by the anti-Diageo lobby, would limit the proportion of cover-over funds allowed to be channelled into industrial subsidies to 10%.

Should that legislation be passed, the St Croix plant would be scuppered, and Diageo’s next move is unequivocal: it would not return to Puerto Rico, but would take its rum production outside the US altogether. A huge loss to the USVI economy – and yet, perversely, Puerto Rico would be better off.

How so? Because of the workings of the cover-over legislation, Diageo’s move to the USVI is the worst possible outcome for Puerto Rico. Aside from losing Diageo’s business, the territory will also forfeit every future cent of cover-over from excise taxes charged on Captain Morgan, because Puerto Rico is not entitled to any of the cover-over derived from rum produced in the USVI, and vice versa.

But it’s different if Diageo moves abroad, because then the cover-over pot from Captain Morgan is split between Puerto Rico and the USVI – just as it already is for Appleton, Mount Gay or any other rum produced outside the US. Puerto Rico wouldn’t get as much cover-over as it does today, but it would be far better off than if Diageo goes to the USVI.

Bacardi says the issue is all about “the proper use of federal tax dollars”, but it would be disingenuous of the company - and of Puerto Rico - to deny that there’s a large dollop of self-interest at work here. If the effective refund of part of Diageo’s excise bill for the next 30 years looks odd, what of the fact that – as things stand – Puerto Rico and its distillers would be better off if Captain Morgan and all its jobs were lost to the US altogether?

In the final analysis, the US decided to give these islands the rum tax revenues so they could decide how best to improve the lives of their inhabitants through economic development, the building of infrastructure, etc. The USVI has subsequently decided to bet a large chunk of it on the future success of the rum sector in general, and of Captain Morgan in particular, reasoning that it will transform its economic fortunes in the process.

The actions of the USVI and Diageo have been called a lot of things in the past few months: “excessive, unreasonable and wrong” and “giving away the ranch” are just two.

But there’s another word for it and – love it or loathe it – it’s one that should ring a few bells in Washington and in the boardrooms of drinks companies around the world.