Luxury tequila, a smooth sip that can retail for a few hundred dollars a bottle, is driving growth in the world’s fastest-expanding spirits category. But its makers say tax rules in tequila’s home country are getting them slammed.

Diageo, the world’s largest distiller, is lobbying Mexico to stop taxing drinks by price and switch to the kind of system based on a rate levied by alcohol content that is in force in all but four of the 34 OECD countries. Only Chile, South Korea and Mexico, as well as Israel for spirits, apply what is known as the ad valorem system.

A margarita or a lager may deliver the same buzz but Diageo says that because of the ad valorem system spirits in Mexico are subject to 53 per cent tax and beer, the country’s favourite tipple, 26 per cent.

The UK company’s latest acquisition is Don Julio, Mexico’s top super-premium tequila brand. To make the spirit, spiky blue agave plants carpeting the hills around Atotonilco el Alto in western Mexico are tended for up to nine years before being harvested, trimmed to resemble gigantic pineapples, cooked, pressed, distilled and in some cases aged in bourbon barrels.

Don Julio Real, its top-of-the-range offering, retails for $375 a bottle, a far cry from the 250 pesos ($14) five-litre plastic bottles of what is claimed to be the national drink but is in fact sugar cane liquor sold at roadside stands outside town.

Sales of tequila in Mexico hit $1.14bn in 2014, according to IWSR, the wine and spirits authority.

Ivan Menezes, Diageo’s chief executive, pushed his case for a rethink on the tax policy at meetings with President Enrique Peña Nieto and Luis Videgaray, the finance minister, in Mexico City this month. He argued that the status quo not only gives beer and cheaper spirits an unfair advantage, but that it exacerbates Mexico’s problems in combating a mammoth illicit alcohol industry.

A staggering 43 per cent of the spirits consumed in Mexico are untaxed and illegal — either faked, contraband, unregulated or the product of under-invoicing, a study by Euromonitor International has found.

Chart: Growth in retail sales of spirits

“Best practice, according to the OECD, on taxes for alcohol are based on alcohol content and not price. This is discriminatory for premium products like tequila and whisky,” Mr Menezes says. “Changing the ad valorem system to a system based on litres of pure alcohol has clear benefits — it widens the tax net, it’s easier to administrate and promotes equal treatment among all alcohol categories.”

Francisco Soltero, institutional affairs director at Tequila Patrón, the top-selling premium brand in the US, says producers are studying the issue, through the National Chamber for the Tequila Industry. One answer, he says, could be a system including a minimum fixed quota paid by all “to prevent someone lowering their prices and quality to pay less tax”.

It is not just distillers that like the idea. Acermex, the Mexican brewers’ association, says craft beers are also suffering because of a system that taxes the value, not the volume, of sales. 

The Mexican government is reluctant: Mr Peña Nieto has pushed through a string of tax reforms and has repeatedly promised he will not raise levies before his term ends in 2018.

Even with revenue so squeezed by falling oil prices the government has had to slash spending, “I don’t see us making changes,” one senior government official says.

As consumers trade up to premium brands — what Mr Menezes calls an “affordable indulgence” — governments see a chance to cash in. But beer, which flows like water in Mexico and accounts for $24.6bn of the $35.7bn total Mexican alcoholic drinks market, according to Euromonitor International, remains a bigger tax earner.

Beer sales add 30bn pesos a year to government coffers, compared with 13bn pesos for wine and spirits, the government official says. According to Euromonitor International, the illicit spirits market costs 6.4bn pesos in lost taxes.

Chart - Mexico: retail sales growth of tequila

Diageo is undaunted. It says it has proof from Brazil that the ad valorem system does not work. Struggling with a plunging economy, the Brazilian government has, however, reintroduced the ad valorem system, lifting tax on spirits by 30 per cent and on beer by 8 per cent, Diageo says.

“In 2004, we presented a comprehensive study to the [Brazilian] government demonstrating that reducing taxes on an individual bottle of ready-to-drink [vodka] to compete more effectively with beer would increase total revenue on tax as a result,” says Alberto Gavazzi, Diageo’s president for Latin America.

Diageo guaranteed the government would earn at least as much as under the old system. “As predicted, the plan worked and within a year, the government was making more revenue collection than what the [Diageo] proposition offered,” says Mr Gavazzi, calling it a win-win-win situation — for consumers, the government and the industry.

“We aren’t here to fight the government,” he says. “We are here to support it.”

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