Border Adjustability Update

One of the key components of the tax reform proposals that has been discussed in recent months has been the idea of “border adjustability” or a border adjustment tax (BAT). Like many aspects of the various proposals that have been considered in these discussions, it is somewhat simple on its face but is very complicated to put into practice. The devil is always in the details.

The original concept is attributed to Alan J. Auerbach, a professor at the University of California, Berkley and a former Deputy Chief of Staff of the U.S. Joint Committee on Taxation. During the recent presidential election campaign, then-candidate Donald Trump advocated for a border tax on imports. That proposal was conceived of as a traditional import tariff to be assessed on goods and services destined for U.S. sources. The version currently being debated was included in the tax reform blueprint released by the House Republicans earlier in 2016 and impacts both revenue and costs.

In economic terms, the BAT is a destination-based cash flow tax which taxes profits based on the location of the ultimate customer. Our current system often taxes profits based on the location of the manufacturer or producer. Take something like windshield wiper blades as an example. If manufactured here in the U.S. using both imported and domestic raw materials and labor, the net profit is subject to U.S. tax because it is produced domestically. Whether these wiper blades are sent to Tennessee or Timbuktu, the net profit is taxed here. Under the proposed BAT, if those wiper blades were shipped to a customer outside the U.S., none of the profits associated with this sale would be taxable here, since the buyer is outside of the U.S. From a cost perspective, any raw materials or labor incurred in the manufacture of a product from foreign sources would not be deductible when computing net profit but those same costs would be deductible were they to originate from domestic sources.

For tax purposes under this regime, “profits” would be computed by adding all domestic sales and deducting all domestic costs. As a result, those businesses that have large export sales generally support this proposal. But those companies that heavily rely on imported goods, either to be included in their final product or for resale of that imported product in final form, are against it. There is a definite divide between importers and exporters when it comes to the BAT. Companies in the retail, auto and energy industries have come out against it, arguing that it will raise the price of basic consumer staples like clothing, gasoline, and food. Other companies that heavily rely on exports to foreign customers, especially those who manufacture their products here in the U.S., support it.

The ultimate goal of such a system is to reduce the incentive for U.S. companies to move profits off-shore. Many companies like Google, Apple, and Microsoft have structured their operations to avoid paying current U.S. tax by generating a substantial portion of their profits outside of the U.S. With a lower overall corporate tax rate, coupled with the BAT, there would be less of an incentive to shift profits, thereby keeping a larger part of a company’s operations here in the U.S. Economists are split on the issue, as some believe that the increased cost of imported goods would create an inflationary environment. Others argue that this method of taxation would increase the demand for U.S. goods overseas, thereby strengthening the U.S. dollar, which would allow for the purchase of these more expensive foreign goods.

Similar contrasting views have been expressed by our political leaders. The current administration seems to have changed its view on the subject. Although it may have thought favorably of such a tax at one time, apparently the White House no longer does. House Speaker Paul Ryan, formerly a key supporter of the measure, seems to be considering other options. House Ways and Means Committee Chair, Kevin Brady, has raised the idea of a phase-in of such a concept over an extended period of time and providing some exemptions for specific products or services. One thing that everyone can agree on is that this tax was to be the source of a substantial amount of revenue which would offset the decline in revenue from the reduction in income tax rates. Although abandoning such an idea doesn’t make overall tax reform impossible, it does change the conversation about the scope of the subject.

For up-to-date information on all the latest tax reform news, look to the AICPA’s Tax Reform Resource Center which provides current information on various proposals and how the proposed changes will impact you and your clients.

Henry Grzes, CPA, Lead Manager-Tax, Association of International Certified Professional Accountants

Border tax courtesy of Shutterstock

Border Adjustability Update

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