Tax Reform Watch: Introducing the Border Adjustment Tax– March 31, 2017

The push for tax reform is heating up now that the effort to repeal and replace the Affordable Care Act did not garner enough support. Accordingly, President Trump has signaled that tax reform is the next stop on his agenda.
One compelling reason for overhauling the current tax regime is so the U.S. can be more competitive with our international trading partners. Currently the U.S. corporate income tax rate is 35 percent while the average worldwide rate is 22.5 percent. One of the strategies being discussed is moving to a border adjustment tax (BAT). The BAT is similar to the Value Added Tax (VAT), a consumption-based tax used in many countries in the European Union. Under a BAT system, foreign- and domestic-produced products imported into the United States would be taxed; but exports, items made in the U.S. that are not sold here, would be exempt.
For example, under a BAT, if a U.S. company ships tires to Mexico where they will be used to make cars, the profit the tire company makes on the exported tires is not taxed. However, if an American car company purchases tires from Mexico for use in cars made in America, that company cannot deduct the cost of the imported tires as a business expense.
An important distinction to note is that the BAT is not a tariff on specific foreign goods; it is more of a sweeping effort to change the U.S. tax system from one that taxes production to one that taxes sales. The underlying theory of the BAT is that it will keep, and create, jobs in the U.S. As the demand for American-made, tax-exempt exports increases, so, then, should the number of jobs in the U.S. Implementing the BAT also would be part of a larger plan to reduce the corporate income tax rate, since companies would be taxed where their income is earned rather than where the product is made; and to shift from a worldwide U.S. income tax system to a territorial tax system, which is based on indirect cash flow basis and tax consumption. The transition to a territorial system would have to take place for the World Trade Organization (WTO) to even allow the BAT, as they do not allow a BAT for direct income tax, which is the current U.S. tax system.
While the U.S. may win in many respects, encouraging U.S.-made products and potentially increasing the job count, some certainly will lose unless they change their current practices. Many of the big box stores such as Best Buy and Walmart, who rely heavily on importing products, would not be allowed a deduction for the cost of the imported products sold. That means either customers will pay more or stores themselves will face lower profitability. Big questions also remain about the tax itself, such as will it be considered an income tax or as a gross receipts tax, which would be unconstitutional. And there is still the chance that the WTO may consider the BAT an unfair trade advantage to the U.S.
Whether the BAT prevails or a different idea takes center stage, it’s highly likely that our international tax system will play a key role in tax reform moving forward. 

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