Although the attention has been on who will build the border between the U.S. and Mexico this past year, an even hotter topic in the coming months may be the potential border, both figurative and literal, between the Republican-led House of Representatives and Trump.
The Border Adjustment Tax is being discussed vehemently these days, both in Congress and in the White House. House Speaker Paul Ryan and the GOP are strong advocates for it, while President Trump has been outspoken against it (although, in recent weeks, has started to warm up to the idea. Tremendous!).
Before delving into the minutiae, let’s start with the basics: as touched on in prior TrumpWatch columns, the current U.S. corporation tax rate is 35%.
Under current law, corporations are taxed on their net profits, meaning the tax is based on the company’s gross income minus expenses. These expenses are made up of direct cost of goods sold, various operating costs (general administrative expenses, interest expense, advertising, etc.), as well as depreciation, which allows you to write off the cost of a fixed asset over several years, depending on the asset type. To quote Kramer from Seinfeld:
“Jerry, these big companies, they write off everything! … I don’t know what that means, but they do, and they’re the ones writing it off!”
As discussed in our most recent TrumpWatch on international taxation, U.S. corporations are taxed on profits earned overseas and repatriated back to the U.S.
The proposed GOP plan, backed by House Speaker Ryan and Kevin Brady, Chairman of the House Ways & Means Committee, would create a destination-based-cash-flow-tax-with-a-border-adjustment, aka DBCFT (maaaaaybe we’ll just stick with “Border Adjustment Tax” for short).
This proposal indicates that a U.S. company would pay tax on where the goods are sold (i.e., where they end up), not where they are produced. In other words, the proposal would push towards the “consumption tax” concept instead of the “income tax” concept. In addition, the proposal would look to reduce the corporate rate and tax domestic revenue minus domestic costs from 35% to 20% (although Trump’s still proposing a reduction to 15%).
As much as I love to bold and underline words, there actually is a reason for the emphasis on “domestic.” Current law allows for companies to be able to deduct the cost of imported costs and materials from their revenues. The proposal would eliminate this concept: since we’d be shifting to a “consumption tax” (again, taxation on where the goods are consumed), import costs would not be an allowable deduction. Contrarily, exports and other foreign sales would be made tax-free (remember, tax only on where the goods were consumed). The goal: keep businesses, production, and manufacturing within the U.S.
While losing deductions for imported materials may be detrimental to several companies (like retailers, who derive a bulk of their goods from imports), several economists have noted that this shift in taxation may increase the value of the dollar; thus, if the dollar were to increase, those same imported goods would be less expensive. In simple terms: the increase of the dollar may offset the tax increase to importers. Importantly, consumers will most likely pay more for those products.
Just for comparison’s sake, most other countries use what’s referred to as the Value Added Tax (VAT) system. This is, for all intent and purpose, the same as the proposed Border Adjustment Tax, the only difference being under the VAT, a company cannot deduct wages, while under the proposed plan, wage-deduction would be fair game.
As things stand, there still is that figurative border between the House’s proposal and Trump’s own corporate tax reform proposal (despite Trump warming up to the concept). Either way, the months ahead should prove to be very interesting as to what ultimate corporate tax reform the U.S. will be adopting in the near future.
Stay tuned to the REM Cycle for further TrumpWatch updates.
David Roer is a Tax Manager in Raich Ende Malter & Co. LLP’s New York City office. David specializes in high net worth individuals, as well as closely-held corporations, S-Corporations, and small businesses.
Contact David at firstname.lastname@example.org or (212) 944-4433.