Why You Need to Know the Basics of Border Adjustment Tax

By Sarah Parneta, US Tax Manager, Radius

Although uncertainty surrounding the nature and timing of US corporate tax reform continues, there is a general consensus that some type of reform is likely. New US Treasury Secretary Steven Mnuchin told The Wall Street Journal last month that, as the Journal puts it, the Trump White House is “working with House and Senate Republicans to smooth over differences among them on tax policy, with the aim of passing major legislation before Congress leaves for its August recess.”

Trump and Mnuchin believe tax reforms could spur US economic growth to a rate of three percent or higher, which according to the Journal would be a substantial increase over the average rate of about two percent in the last decade.

Trump and Republican lawmakers are considering some type of tax on imports, although what form that tax will take is still unclear. The House GOP “Better Way for Tax Reform” plan (also known as the Blueprint or the Ryan Plan) calls for a complete replacement of the current US corporate income tax with a destination-based cash flow tax commonly referred to as a border adjustment tax (BAT). As the full text of the Blueprint explains, “border adjustments mean that it does not matter where a company is incorporated; sales to US customers are taxed and sales to foreign customers are exempt, regardless of whether the taxpayer is foreign or domestic.”

In the past, President Trump had made statements about imposing tariffs on specific countries and had rejected the idea of imposing a BAT. More recently, however, he has signaled that some form of BAT may be included in his tax plan. In an interview with Reuters last month, Trump said, “I certainly support a form of tax on the border because everybody else does. … we’re one of the very few countries, possibly the only country, that has no border tax.”

If House GOP leaders and Trump have their way, then, BAT could replace the existing US Federal corporate income tax code. So US corporate leaders need to familiarize themselves with the basics of BAT if they haven’t already.

A US border adjustment tax would likely work in the following way, broadly speaking:

• The US corporate tax rate would be lowered from 35 to 20 percent.
• Sales within the US would be taxable.
• Sales made to countries outside the US would be exempt from the US BAT.
• The cost of imported parts or finished goods for use or sale in the US would no longer be deductible for tax purposes.
• Interest expense would be non-deductible, although interest deductions could be carried forward.
• Capital expenditures would be immediately deductible (as opposed to depreciated).

If a BAT is implemented in the US, we would likely see the following effects:

• Multinational companies will simplify their corporate structures.
• The use of IP holding companies may become obsolete.
• US domestic R&D will be encouraged.

Needless to say, there are opponents and proponents of implementing a border adjustment tax in the US. US manufacturers and exporters are of course supporters of border adjustment, since income on exports would not be taxable. A Wall Street Journal article on the subject notes that some profitable exporters under a BAT system could actually claim losses on their US corporate tax returns. While that would be welcome news for those exporters, the Journal adds that “the prospect of profitable companies paying no taxes poses a political problem for [BAT] proponents.”

Other US industries — like retailers, who rely heavily on imported goods and related deductions — are against a possible move to a BAT system. A CNBC article explains that 95 percent of clothing and shoes sold in the US are manufactured in other countries. The article poses a scenario in which the proposed GOP plan would raise taxes on a $100 sweater from $1.75 under our current corporate tax system to $17 under a BAT system. It adds that economists are divided as to whether and how much the dollar would appreciate to offset that burden.

When it comes to BAT in particular and corporate tax reform more generally, US exporters, importers and consumers are left in an increasingly familiar situation. That is: uncertainty will continue, at least into the near future.