Where is US Corporate Tax Headed Under the New Administration?By Solomon Packer | May 4, 2017
It is contemplated that US Congress will soon revise corporate tax policy.
Among the proposals coming to the fore, and being highly-debated in business and tax journals, is “destination-based cash-flow tax,” or “DBCFT.”
It is important to recognize that a DBCFT tax regime differs greatly from our current income tax system, and incorporates two distinct elements: a destination-based tax system, and a cash flow tax system. Each of these regimes can operate independently – but the proposed DBCFT combines the distinct approaches.
As such, it is imperative that executives understand how corporate taxation may change under a DBCFT tax regime, and how such a regime might benefit or adversely impact their business.
The cash-flow component explained
Under a “pure” cash-flow tax regime, the entity structure used would not be material as tax liability would be based on the net of receipts less capital employed. The borrowing of funds would be a taxable receipt and the payment of interest would be a deductible expense. Capital employed would include purchases of inventory, equipment, rent, utilities and other expenses related to assets used or consumed by the business including loan repayments, interest and labor. Assets would be wholly-deducted in the year purchased, and depreciation would no longer have to be computed. There would be no difference in tax based on whether or not an asset is a capital asset. Business income would be taxed at a single rate.
Under this approach, borrowing would not be encouraged by the tax system while investment in businesses will be encouraged. No net tax benefit is derived when a company makes an investment with borrowed funds as the borrowing is considered a taxable receipt and is offset by the asset investment. A net tax deduction is received in the year of investment when a company makes an investment with equity funds.
It is probable that modifications to the pure cash-flow tax regime might be required for certain business sectors whose income might not easily fit within the defined receipt and capital employed concepts. If Congress wishes to provide incentives to certain industries, it will consider granting tax credits to reduce taxes payable.
Tax plans presently being considered by Congress are not “pure” cash-flow regimes, but rather incorporate significant elements of a cash-flow tax. For example, under plans now being considered, interest expense would not be deductible, while net interest income and non-active income earned by businesses would be subject to tax.
What is a destination-based tax system?
Under a destination-based tax regime, transactions sited in the United States would have a tax consequence while foreign-sited activity, or “consumption,” would not impact US taxation. So far, Congress is considering the destination-based component of taxation solely for businesses while individuals will continue to be taxed on their global income.
Under a destination-based regime, receipts from foreign buyers of goods or services would not be subject to US business tax. Because taxable business receipts are determined by where a product or service is consumed, exporters are supportive of this tax regime, as their export receipts will not be subject to US tax while their cost to produce the exported product would not be deductible.
Importers of goods to the US, however, are not supportive of this regime, as goods being imported would be subject to US taxation at the border upon importation. It is questionable whether this import tax will increase the price paid by US consumers for foreign goods. Proponents of this tax claim, that through price adjustments or foreign exchange adjustments, the cost of the import tax on goods would be lessened or eliminated. However, those objecting to the tax claim that there will be an overall cost increase to the US consumer.
Nevertheless, a destination-based tax regime eliminates the need for US businesses to relocate abroad to reduce their overall effective tax rate. US businesses will no longer believe that the US tax system places them at a competitive disadvantage. Goods exported to foreign jurisdictions will no longer incur the higher of the US or foreign tax - and income earned abroad can be repatriated free of any additional US tax. Net profits will be considered earned where goods or services are consumed.
Goods imported to the US would bear US tax at the border, while receipts from the sale of exported goods or services will be exempt from US business tax. Businesses, however, will need to accurately determine the cost of manufactured goods, as such costs will not be deductible in calculating US tax liability.
Both Congress and the new administration have unequivocally promised that tax reform will be a top priority in 2017. Whether or not the DBCFT is selected as US tax policy for years to come, business leaders operating stateside and abroad should follow the latest discussions around reform, and plan accordingly to manage the resulting impact.
This article was originally published in Morison KSi's quarterly tax newsletter, Global Tax Insights, Q1 2017.
About Solomon Packer
Solomon Packer, CPA, JD, LL.M., is a Senior Consultant at Marks Paneth LLP. He specializes in the area of international taxation. In this capacity, Mr. Packer advises foreign persons and corporations on how to do business in the US and, conversely, advises US corporations on how to conduct business overseas in order to effectively reduce their worldwide tax exposure. His areas of specialization include international mergers and acquisitions, tax issues related to foreign ownership of... READ MORE +