Know the Law: Preparing for a ‘Border Adjustment Tax’

Catherine H. Hines
Counsel, Tax Department
Published: Union Leader
April 10, 2017

Q. What is the proposed “border adjustment tax,” and what does it mean for businesses?

A. Donald Trump campaigned on the promise of bringing manufacturing jobs back to the U.S. and called for imposing tariffs on imported goods to accomplish this. The House Republican leadership has responded by proposing the border adjustment tax instead.

A border adjustment tax would replace the current corporate income tax with a tax that is imposed on corporate income from domestically-consumed goods and services only. A corporation’s taxable income would be equal to its revenue from sales in the U.S. less the cost of domestic labor and domestically-sourced supplies.

Revenue from exports will not enter the equation, nor will the expense of paying for foreign labor or goods. The net result will be to tax profits from the sale of goods sold in the United States (whether imported or domestically produced). This will have the salutary effect of eliminating tax incentives for corporations to locate operations and assets in tax haven jurisdictions.

The border adjustment tax proposal has generated a great deal of controversy: Exporters generally favor it, while importers are lining up in opposition. Businesses that have their operations, suppliers and sales solely in the U.S. should be unaffected. For exporters, reduced taxes should drop right to the bottom line, increasing their short-term profitability.

But businesses that rely on imported goods (for instance, retailers) cannot deduct the cost of those imports, and their taxes may increase dramatically. Many economists believe that in the long run, the border adjustment tax will cause the U.S. dollar to strengthen, making imported goods less expensive and domestic goods more expensive; and this change in the exchange rates will offset both the tax advantages for exporters and additional taxes for importers, leaving the border adjustment economically neutral for both.

That said, the economic disruption that could be caused by the transition to a border adjustment tax could be substantial and the as-yet unwritten transition rules will be critical to determining the ultimate impact.