Proposed US Border Adjustment Tax
16 March 2017
The Republican majority in the US Congress plan to introduce legislation to implement a destination based cash flow tax (DBCFT), also now being referred to as a border adjustment tax (BAT). A target time for completion of this Spring has been mentioned.
This is despite the fact that President Trump has so far stated that DBCFT would be “too complicated” and has stated that he will be unveiling his own “massive tax plan” in the not too distant future.
This briefing considers potential key implications for non-US retail and food and beverage businesses if the proposed DBCFT or BAT is enacted substantially as planned:
- Exports to the US may be more expensive (as no tax deduction for the cost), in which event sales to the US would be expected to fall.
- Potentially cheaper imports from the US may reduce sales in home markets.
- Economists expect that the US $ would gain in value, although opinions differ as to how great the effect would be and it may be very uneven. A rise in the dollar would tend to counteract the effect of the border adjustment on imports and exports.
- There is a significant risk that the reforms would breach WTO rules on anti-dumping and/or subsidies and countervailing measures. The process for challenging the reforms through the WTO’s Dispute Settlement Body would take significant time.
- If as proposed, no deduction for net interest costs was permitted then financing investment would arguably become more expensive for US retail and food and beverage businesses in comparison with non-US businesses. The availability of full tax deduction for capital expenses may however counteract this effect.
- The proposals arguably breach various US double taxation treaties. For example, under such treaties importers cannot generally be denied a deduction for income tax purposes for purchases from a non-US supplier where one is available for similar purchases from a US supplier, but there is a question as to whether this should apply to a DBCFT.
- Non-taxation of exports would breach the OECD BEPS guidelines as double non-taxation and would enable importing countries to disallow a deduction to the importer under BEPS tax mismatch rules. It might also qualify as an illegal export subsidy under WTO rules, depending on how the tax is structured.
- In the US there would be winners and losers amongst US retailers and food and beverage businesses. It is possible that mergers of importers and exporters would be encouraged by the need to match deductible costs of retail exporters with taxable retail sales.
- It remains unclear how non-US retail businesses (without a US permanent establishment) would be treated on sales into the US. If their sale of imported products is not taxed in the US (unlike US businesses sales of imported products), then this gives a clear advantage to such non-US businesses in the sector. It is therefore likely that special rules will be needed in relation to non-US businesses which sell imported products in the US without a permanent establishment, again potentially in breach of double taxation treaties and OECD guidelines. This could affect many non-US businesses with US customers which could find their sales of goods and services subject to US tax.
It is in practice most unlikely that there would be no retaliation by other countries, although it is uncertain how quickly others would react and whether WTO procedures would first be fully followed. Possible responses include:
- Disallowing a deduction for goods and services imported by non US retailers and food and beverage businesses from the US. This could possibly be implemented very quickly as some jurisdictions already have (or are in the process of enacting) legislation to effect various actions under the OECD BEPS project. Where tax mismatch legislation is in place this should operate automatically to disallow deductions for imports for non-US businesses from the US where the sale is not taxed in the US.
- Non-tariff measures to disrupt advantages to the US from the tax changes. The possibilities for these are many and, while the US could challenge through the WTO’s Dispute Settlement Body, this would (as with challenges to the US) take time and could result in significant harm to US interests in the meantime.
- It is possible that protectionist measures could escalate on all sides (‘a trade war’) which would be likely to result in even greater damage to US and others economic and political interests. The rest of the world may be able to limit the damage outside the US by acting together, whether through the WTO or otherwise.
- Alternatively, ‘retaliation’ may take the form of following the US measures. While this could level the proverbial playing field such an outcome could permanently reduce world trading volumes as it would arguably provide a tax penalty for any cross border activities.
Of course the objections of Senate Republicans to the plan as currently formulated and the expected announcement of a “massive tax plan” by President Trump may change this outlook completely.