Possible Advantages of Border Adjustment

Published on: 12:23PM Feb 16, 2017

~~We previously posted on the proposed destination based cash flow tax and how this might affect farmers.  The Tax Foundation issued a report yesterday on how this may affect imports and exports and other related issues.  The conclusion by them that is essentially over time imports and exports will equalize to their current levels.  The detail on this is fairly lengthy so I am going to recap some of the advantages that they see from a destination-based tax from our current "origin-based" tax:

•Eliminates Current Law Profit Shifting Techniques - A destination-based tax should prevent the type of current profit shifting that erodes our tax based under current corporate tax rules.  Essentially a destination-based tax ignores these types of transactions.  Under current law, if a company imports $100 million of goods from a foreign-based subsidiary that has a lower-tax rate, there is an incentive to over-price the imports to reduce the taxation to the US based company.  Likewise, there is an incentive to underprice exports of US based goods to the foreign subsidiary.  Under the destination-based tax, these shifts in profits are ignored. 

•Simplifies Many Aspects of the Corporate Tax and Eliminates the Need for Complex Anti-Base Erosion Provisions - There is a large business by many CPA firms and other advisors in calculating the "best" price or method on these inter-border transactions.  The imposition of a destination-based tax will eliminate many of these calculations.

•Broadens the Tax Base and Pays for Other Pro-Growth Reforms. It is expected that the destination-based tax will raise about $1 trillion in revenue over a ten year period.  This will help pay for lowering the tax base for individuals and flow-through entities.  However, this boost in revenue is not permanent.  As export and import "prices" adjust, the additional revenue will slowly shrink.  However, all tax revenue scoring is based on a ten-year window, so what happens after ten years usually does not concern Congress much.  That is why June 30 corporate tax returns are still due 2 1/2 months after their year-end versus 3 1/2 months for all other corporate returns for the next ten years.

There are some challenges with the destination-based tax:

•How will the WTO view this tax.  Although it is unlikely that the destination-based tax will create unfair trade advantages to the US, it is uncertain how the WTO will view it.  WTO rules allow for border adjustments on imports and exports.  First, a border adjustment is typically allowed as an indirect tax such as an excise tax and not a direct tax such as a corporate income tax.  Second, a tax with a border adjustment needs to treat domestic and foreign goods equally.  Third, exports cannot receive a larger tax rebate.  It is unclear if the WTO will challenge this, especially since Japan has had a very similar tax since the early 1990s.

•Implementation Challenges - This will be a very complex tax to implement.  If a company has a large export tax base, they may never pay taxes and never be able to get paid a "credit" for their "saved" income taxes.  Some options proposed may allow for these companies to sell their net operating losses or get paid on any losses generated.  If these are implemented the tax revenue raised will shrink reduction the benefit to individuals, etc.  Plus, it will take a lot of new IRS Regulations to implement this tax.

As you can see, this can get very complex.  I would highly suggest reading the article.  It gives a lot of detail on how this tax may work along with the advantages and disadvantages.  We will keep you posted.