The Border Adjustment Tax is Dead…or is It?? by James W. Spencer CPA
Posted on August 21, 2017
As Congress shifts its attention from healthcare to tax reform, key Republicans and the White House on July 27, 2017, issued a joint statement agreeing to “set aside” a proposed and much-hyped border adjustment tax (BAT) on imported goods. Business groups that feared a destination-based tax would drive up costs cheered this news. However, it is important to note that the strongest supporters of the BAT, Speaker of the House Paul Ryan, and Ways and Means Committee Chairman Kevin Brady, tempered the announcement by stating that they would set aside the BAT temporarily, “at least in the short term.”
What is the Border Adjustment Tax?
Not long before the 2016 presidential election, House Republicans under Speaker Paul Ryan drafted an ambitious plan for tax reform that, among other things, recommended a destination-based border adjustment tax on products and services that U.S. businesses import into the country. When Trump took office, it appeared the BAT would become a reality, since it aligns with the president’s directive to get tough on trade and bring jobs and businesses back to the U.S.
The Republican proposal is a far departure from the U.S.’s current system that levies a 35 percent tax on profits corporations earn and bring back to the U.S. from sales of goods and services produced in the U.S.
Under a BAT regime, corporate cash flow would be subject to a flat 20 percent tax based upon the location where a product, service or intangible is actually sold and consumed. More specifically, the BAT would apply to goods produced in foreign countries and imported for consumption in the U.S., as well as goods produced and sold for consumption in the U.S. All exports would be exempt from taxation.
As an example, consider a U.S. manufacturer that ships fuselages to China, where they will be used to make airplanes. The profits the manufacturer makes on its exports will not be subject to U.S. taxes. However, if an American company that builds and sells airplanes for $10 million purchases a fuselage from China for $8 million, the company would be subject to U.S. tax on $2 million in profits plus the full $10 million of proceeds from the sale of the aircraft. Moreover, the manufacturer would not be able to deduct the costs it incurred to purchase the fuselage from overseas.
A BAT can be comparable to the Value Added Tax (VAT) that most foreign countries impose on goods and services consumed within their borders, regardless of where those goods are produced. It is also comparable to the U.S.’s current system of retail sales tax, for which goods produced in one state are exempt from state-level sales tax when they are sold and exported to another state.
While a BAT aims to reduce or eliminate the common tax-planning practice of artificially shifting profits overseas to low- or no-tax jurisdictions, it would provide a distinct advantage to businesses that purchase materials from U.S. suppliers. Items that businesses purchase domestically for manufacturing or resale would qualify as deductible business expenses, whereas the costs for importing those materials from abroad would be limited. Because the U.S. currently imports more than it exports, it is expected that a destination-based cash-flow (DBCF) BAT would generate more than $1 trillion in tax revenue for the U.S. over a 10-year period.
Winners and Losers
The imposition of a border adjustment tax could be a boon for exporters, who would escape taxation on sales outside the U.S., even when they bring the profits from those sales back to America. Theoretically, the exemption of exports would encourage businesses to manufacture in the U.S. and potentially increase foreign demand for lower-priced U.S. goods. Moreover, supporters of a BAT that treats income from foreign sales favorably believe that it would reduce corporate incentives to move profits overseas for tax-planning purposes, and instead incentivize businesses to invest and manufacture in the U.S.
Yet, without the imposition of a BAT, many U.S. businesses will still have an opportunity to reduce their tax rate on exports from approximately 40 percent to 20 percent, when they form a separate Interest Charge-Domestic International Sales Corporation (IC-DISC) that receives commissions on sales to non-U.S. customers.
Conversely, a BAT would impose significant costs and administrative burdens on importers, who would pay higher taxes on all goods, services and intangibles they bring in to their country, regardless of where the end-product is produced. This, combined with restrictions on business deductions for import activities, would ultimately narrow profit margins and lead to higher prices passed on to U.S. consumers. Under these circumstances, businesses would need to reassess their value chains and transfer-pricing policies.
Supporters argue, however, that a border adjustment tax would promote investment in the U.S. and preserve neutral tax treatment between domestic sales and exports. At the same time, a BAT would support the Administration’s goal of lowering the current corporate tax rate from 35 percent to a target of 20 percent. Without a BAT, the administration may not reach its tax reform goals, and it may need to identify additional methods for raising revenue.
What’s Next for U.S. Manufacturers?
With the government’s decision to set aside the BAT for the time being, retailers and consumers can breathe a temporary sigh of relief. Yet it is unclear what alternative strategies the administration will come up with to achieve its ambitious tax reform goals in the future. As a result, it is advisable that affected businesses plan to meet with experienced tax advisors and accountants to understand their options and be prepared to implement alternative strategies that may minimize their exposure to unnecessary operating costs and additional tax liabilities.
About the Author: James W. Spencer, CPA, is a director with Berkowitz Pollack Brant’s International Tax Services practice, where he focuses on a wide range of pre-immigration, IC-DISC, transfer pricing and international tax consulting issues for individuals and businesses. He can be reached at the firm’s Miami office at 305-379-7000 or via email at firstname.lastname@example.org.