The GOP’s Blueprint proposes a fundamental change to the taxation of business income, where the tax base would be determined by the cash flow of a business, and not necessarily by its profits.

The House GOP released a proposal in July 2015 for comprehensive tax reform (available here). If adopted, this plan would fundamentally change business taxation. The centerpiece of the Blueprint’s corporate tax reform proposals is the conversion of our current corporate income tax to a so-called “destination-based cash flow tax” (“DBCFT”).

Under the current corporate income tax regime, corporations are generally taxed on their profits at a marginal rate of 35 percent. To arrive at the amount of taxable profits, a corporation is allowed to deduct a number of items (lowering the taxable profits), including interest on liabilities of the corporation and depreciation of capital expenditures.

Instead of taxing profits, a DBCFT does what its name implies: it simply taxes the cash that flows through a business (i.e., gross revenues). However, the proposal includes certain offsetting deductions against the business’s taxable cash flow. Most importantly, instead of depreciating capital expenditures over a period of time, the proposal would allow businesses to immediately expense U.S. capital expenditures (reducing the amount of taxable cash flow of the business), thus potentially eliminating the need to track basis and other similar complexities. Importantly, however, the proposed DBCFT would eliminate the deductibility of net interest.

The DBCFT is very similar to a value-added tax (“VAT”) except that the proposed DBCFT permits the deduction of wages. This feature may have attractive distributional properties, but may result in complexities with respect to WTO compliance.

For further explanation of what makes the proposed cash flow tax “destination-based,” please see our posts on Territoriality and Border Adjustment.