It is all over the news; President Donald Trump has hit the ground running and is making changes at lightning speed.  He is moving on his agenda and signaling that he wants things to happen fast.  Tax is no different.  Tax priorities and ideas are changing on a daily basis.  President Trump has now seemed to warm up to a border adjustment tax after initially opposing it as too complicated.  The border adjustment tax has become a new hot topic for business owners.  The tax rules have not been written yet, so our comments are only speculation on how the border adjustment tax may operate.

Mechanics of Border Adjustment Tax (BAT)

The 20% border adjustment tax would be in place of the proposed 15% business income tax.  Under this plan, the corporate tax rate would drop to 20%, imports would no longer be a deduction, and exports would be exempt from tax.

For a corporation with a 50% gross profit and 80% Imports:


Current Law Proposed Border Adjustment Tax
80% 80% If 100%
Imports Imports Domestic
Sales    1,000,000    1,000,000    1,000,000
Cost of Goods Sold     (500,000)     (500,000)     (500,000)
Operating Expenses     (300,000)     (300,000)     (300,000)
Profit Before Tax       200,000       200,000       200,000
Add: Foreign COGS       400,000
Subject to Tax       200,000       600,000       200,000
Tax 35%       (70,000) 20%     (120,000) 20%       (40,000)
Net Profit       130,000          80,000       160,000

Although illustrated for a corporation, the effect would be similar for owners of pass-through entities.

 Products from US Suppliers

Just because a product is purchased from a US Supplier does not mean that it is free of the border adjustment tax.  To the extent that products have foreign content, BAT tax will have already been paid by the US Supplier.  When the US Supplier later sells their finished products, prices will reflect the amount of BAT taxes previously paid.  So even when products are purchased from US Suppliers, customers may indirectly pay some BAT taxes in the form of higher prices.

 Comparison to Value Added Tax (VAT)

This BAT tax is often compared to the VAT (Value Added Tax).  With a value added tax, tax is collected at the border and every time it is resold.  But each buyer gets credit for all previous VAT paid.  Otherwise, the same tax is paid on the same item, over and over again.  Without a credit, after the goods are passed through a few hands with mark-ups, the total tax collected becomes more than the item cost.

So you would think that there will have to be some mechanism to avoid double taxation for the BAT.  The tax could be tracked, paid, and credited at every stage of sale like the VAT.  The goods could be considered domestic after the first US buyer.  Or there could be some kind of deemed tax credit calculated, when figuring income tax.

What if different product components go back and forth across the border a few times?  What if some services are done in other countries and some services are done here?  It seems that the tax calculation could get very complicated very fast.

Concerns about the BAT

Some economists and plan supporters say the dollar will rise to offset the tax change.  If that happens, importers would pay less for goods they import, because a stronger dollar would reduce the actual cost of imports.  They believe that although there are more taxes paid, after-tax profits will be unchanged because of lower costs after currency adjustments.  A stronger currency may not be totally helpful; it could make it harder to export some products.

Others are worried that the dollar won’t rise quickly enough or high enough and it will penalize big retailers and other large corporations reliant on lower-cost foreign production.  It could also prove painful for small firms, which typically have less ability to negotiate better deals with suppliers or push through price increases to customers.  Also, experts are worried that smaller firms don’t have the time and money to spend modeling tax changes into their sales prices.

Strategies to Deal with BAT

Companies would likely adopt new strategies to deal with a border adjustment tax.  They will try and use more US raw materials and parts in their products, even if the products are made overseas.  Instead of importing completely finished items, companies may import partially completed items and finish the products in the US.  Operations done overseas merely for convenience or to be near suppliers may now be done in the US.  With 20% tax savings on exports, foreign sales may go up.

There is concern that the US manufacturing infrastructure is gone.  That there are not enough skilled laborers and that manufacturing is a lost art.  On the other hand, when manufacturing first started going overseas in the 1980s, there was not laptop computers, smart phones, or the internet.  Robots and computer controlled machines were in early stages of development.  It may take time, but with today’s technology, maybe highly automated plants could be built in low cost areas of the US and the 20% tax savings would justify it.  Businesses may see it as a new investment opportunity.

Where products are totally done by hand and the 20% BAT savings won’t justify bringing products back to the US, everyone will be in the same boat with the same tax.

Foreign companies may also want to make major changes.  Without US content or services being used to make their products, foreign companies could be taxed 20% on their entire sales price.  With a 20% sales tax, foreign companies may try harder to use US materials, parts, and services.  They may be more likely to open US offices, move operations to the US, or buy US companies.

We hope we have answered your questions.  Please feel free to contact our partners or tax department with any questions that you might have.