What to Expect from Tax Reform and Border Adjustability
By Brian Kuehl and Dave Burger
As the 115th Congress begins in Washington, DC, comprehensive tax reform is set to be one of the top priorities for Congress and the Trump administration. K·Coe Isom believes there is a high likelihood of comprehensive tax reform in the next two years, and that much of the debate and formulation of the legislation will occur this year. It is critical that Association members engage in this discussion and plan for how tax reform could affect your profitability and competitiveness.
One of the most significant changes proposed by the Republican Tax Reform Blueprint would be for the U.S. to adopt a tax system that includes “border adjustability.” Under border adjustability, the U.S. would move toward a destination-based tax system similar to a value-added tax (VAT) used by many other countries (except with continued deductibility for wages). A VAT is a consumption tax placed on a product whenever value is added at a stage of production and at final sale.
Under border adjustability, if a U.S. farm equipment manufacturer were to sell equipment to a domestic purchaser, the revenue from those sales would be taxed as income. However, if the company were to sell equipment overseas, the revenue from those sales would not be treated as income under the Internal Revenue Code (I.R.C.).
By extension, if a U.S. company were to purchase equipment from a domestic manufacturer, the cost of that purchase would be deductible as a business expense. By contrast, if the company were to purchase equipment from Mexico or other foreign sources, the cost of that purchase would not be deductible as a business expense under the I.R.C.
The practical effect of this new tax structure is to increase the cost of imports by 25 percent. If a U.S. company were to purchase $10,000 of equipment from a domestic producer, the true cost of that purchase would actually be $8,000 since the cost of that purchase would be deductible as a business expense and would reduce the purchaser’s income tax by $2,000.
By contrast, if one were to purchase $10,000 of equipment from a foreign producer, the actual cost of that purchase would be $10,000 since it would not be deductible as a business expense.
As a result, the foreign-sourced equipment would have an effective cost 25 percent higher than domestic-sourced equipment.
While this sounds like a great thing for domestic producers (and not such a good thing for importers), proponents of border adjustability argue that the real cost increase on imports will be negligible or non-existent since the U.S. dollar will strengthen as a result of this change to the U.S. tax code, thereby offsetting any cost increases.
A stronger dollar could make U.S. agricultural exports less competitive, sending ripple effects through the economy that could impact agricultural manufacturers. In addition, some analysts are not optimistic that appreciation of the U.S. dollar will perfectly offset increased prices on imports. Among their concerns is that many U.S. trading partners, including China, have currencies that do not float freely. Because of concerns that the tax system would disadvantage industries reliant on imports, some of the nation’s largest importers, including retailers and the petroleum industry, have begun lobbying against the border adjustability plan.
Another key concern with border adjustability is that it could trigger retaliatory tariffs under the World Trade Organization (WTO). Under the WTO, countries are permitted to adopt a tax that is border adjustable if it is an indirect tax. By contrast, a border adjustable direct tax is considered an export subsidy that is prohibited by WTO rules. This could result in retaliatory tariffs on U.S. sourced agricultural equipment and products.
So how will comprehensive tax reform affect your business? The only way to answer this question is to conduct an analysis that considers your individual circumstances. If you are a U.S. company currently paying income taxes, you will want to consider the combined effect of all of the proposed tax code changes (lower rates, immediate expensing of equipment, border adjustability, etc.). You will also want to consider the effect of changes in the strength of the U.S. dollar and potential retaliatory tariffs that could impact your business.
If you are a foreign corporation that currently does not pay U.S. income taxes, you will want to recognize that the revenue from your imports may become subject to U.S. taxation, and that your customers may no longer be able to deduct such purchases as business expenses. Fortunately, whether you are a U.S. or foreign company, there are many steps you can take today to position yourself to maximize your profitability and competitiveness under a new U.S. tax system.
Brian Kuehl is the director of federal affairs at K·Coe Isom. Dave Burger, CPA, is a principal at K·Coe.