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Controversial Border-Adjusted Cash-Flow Tax: A Proposal to Monitor


2/20/2017
 
Summary
 
Last year, before the Presidential elections, House members set forth a dramatic proposal for tax reform (commonly referred to as “the Blueprint”). This proposal included a border-adjusted cash-flow tax. Now, as this proposal is being considered, the President’s suggestion to include a different border-adjusted cash-flow tax is generating additional controversy and confusion. Companies would be wise to monitor developments as these proposals could impact them significantly.
 
Background
 
A border-adjusted cash-flow tax (“BACFT”) could have a significant impact on consumers, on retailers that have substantial sales of imported products, and on many different industries. A BACFT is a destination-based tax (“DBT”), in that it is designed essentially to tax a flow of goods based on where the goods end up. 
 
The Blueprint proposal includes a DBT which is being opposed by a number of industry groups including retailers and consumer products companies. Opponents of the DBT argue that the tax would be regressive and adversely affect lower-income taxpayers as a result of inevitable price increases that would arise from the inability to deduct the cost of imported goods. Moreover, representatives for industries that heavily rely on imports argue that they may not be able to pass on a large portion of the added tax cost and, as a result, the proposal would be harmful to their industries as well as to consumers. Proponents argue that a DBT should greatly enhance the competiveness of U.S. manufacturing. Many economists believe that the tax could be neutral for importers because it could result in an increase in the value of the dollar (making imports less expensive).
 
The President and leading members of his transition team have also expressed disfavor towards a universal DBT. Newly appointed Treasury Secretary Steven Mnuchin has made clear that the President does not support tax reform plans that would impose a universal border-adjustment tax on imports as part of a corporate tax reform package. Mnuchin has emphasized that, in contrast, when the President mentions a “border tax,” he is referring to a small number of companies that have moved their jobs, or are moving their jobs, outside of the United States and then selling products back into the country.  The President has proposed taxing only those particular companies specifically. As such, the BACFT that is included in the Blueprint has not been part of the President’s recent tax reform proposals.
 
In any case, there is currently very little in the way of detail for how the Blueprint would work and there has been no proposed legislative language. Best expert guesses have been that the result would essentially be subsidized exports and penalized imports.
 
What is known about the Blueprint is summarized in the following bullet points:
 
  • 20% corporate tax rate (25% tax rate on pass-through owners’ income) 
  • Capital investments fully expensed 
  • Corporate deduction for net interest expense eliminated
  • All special business provisions repealed except for R&E credit and LIFO 
  • “Border adjustability” exempting exports and taxing imports 
  • Territorial tax regime and tax on previously untaxed accumulated foreign earnings 
 
The business tax provisions of the Blueprint are economically similar to a value-added tax (VAT) in many respects, with a structure similar to a subtraction-method VAT: 
 
  • Businesses would be taxed on their receipts less purchases from other businesses 
  • Unlike a VAT, businesses would also deduct labor costs, with the labor income received by employees subject to a separate individual level tax at graduated tax rates 
  • The proposal would also tax investor-returns received as capital gains, dividends, and interest at a top effective rate of 16.5% 
  • A graduated-rate schedule applied to wages, plus the tax on investor-returns, makes the proposal more progressive than traditional consumption taxes

 

The tax press has suggested that the proposal would effectively transform the current corporate income tax into a 20% BACFT, with “border-adjusted” meaning that the BACFT would be applied to all domestic consumption and exclude any goods or services that are produced domestically and consumed elsewhere. The press has made the following observations:
 
  • Cash flow from exports (i.e., export sales) would be excluded from taxable income
  • Cash flow used to purchase imports (costs of goods sold (or COGS)) would be included in taxable income (i.e., non-deductible) regardless of the place of production
  • The VATs imposed in most other countries are examples of border-adjusted taxes

 

In a recent speech at the U.S. Chamber of Commerce, Senate Finance Committee Chairman Orrin Hatch said it was too early for him to take a hard stance on border adjustability.  He cited three main questions he has about the proposal. First, who will end up bearing the tax?  Second, is the tax consistent with international trade obligations? And third, would changes need to be made to ensure that specific industries are not “unduly” hurt? “We don’t have definitive answers to any of those questions at this particular point, and without them, I don’t think I can give definitive positions on the proposal,” Hatch said.
 
What Does CohnReznick Think?
 
On the one hand, the enactment of a DBT may have support from those who favor destination-based VAT systems which are common throughout the rest of the world. On the other hand, the Blueprint’s DBT may be such a departure from the current system in terms of potential winners, losers, and implementation disruptions, that enactment of the proposal in the short-term may be unlikely. 
 
Something of a “compromise” is circulating as an alternative proposal in terms of a flat border-import tax at a relatively low rate. There are also variations circulating to either fully or partially disallow wages paid as a deduction.
 
To sum up, taxpayers and industry groups that could be impacted significantly by a BACFT should continue to monitor developments and should seriously consider participating in the debate. We recommend that companies potentially impacted by a DBT consult with industry-group representatives such as the NRF to learn how their individual voices can be heard and how to formulate a course of action. Also, taxpayers that may be impacted by the President’s objections to companies that have moved their jobs overseas, or are moving their jobs overseas, while putting products back into the United States, similarly need to monitor the situation closely. 
 
Contact
 
For additional information, please contact:
 

 

Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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