The Border Adjustment: A Primer

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If the Trump Tax Plan passes congress, US taxpayers, especially those with cross-border operations can expect a lot of changes. Perhaps the biggest change to the way US businesses perceive and plan for income taxes would be the “Border Adjustment”.

What is the Border Adjustment?

The Border Adjustment (or technically, the Destination-Based Cash Flow Tax with Border Adjustment) is a mechanism to provide an improved tax position for US companies exporting products, while eliminating tax benefits to US companies importing products. In a nutshell, taxable revenue would include sales transacted in the US (removing export sales from taxable revenue) and deductible costs (tax deductions) would be limited to US production costs, eliminating deductions for the cost of goods imported.

While the US would implement the Border Adjustment on an income tax basis, to the rest of the world the Border Adjustment is a mechanism more frequently used with respect to indirect taxes, such as the Value Added Tax (VAT), which is the largest source of tax revenues for most of the US’s primary trading partners.

Why the Border Adjustment?

The primary purpose of the Border Adjustment Tax is to bring jobs back to the US – especially manufacturing jobs. The Border Adjustment would greatly increase the tax burden for those companies importing products, thus providing incentives to produce those products in the US.

Economists tell us, however, this large incentive to produce exports and stop imports is only temporary and equalization will occur when the US dollar increases in value by about 20%. 20%!!! A 1% move in the dollar is considered a major swing. Additionally, the National Retail Federation (yes, the importers) predict that the increased cost of importing will be borne by US consumers – most everyday items, not just imports, will become more expensive by at least 15% if the Border Adjustment is enacted.

Maybe Yes?

If the plan is adopted and the US dollar increases in value, companies would be encouraged to produce goods in the US and manufacturing jobs would thereby increase. With a strong dollar, US companies would have more buying power and inflation might be “managed”. For companies that export, the reduced tax cost would make it much cheaper to manufacture and assemble goods in the US (however, if the dollar rises, US-made goods could become too expensive for foreign buyers – e.g., in 2015, the US manufacturing section went into a recession because of the sharp increase in the dollar).

Maybe No?

Retailers (especially big-box retailers) and even the Federal Reserve’s economist are not so positive about the destination-based cash flow tax with border adjustment. The retailers don’t like the added tax cost of not being able to deduct the cost of imported goods and the economists don’t believe the dollar will rise in value (enough or quickly enough) to offset increased costs to US consumers or to keep inflation manageable. Bear in mind, the value of the dollar has many influences beyond tax policy.

What Else? Other US international export incentive programs (the Foreign Sales Corporation and the Extra-Territorial Income Exclusion) have been rejected by the World Trade Organization. It is probable the Border Adjustment would not pass muster with the WTO, meaning our trading partners could sue the US through the WTO for the time period the Border Adjustment was operational. It could likely be a number of years between enactment and revocation by the US Congress if the Border Adjustment Plan is rejected by the WTO.

Before getting too far ahead of ourselves, the Trump Tax Plan, as presented, was low on details and not much has come out of the Congress regarding specifics. Before restructuring businesses or changing plans, it would be wise to wait and see what actually gets passed by the House and Senate.

Ask the Experts

Kimberlee Phelan, CPA, Partner
T (609) 520 1188
kphelan@withum.com

kphelan@withum.com

To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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