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Puerto Rico businesses fret tax hikes will erode profits

Puerto Rico's Governor Alejandro Garcia Padilla delivers his state of the Commonwealth address at the Capitol building in San Juan, Puerto Rico April 30, 2015. REUTERS/Alvin Baez

By Nick Brown and Megan Davies

SAN JUAN/NEW YORK (Reuters) - Business is tough enough already for Carlos Jimenez without having to face higher taxes. Fast Lane, his three-location car-wash chain in Puerto Rico, has laid off about half the 106 employees it had in 2007.

"Every year you take out two or three people, make your business leaner," he said.

But starting in October, entrepreneurs like Jimenez will see their taxes rise to 11.5 percent on some business-to-business (B2B) dealings, and expand to include a 4 percent duty when using professional services such as accountants and lawyers. The sales tax also rose, from 7 percent to 11.5 percent, in July.

The new levies come as the Puerto Rican government pursues a plan to jumpstart its foundering economy and claw its way out of a $72 billion debt hole in part by spurring small business growth. The plan also asks bondholders to take reduced payouts on $18 billion of debt, and proposes changes to the government's operations.

While the proposed benefits of the plan are uncertain -- requiring legislation or U.S. government action -- the taxes are real, and some business owners worry they'll offset future benefits.

Jimenez, for example, said he's willing to get on board with the tax hikes, but only if the government can follow through on other parts of its turnaround plan, such as securing concessions from bondholders.

Some business advocates said high taxes could mean slower corporate development and layoffs as well as higher prices for consumers.

"Do you want poorer consumers?" said Jaime Morales, a former small business advocate and now city manager in seaside Cabo Rojo. "That shouldn't be the goal."

Jimenez says he's cautiously optimistic the government's plan can help ebb his company's spate of layoffs. "I hope it ends here," he said.


The turnaround plan, presented by Puerto Rican Governor Alejandro Garcia Padilla, would also promote corporate growth by overhauling a tax compliance structure that can disadvantage small businesses with limited resources; lengthen probationary periods for workers; and reduce labor costs by freezing the minimum wage and eliminating Christmas bonuses.

Business owners said they support some of those measures, primarily tax simplification and probation extensions, which give them more flexibility to fire.

But there's no guarantee the plan will come to fruition, and in the meantime, taxes will climb.

And starting next April, all business-to-business and professional services transactions will be subject to a 10.5 percent value added tax, with a 1 percent municipal sales tax. Businesses may also become eligible for tax credits at that time, which could give them some relief.

Alberto Bacó Bagué, secretary of Puerto Rico's Department of Economic and Commercial Development, said he wants to hear business owners' concerns. 

"Taxing more is not the solution, it's taxing more intelligently," Bacó told Reuters at an event to mark a new hotel project in San Juan's tourist district. "This plan ... has a spirit of discussion. That's part of what we want to generate, to see what (business owners) think."

The tax measures, while part of the turnaround plan, have already been signed into law. And they are already hurting businesses that either have to pass the costs onto customers or take a hit on their profits.

George Pavarini, a Puerto Rico-based builder and architect who develops affordable housing, says he's being squeezed as his costs on nails, concrete and other supplies rise with the added tax, while the housing he develops has capped sales prices.

"I'm not selling eggs, where I can raise the price to absorb that," says Pavarini, who is hoping for an exemption to the rises. "I end up absorbing directly the increases."

Instead, Puerto Rico should be focusing on growth, business owners said.

"I think the focus should be on stimulating businesses that export," said Pavarini, adding that he has lost labor and clients to the U.S. mainland as Puerto Rico's economic woes have worsened. "I don't think people see light at the end of the economic disaster tunnel."

Pavarini said he saw enough demand to continue with his business, although he would proceed cautiously.

To be sure, Garcia Padilla's plan proposes continued investment in infrastructure, including $1.4 billion for water authority PRASA, which has been a focus amid an ongoing drought. 

Humberto Reynolds, president of the Puerto Rico chapter of the Associated General Contractors of America, supports the investments. “The better alternative to promote growth and hiring is to create a healthy investment environment … and how you achieve that is through infrastructure,” Reynolds said.

Employers reacted more tepidly to measures in the plan that would freeze the minimum wage and cut bonuses, saying they don't believe the savings would have a big enough effect to justify the increased pain for workers.

"Right now people cannot even afford a $5 car wash," said Jimenez. "If you cut their salary more, I don't think it will make the economy better."

A minimum wage freeze could avoid layoffs that sometimes result from wage hikes as companies look to offset costs. But it could also discourage tax reporting, exacerbating the already problematic underground economy in Puerto Rico, where only about 40 percent of the working age population is in the workforce.  

One San Juan resident, who works seven days a week as a driver for about $40,000 a year, admitted to under-reporting taxes, saying it’s necessary to afford a living wage.

"I believe in work, and most people believe in work, but the compensation has to be there," the person said. "Poor people like money too. You have to incentivize regular people, not just the rich."

Bacó acknowledged that labor cost reductions "have to be further discussed." 

"I believe in the theory of abundance and I would like to give more benefits," Bacó told Reuters. "I would like the people in Puerto Rico to make more money."

But Bacó also said the plan is a good start, saying corporate tax overhauls and infrastructure investments would help businesses. 

The plan "recognizes investment, that we need to invest in Puerto Rico, that we need to finish basic infrastructure," he said. 

San Juan Mayor Carmen Yulin Cruz told Reuters last week that bondholders should take more of the pain, as workers have already made sacrifices. "You don't revive your economy over the shoulders of those who will build it," Cruz said.

On the other hand, said Height Securities analyst Daniel Hanson, bondholders are likely to demand more austerity, not less, as a condition for concessions.

(Reporting by Nick Brown in San Juan; and Megan Davies in New York. Additional reporting by Jessica DiNapoli and Suzanne Barlyn. Editing by John Pickering)