Reproduced with permission from Daily Tax Report, 31 DTR J-1, 2/16/17. Copyright 2017 by The Bureau of National
Affairs, Inc. (800-372-1033) http://www.bna.com
Tax L e g i s l a t i o n
Karl L. Kellar, George Korenko and Lori Hellkamp look at the practical, legal and policy
implications—as well as many unknowns—springing from border adjustments contemplated
in the GOP’s destination-based cash-flow tax proposal. ‘‘Before the GOP proposal is
adopted, far more economic and policy analysis and design are necessary, and much
greater attention must be given to details concerning mechanics, implementation and enforcement,’’
the authors write.
Border Adjustments in the Destination-Based Cash-Flow Tax:
A Bold Proposal With Unanswered Questions
BY KARL L. KELLAR, GEORGE KORENKO
AND LORI HELLKAMP
This may be one of those rare times in Washington
when there appears to be consensus across party
lines (including within the Treasury Department)
that the current tax system is broken and reform is desirable.
However, this illusion of consensus begins to
break down once the different actors start to propose
how to reform the rules.
The first salvo, and the subject of this article, was
fired in June 2016 when the House Republicans released
their blueprint for tax reform: ‘‘A Better Way:
Our Vision for a Confident America.’’ The House GOP
proposal has received renewed attention with the unexpected
election of President Donald Trump, as fundamental
tax reform now seems a real possibility.
The GOP proposal promotes a new ‘‘destinationbased
cash-flow tax’’ (the DBCFT), which is intended to
move U.S. business taxation toward a simpler,
consumption-based model of taxation. This article focuses
on selected legal, economic and policy aspects of
the most controversial component of the DBCFT, its socalled
Like others who have addressed the DBCFT in general,
and border adjustments in particular, we have to
make certain assumptions about how the border adjustments
would work because the details in the proposal
are so scant.
Indeed, the description of the DBCFT occupies less
than two pages of the proposal, and only a few sentences
describe the border adjustments. We don’t yet
know, for example, whether or how the new system will
apply to the financial sector, digital goods, services,
cloud computing or passthroughs; nor do we know the
extent to which it will supplant, or supplement, the current
income tax system.
Likewise, we don’t know what accommodations will
be made and what transition rules enacted to facilitate
the conversion to such a radically different system, including
the need for businesses to switch from income
tax accounting to cash-flow accounting—and to protect
themselves against the potential (intended and unin-
Karl Kellar is a tax partner in the Washington
office of Jones Day with extensive experience
in transfer pricing and other areas of international
taxation. George Korenko is a partner
at Edgeworth Economics and an expert
in the economics of transfer pricing, antitrust,
labor and executive compensation, intellectual
property and housing finance. Lori
Hellkamp is a senior tax associate in the
Washington office of Jones Day specializing in
international taxation, including transfer pricing
and tax treaties.
The opinions expressed in the article are those
of the authors and do not necessarily represent
the views of Jones Day or Edgeworth
COPYRIGHT 2017 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 0092-6884
Daily Tax Report®
tended) adverse effects the proposal could have on
business structures put in place in reliance on the existing
international tax rules.
Even the high-level description of the DBCFT provided
in the proposal raises many questions and issues,
both as to the economics—such as the intended and unintended
effects it could have on the economy, the financial
markets, foreign trade, interest rates and various
U.S. business sectors—and to tax policy, including
practical enforcement and implementation issues.
Exploring some of these uncertainties and practical
issues, from both an economic and a legal perspective,
makes one thing clear: Before the GOP proposal is adopted,
far more economic and policy analysis and design
are necessary, and much greater attention must be
given to details concerning mechanics, implementation
The GOP proposal would radically restructure business
taxation: It proposes lowering income tax rates on
businesses, moving to a (mostly) territorial system by
exempting dividends from foreign subsidiaries and repealing
much of Subpart F of the U.S. Internal Revenue
Code, and introducing the DBCFT, which entails allowing
full expensing of most capital investments and denying
deductions for net interest expense.
The most complex, and controversial, aspect of the
proposal is the DBCFT’s ‘‘border adjustments,’’ a concept
more common in value-added tax (VAT) systems.
As used in the GOP proposal, the border adjustments
mean that exports of products, services and intangibles
would be entirely exempt from U.S. taxation, while
goods, services and intangibles imported into the U.S.
would remain subject to U.S. income tax. In fact, U.S.
importers would be denied any deduction for foreign input
costs and thus be taxable on gross revenue—the resulting
increased income tax liability being an implicit
‘‘import tax.’’ By contrast, not only would U.S. exports
be exempt from income tax, U.S. exporters would still
be able to deduct their domestic input costs (including
labor expenses), thus resulting in tax losses—i.e., negative
U.S. tax liability on exports.
A flood of articles and papers discussing various aspects
of the GOP proposal, ranging from detailed scholarly
analyses to brief summaries, have already been
published, and undoubtedly many more can be expected.
This is inevitable, given that such a radical
change in our business tax system will likely have a
profound impact on the U.S. and global economy,
global financial markets, international trade and tax
policy, not to mention individual U.S. businesses and
consumers. Given both its importance and the overload
of information and perspectives—of everyone from
theoretical academic economists to tax administrators
and tax policy experts, practicing lawyers and political
actors—it may be helpful to take a step back and consider
what we know and don’t know about the GOP
proposal and its potential impacts. This can point to issues
that need more consideration and analysis—in
some cases far more—before such a revolutionary system
For example, perhaps one of the most obvious, but
least discussed (and little understood) set of issues involves
behavioral reactions to the DBCFT’s implementation.
Much of the literature and economic scoring has,
to a large extent, assumed static conditions and behavior;
but it seems evident that consumers and businesses
will react—repositioning themselves and their transactions
to exploit, or avoid, the economic (dis)incentives
presented by this new tax landscape. We briefly explore
these and other issues below.
Some supporters of the GOP proposal suggest that its
border adjustment mechanism will increase exports
and decrease imports, thus providing a boost to domestic
businesses and reducing the U.S. balance of trade
For example, the proposal states that the border adjustments
‘‘will allow U.S. products, services, and intangibles
to compete on a more equal footing in both the
U.S. market and the global market.’’ This argument appears
to consider only the direct effects of the tax. That
is, it appears to be based on the assumption that, because
imports will be taxed, they will become relatively
more expensive to U.S. purchasers, who will decrease
their purchases. Similarly, since exports won’t be taxed,
they will become relatively less expensive to foreign
purchasers, who will increase their purchases.
Much of the literature and economic scoring has,
to a large extent, assumed static conditions and
behavior; but it seems evident that consumers and
businesses will react.
Other proponents of the DBCFT, however, argue the
opposite. Although it may seem counterintuitive to a
non-economist, they rely on economic models that
show currency exchange rates will automatically
adjust—completely offsetting both the benefit to exports
and detriment to imports that would otherwise
occur—resulting in no net change in the real prices (or
quantities) of imports and exports. Thus, the argument
goes, the border adjustments will neither distort international
trade nor harm U.S. importers. Martin Feldstein
makes that case in a Jan. 5 article in The Wall
Street Journal, arguing that ‘‘in the end, the prices paid
by U.S. consumers would be essentially unchanged.’’
Nevertheless, since the U.S. is a net importer, the
border adjustments would be expected to increase tax
revenues. For example, Feldstein suggests that
‘‘[b]ecause U.S. imports are about 15% of [gross domestic
product] and exports only about 12%, the border tax
adjustment gains revenue equal to . . . $120 billion a
It isn’t clear which of these diametrically opposed
viewpoints would bear out in real life, but one thing is
clear: They can’t both be right.
It is true that, as a matter of economic theory, the border
adjustments would trigger an appreciation in the
U.S. dollar because a decrease in U.S. demand for imported
goods would cause a decrease in demand for foreign
currency, resulting in an appreciation in the dollar.
This, in turn, would result in imported goods becoming
relatively cheaper to U.S. purchasers, offsetting some of
2-16-17 COPYRIGHT 2017 BY THE BUREAU OF NATIONAL AFFAIRS, INC. DTR ISSN 0092-6884
the decrease in demand for imports. Similarly, as the
demand for U.S. exports increases, the demand for U.S.
dollars will increase, causing an appreciation in the dollar.
This results in U.S. exports becoming relatively
more expensive for foreign purchasers, offsetting some
of the increase in demand for U.S. exports.
This concept can be illustrated by the following example.
Suppose the cost of production of Product A is
$90, and Product A sells for $110. If there were no border
adjustment, the producers would pay a 20 percent
tax on the resulting $20 profit, their tax liability would
be $4 and their after-tax profit would be $16. The imposition
of the border adjustments means that exporters
receive a tax rebate (here shown as a negative tax),
while importers pay a 20 percent tax on gross revenue.
(For simplicity, this and other examples assume no
other operating expenses.) A comparison of the effects
of the border adjustments with and without such currency
adjustments for U.S. exporters and importers is
illustrated in the accompanying table.
As the example shows, assuming a perfect adjustment
of exchange rates, there are no real effects on U.S.
importers or exporters—after-tax profit is the same in
This is sound economic theory, but empirical studies
concerning the amount and timing of such exchange
rate adjustments are less clear. For example, though it
is widely recognized that the trade deficit affects exchange
rates, the U.S. experience shows that there can
be long and substantial divergence. (See Dennis R.
Appleyard and Alfred J. Field Jr., International Economics
(Irwin McGraw-Hill: 1998), ch. 24, especially p.
A 2014 International Monetary Fund study by Atish
Ghosh, Mahvash S. Qureshi and Charalambos G. Tsangardes
found that a bilateral trade imbalance may persist
for two or more years while exchange rates adjust.
Other research has concluded that there is little relationship
between trade deficits and exchange rate adjustments.
(See, for example, ‘‘A Faith-Based Initiative
Meets the Evidence: Does a Flexible Exchange Rate Regime
Really Facilitate Current Account Adjustment?’’
by Menzie Chinn and Shang-Jin Wei in The Review of
Economics and Statistics, Vol. 95, No. 1 (2013)).
But even if the currency adjustments precisely offset
the tax effects on cross-border transactions, this discussion
is incomplete, as it relates to aggregate effects
across the entire U.S. economy. It is useful to consider
some of the individual factors at work to gain a deeper
view of the likely effects in the real world:
s There is no single U.S. dollar exchange rate. Exchange
rates are bilateral, and changes in the value of
the dollar relative to each currency may vary. For example,
the magnitude and speed of adjustment of the
dollar relative to each individual foreign currency will
depend on, among other things, each country’s exchange
rate policy. For example, some countries allow
their currencies to fluctuate freely in response to market
forces, facilitating more rapid adjustment, while
some countries peg their currency to other stable currencies,
such as the U.S. dollar, which typically slows
the adjustment. Regardless, the full adjustment in bilateral
exchange rates can be expected to occur over a period
of years (see, e.g., Ghosh et al).
s There is a single U.S. dollar exchange rate with
each country, and the adjustment that occurs will reflect
the average tax effect. However, the effects on a
particular U.S. business will depend on the firm’s mix
of inputs and, particularly, the extent to which those inputs
are imports. For example, two firms in a given industry
that use different mixes of labor costs (deductible
on an ongoing basis as incurred) and capital investment
(under the GOP proposal, deductible on a frontloaded
basis) will realize different effects. However,
both firms will experience the same exchange rate adjustment.
s Firms that have substantial overseas exposure in
terms of financial investments may realize a dramatic
decrease in the value of those investments. Alan D. Viard
of the American Enterprise Institute argues in a
2009 paper that the value of a multinational firm’s assets
denominated in foreign currencies actually will decrease
as the U.S. dollar appreciates in value.
$110 $110 $88 $110 $110 $110
$90 $90 $90 $90 $90 $72
$20 $20 ($2) $20 $20 $38
$4 ($18) ($18) $4 $22 $22
$16 $38 $16 $16 ($2) $16
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s Currency adjustments wouldn’t offset tax effects if
the product is a commodity traded globally in a single
currency. For example, if a product is priced in dollars
both in foreign and domestic markets (such as crude
oil), an exchange rate adjustment won’t offset the effect
of the tax.
To illustrate more concretely some of the economic
effects of the GOP proposal, consider two examples.
The first involves widgets that are produced both domestically
and abroad and therefore may be imported
to or exported from the U.S., and are priced in the currency
of the seller. The second involves crude oil, which
is globally priced in dollars.
U.S. purchasers of widgets would have an incentive
to use domestically produced (tax-deductible) widgets
over imported (non-deductible) widgets. This shift in incentives
would lead to an increase in the demand for
domestic widgets and an increase in their price, and a
decrease in the demand for imported widgets and a decrease
in their price. Domestic widget producers will
benefit from that price increase, but will they want to
sell their widgets domestically and pay taxes on the
proceeds? The incentive will be for them to export their
widgets and avoid paying a 20 percent tax, unless the
U.S. price is sufficiently high. For example, given a 20
percent tax rate and assuming the current price of widgets
is $50, the U.S. price at which domestic producers
would be indifferent between exporting at $50 or selling
into the U.S. would be $62.50 ($50/(1 – 0.2)).
When the dust settles, the overall economic
effects on U.S. crude oil producers and purchasers
are likely to be substantial, with ‘‘winners’’ and
‘‘losers’’ emerging based on the structure of their
As discussed above, the dollar would appreciate,
making U.S. exports relatively more expensive to foreign
purchasers. However, the exchange rate adjustment
wouldn’t be specific to widgets, and only by
chance would the adjustment fully offset the changes in
the price of domestic and imported widgets. In particular,
if exchange rate changes didn’t fully offset the effects
of the tax, we would observe a net increase in exports
of widgets, an increase in the price of domestically
produced widgets, and likely higher prices to U.S.
consumers when they purchase products that contain
Next, consider the likely consequences of the border
adjustment on crude oil exporters and importers. Generally,
the effects of the border adjustment will be similar
to those for widgets. For example, as with the example
for widgets, exporters will have an incentive to
use domestically produced crude oil, as they will receive
a tax deduction for the input cost.
However, because crude oil is globally priced in U.S.
dollars, changes in the value of the dollar relative to foreign
currencies won’t lead to a neutral effect on aftertax
profits. Rather, exporters of crude oil will experience
a windfall because they pay no taxes and don’t
have to sell their oil at a lower exchange rate-adjusted
price. For a hypothetical example, see the ‘‘Border Adjustment
Without FX Adjustment’’ column under ‘‘Exports’’
in the accompanying table. In this example, exporters
would enjoy greatly increased profits but also
have a negative tax liability.
On the other hand, importers of crude oil will be
worse off as they will pay the full global price of crude
oil in dollars and will also incur the border adjustment.
For a hypothetical example, see the ‘‘Border Adjustment
Without FX Adjustment’’ column under ‘‘Imports’’
in the table above. In this example, importers
would incur a loss on each barrel of imported crude oil.
When the dust settles, the overall economic effects on
U.S. crude oil producers and purchasers are likely to be
substantial, with ‘‘winners’’ and ‘‘losers’’ emerging
based on the structure of their businesses. An extended
discussion of the effects of the proposal on crude oil
and petroleum products can be found in a Dec. 16,
2016, white paper from the Brattle Group (‘‘Border Adjustment
Import Taxation: Impact on the U.S. Crude Oil
and Petroleum Product Markets,’’ by Philip K. Verleger
Jr., Kevin Neels, Pallavi Seth and Fabricio Nunez).
Selected Legal, Policy
And Practical Implications
Leaving aside the very significant (but already muchdiscussed)
issue of whether the DBCFT scheme violates
World Trade Organization rules, there are numerous
implications that should be considered and issues that
will need to be resolved before the border adjustment
proposal can be implemented.
Alan J. Auerbach, a University of California-Berkeley
economics professor credited as an architect of the
GOP proposal, lays out the arguments in favor of border
adjustment in two recent white papers:
‘‘Destination-Based Cash Flow Taxation,’’ co-written
with Michael P. Devereux, Michael Keen, and John
Vella, is published by the Oxford University Centre of
Business Taxation as Working Paper 17/01 (hereafter,
‘‘Auerbach 2017 Working Paper’’). ‘‘The Role of Border
Adjustments in International Taxation,’’ is co-written
with economist Douglas Holtz-Eakin of the American
Action Forum (November 2016).
University of Michigan law professor Reuven Avi-
Yonah and Reed College economics professor Kimberly
A. Clausing take the opposing viewpoint in ‘‘Problems
with Destination-Based Corporate Taxes and the Ryan
Blueprint,’’ Law and Economics Research Paper Series
(draft, January 2017).
Variations by Industry
As with the currency adjustments discussed above,
other legal, tax and practical impacts will vary by industry
and business. So, too, will the inevitable reactions by
taxpayers. For example, heavily import-reliant industries
in which inputs can’t be obtained domestically (or
can’t be obtained in sufficient quantities)—either because
doing so would be cost prohibitive or because the
U.S. simply doesn’t produce the relevant raw
materials—will undoubtedly react, rather than be punitively
taxed or pin all their hopes on the currency adjustment
mechanism discussed above.
Likewise, rather than eliminating transfer pricing,
the border adjustments will likely shift its focus, incen-
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tivizing multinationals to minimize the cost of imports
by U.S. affiliates (because such costs would no longer
be deductible expenses) and maximize U.S. affiliates’
revenue from exports (because such income would escape
U.S. taxation and possibly even result in tax rebates).
Simplicity Assumed, Reality More Complex
To date, most discussions about the possible mechanics
of the border adjustments assume a simplified case
of a commercial U.S. exporter or importer of a tangible
product without a complex supply chain or mixed customer
base. One point that isn’t always highlighted in
these discussions is the reality that an import tax will
need to be applied to all U.S. purchasers—not just U.S.
businesses that purchase products, components or raw
materials abroad and resell them in the U.S. That is, direct
sales to U.S. consumers made by a foreign person
must also bear tax—otherwise the border adjustment is
too easily avoided.
Consider an example to illustrate this point: A U.S.
distributor acquires a product from a foreign manufacturer
(FM) for $100 and resells it to U.S. customers for
$160. (For purposes of this and the next example, we
disregard currency adjustments in the figures, as the
principle remains the same and, as seen above, perfect
and immediate currency adjustments offering universal
relief are unlikely.) The U.S. distributor can’t deduct the
$100 paid to FM, meaning the distributor has taxable
income of $160, with tax of $32 (at the proposed 20 percent
rate). Without the border adjustment (and assuming
the same 20 percent rate), the distributor’s tax
would be only $12. Inevitably the U.S. distributor will
try to push at least some of the economic burden of this
additional tax cost onto FM.
If, instead, FM, which otherwise has no nexus with
the U.S., sells directly to the U.S. consumer for $160, it
bears no U.S. tax. Without the imposition of a standalone
import tax, FM can increase its profit—and even
undercut the retail price relative to what U.S. distributors
must now charge, while still making a higher profit.
In short order, virtually all sales of foreign goods into
the U.S. would be made direct to the end consumer, cutting
out the tax-costly U.S. middleman.
Taking this example one step further, a U.S. seller
into the domestic market will also have a strong incentive
to adopt this same strategy. Assume a U.S. manufacturer
sells the same product as in the above example,
with a cost of production of $80. It will sell to a U.S. customer
at the market price of $160, and would be subject
to tax of $16, resulting in an after-tax profit of $64 ($80
– $16). But if it established a foreign distributor (FD)
and sold the product to FD for $150, followed by FD’s
resale to the U.S. customer for $160, the U.S. seller
would have $70 of profit, subject to no U.S. tax—plus
the $10 of profit residing in FD, also subject to no U.S.
tax (assuming FD otherwise has no U.S. taxing nexus;
for that matter, FD need not be related—U.S. sellers
would probably find little difficulty locating foreign
companies willing to earn modest profits for acting as a
This hypothetical further illustrates why an import
tax is required in business-to-consumer (B2C) sales
(and previews why adoption of the DBCFT might not
mean the end of transfer pricing as some have predicted).
Another potential work-around in the absence of an
express import tax would be the use of sales commission
arrangements, just as commissionaires are sometimes
employed in Europe. Under such an arrangement,
the U.S. distributor could presumably avoid any implicit
import tax because it is merely facilitating the foreign
seller’s sale—i.e., providing sales, marketing or logistical
support services to the foreign seller—but never actually
purchasing an imported good.
Not only would this arrangement enable the parties
to escape the implicit import tax, it would potentially result
in the U.S. distributor avoiding any U.S. income tax
because it would be receiving compensation for services
provided in the U.S. for the benefit of a foreign
party. Presumably this would be viewed as exporting
services. (It isn’t actually clear how border adjustments
would work for services, because the proposal contains
no explanation of how services would be taxed (or not),
other than to say the DBCFT would apply.)
Again, without a direct import tax on the foreignsourced
goods, the border adjustment is easily avoided,
this time by changing the contractual relationship between
Why the Mechanics of Collection Are Critical
As seen in the above examples, a functioning DBCFT
system can’t be achieved by denying deductions alone.
As the proposal seems to hint, without explicitly acknowledging,
an actual import tax must apply to all
sales of foreign goods and inputs into the U.S.—
including B2C sales. The proposal seems to leave open
the question of whether a new, stand-alone import tax
(beyond the additional tax burden borne by commercial
importers from the denial of deductions) will be imposed
on all purchasers—including U.S. consumers or
foreign businesses with no U.S. taxing nexus.
On the one hand, the proposal’s general description
of the DBCFT states that ‘‘products, services and intangibles
that are imported into the United States will be
subject to U.S. tax regardless of where they are produced.’’
On the other hand, the proposal asserts that it
achieves a consumption-based approach ‘‘by providing
for border adjustments exempting exports and taxing
imports, not through the addition of a new tax but
within the context of the transformed business tax system.’’
It also states: ‘‘This Blueprint does not include a
value-added tax (VAT), a sales tax, or any other tax as
an addition to the fundamental reforms of the current
income tax system.’’ GOP proposal, at 28, 27, 15.
The academics who conceived the DBCFT scheme,
however, affirm that a new, stand-alone import tax (including
on U.S. consumers) will be required for the
DBCFT to work. (See Auerbach 2017 Working Paper.)
Commissionaire-type arrangements would also need to
Thus, the mechanics for collection will be critical. As
it doesn’t directly acknowledge the need for an import
tax, the proposal can provide no guidance on this question.
It appears that there are only two options for
whom to impose the tax on—the foreign seller or the
U.S. consumer. The former poses practical enforcement
issues, especially when a foreign seller otherwise has
no nexus with the U.S. The latter looks like a federal
sales tax and is presumably politically unpalatable (and
also presents collection and enforcement issues). Asking
consumers to withhold and pay over a portion of
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any outbound payment is probably unrealistic. Credit
card processors, banks and/or shipping companies
could instead be tasked with the obligation of withholding
a portion of every outbound payment—although
this can be expected to meet resistance from the financial
and delivery services industries.
Assessing the tax at the border like a customs duty or
excise tax would seem to be the easiest, most efficient
way to collect an import tax. But that approach probably
looks too much like a tariff and makes the DBCFT
(even more) vulnerable to WTO challenge. It also presents
obvious logistical shortcomings when the imports
are digital goods, services or any other items not conducive
to physical border collection.
A workable mechanism similar to that used in VAT
systems could probably be devised, but that too may be
politically unpalatable, as it leaves supporters vulnerable
to the charge that they are imposing new taxes on
American businesses and consumers—and VAT systems
also struggle with some of these same issues, including
electronic commerce and services. Indeed, imposing
a visible, VAT-like tax in the same manner as a
conventional VAT would make the close relationship of
the DBCFT to a VAT more obvious.
This is the very characterization the GOP proposal
sought to avoid by adopting the DBCFT. On page 15 of
the proposal: ‘‘This Blueprint does not include a valueadded
tax (VAT), a sales tax, or any other tax as an addition
to the fundamental reforms of the current income
Assuming these practical implementation issues can
be overcome, the proposal also presents some interesting
policy questions, a few of which are considered below.
The first is simple tax equity. Consider, for example,
two U.S. manufacturers that are identical in every respect
except customer mix. Each produces the same
product, for the same cost, with the same number of
employees and same overhead, and sells the same
amount of product for the same price. The only difference
is that 90 percent of Manufacturer A’s customers
are located abroad, and only 10 percent are domestic.
Manufacturer B is the opposite, with 90 percent of its
customers located in the U.S. Manufacturer A will pay
tax on only 10 percent of its income, while Manufacturer
B will pay tax on 90 percent of its sales revenue—
nine times as much.
One could argue that this result is fine as it will encourage
more exports, but one must also consider the
two-fold counterargument: Is it fair to treat similarly
situated taxpayers so differently, and are exports so
beneficial that their promotion justifies such disparate
Again, although currency adjustments are expected
to mitigate the disparity, as discussed above, such relief
is likely to be neither perfect nor uniformly enjoyed by
all industries and taxpayers. Some importers potentially
disadvantaged by the border adjustment scheme
seem unwilling to put their faith in the exchange rate
adjustment theory. Fortune magazine reported Feb. 1
that Wal-Mart Stores Inc., Target Corp. and Best Buy
Co. are among more than 100 major retailers battling
the border adjustment tax proposal through a coalition
backed by the National Retail Federation and the Consumer
Tax Rebates and NOLs
In order for the DBCFT to function most effectively,
its implicit export subsidy (border adjustment) must
produce an actual tax benefit to the U.S. exporter. This
means, ideally, that any negative tax liability should be
refunded to U.S. exporters. For obvious political reasons,
though, Congress may be reluctant to adopt a
scheme requiring Treasury to write large checks to multinational
The ‘‘next best’’ approach and the one offered by the
proposal, is to allow U.S. exporters to carry forward
their net operating losses (NOLs) indefinitely. If a net
export business remains in a perpetual tax loss situation
and can’t utilize its NOLs, however, the functioning
of the system (and currency adjustment) is impaired.
Accordingly, another wrinkle in need of resolution—
assuming tax refunds aren’t on the table—is how to provide
relief to these businesses. Expect new and creative
markets for unusable NOLs to spring up—whether or
not blessed by the government. For example, U.S. Internal
Revenue Code Section 382 and other loss limitation
rules would come under pressure as profitable companies
try to combine with loss companies in marketdistorting
merger and acquisition deals.
Or perhaps NOLs could be used to offset employment
and state and local taxes, or otherwise monetized. An
historical example of such monetization is provided by
the ‘‘safe harbor leasing’’ provisions found in the Economic
Recovery Tax Act of 1981.
In addition to incentivizing transfer pricing manipulation
to increase income from exports and decrease the
cost of imports, multinationals would also be incentivized
in many cases to move intellectual property to the
U.S. (assuming no U.S. tax on the receipt of royalties
from foreign affiliates). This may be a selling point for
U.S. lawmakers, but it introduces an interesting twist to
the Organization for Economic Cooperation and Development’s
base erosion and profit shifting project: The
U.S. could become ground zero for the facilitation of
base-eroding profit shifting—at least from other members’
Expect other countries to react as multinationals
transfer assets and income out of foreign jurisdictions
and into the U.S. Possible concerns include an increase
in foreign-initiated transfer pricing audits/disputes, the
imposition of retaliatory tariffs or import taxes (or increased
VAT charges) on imports from the U.S., the denial
of deductions for royalties or other payments made
to the U.S. and the denial of treaty benefits. (Such potential
responses would appear to be generally consistent
with U.S. tax treaty policy, which in recent years
has focused on countering base erosion and profit shifting.
See, e.g., ‘‘Treasury Releases Select Draft Provisions
for Next U.S. Model Income Tax Treaty,’’ Treasury
news release (May 20, 2015).)
Multinational taxpayers, particularly those headquartered
in the U.S., have structured their global business
operations in reliance on the existing U.S. international
tax system. While some structures are undoubtedly taxmotivated,
there are also many valid non-tax business
reasons for adopting a global business structure. Moreover,
even a business without a tax-motivated structure
would be negligent not to factor tax effects into its op-
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erations and structures. It is obvious that adoption of
the GOP proposal would profoundly change the taxation
of such structures.
For example, consider a U.S. company ‘‘USCo’’ that
has a large customer base in Asia, and because labor,
construction and regulatory costs are substantially
lower in Asian Country A, USCo forms an Asian subsidiary
‘‘ACo.’’ ACo builds a manufacturing facility and
produces the product for the global market, selling to
unrelated distributors. USCo imports the product for resale
in the U.S. market. Absent the border adjustments
of the GOP proposal, USCo would have U.S.-source income
from its sales in the U.S. (See I.R.C. Section
861(a). We disregard potential Subpart F complications
for purposes of this basic example.) USCo would deduct
the amount paid to ACo for the product as the cost
of goods sold.
Assuming USCo paid ACo $100 and sold the product
for $150, it would have taxable income of $50. But with
the border adjustment, USCo would pay tax on $150.
Even factoring in the reduction of the corporate tax rate
from 35 percent to 20 percent, USCo’s tax bill of $17.50
under the old system (35 percent x $50) would increase
to $30 (20 percent x $150). As discussed above, currency
adjustments would ameliorate this effect, but it
isn’t clear they would completely offset the adverse impact.
And as seen, if USCo and ACo had contracted to
conduct their intercompany sales in dollars, there may
be no alleviation of the adverse impact without revising
The GOP proposal provides no indication as to
whether or how this harsh result would be softened.
Congress could take the position that taxpayers who
structured their transactions in a tax beneficial way are
out of luck; they previously got the benefit and now
must suffer the detriment of their tax planning. But fundamental
issues of fairness arise: Why should a taxpayer
who relied on, and fully complied with, prior law
be penalized under the new system?
To be sure, some taxpayers may be able to restructure
their transactions. Ironically, the most abusive paper
transactions may prove the easiest to restructure,
while real transactions with more economic substance
will be more difficult to correct. It is easy to transfer intellectual
property or the residence of a holding company
with no activities, but totally impractical to relocate
a billion-dollar manufacturing plant.
Query what kind of transitional or other relief might
be extended to relieve taxpayers stuck with international
structures that are no longer economically
viable—particularly ones with substantial imports into
the U.S. Congress could, for example, adopt a substantial
transformation rule, similar to that found in the
Subpart F context (Treasury Regulations Section 1.954-
3(a)(4)(ii)), thus erasing the taint of imports if a U.S.
taxpayer substantially transforms the imported inputs
to produce a new product. (That approach wouldn’t
help USCo because it is only a reseller, not a manufacturer.)
Another possibility would be to allow related parties
to adjust their transfer pricing to take the tax effects
from the border adjustment into account, at least for
some transition period. In the example above, if USCo
purchased product for $87.50 instead of $100, it would
still pay $30 U.S. tax, but would have $32.50 of after-tax
income—the same as it did under the prior system. The
problem with this is that it wouldn’t be an arm’s-length
price, and ACo’s taxing authority wouldn’t be happy
about its corresponding reduction in income.
Both of these approaches also suffer from the obvious
shortcoming that they would reduce the revenue
the GOP proposal is expected to generate. A satisfactory
solution to such issues will need to be found.
U.S. Tax Treaties
If its label as an income (rather than indirect) tax is
respected, the DBCFT may cause issues with U.S. income
tax treaties. For example, imposing an income
(import) tax on foreign residents’ sales into the U.S. regardless
of U.S. nexus would likely be viewed as a legislative
override of the permanent establishment concept.
Interestingly, adopting the DBCFT may also result in
the denial of treaty benefits to U.S. taxpayers under our
own model treaty, as the DBCFT may be a ‘‘special tax
regime’’ and trigger the ‘‘subsequent changes in law’’
provision. (See 2016 U.S. Model Income Tax Convention,
Preamble and Articles 3(1), 28.) A new model may
need to be developed and all affected U.S. treaties
renegotiated—a task that could take years.
The Alternative: A VAT?
According to Auerbach and Devereux, the authors
credited with designing the DBCFT tax scheme, it is the
economic equivalent of introducing a VAT and reducing
taxes on payrolls. If Congress were willing to modify
the DBCFT along the lines of a more traditional VAT
and offer payroll tax relief, most of the issues and
implementation complexity fall away. (This may be the
reason no other country has a DBCFT but most have
A more traditional VAT would also be expected to
withstand a WTO challenge, be compatible with the
U.S.’s existing network of income tax treaties, and enjoy
the benefit of other countries’ experiences, which
could provide guidance for a VAT’s adoption and implementation.
This conclusion may seem obvious, but only if one ignores
political realities—there is no appetite in Congress
for enacting a ‘‘new tax,’’ particularly one that
would ultimately fall on American consumers.
Where Do We Go From Here?
The foregoing discussion raises numerous questions
and potential issues. For some, there are no definitive
answers. For example, we simply don’t know the actual
impact that border adjustments would have on the
global economy, and impacts on separate sectors and
actors in the economy can at best be only roughly modeled,
and are controversial. Likewise, we don’t know
the extent to which exchange rate adjustments will
ameliorate any such effects. Economists acknowledge
there is no perfect model—no empirical data yet exists
for the impact of a tax that, to date, hasn’t been implemented
anywhere else in the world.
In other cases, however, the technical issues such as
means of implementation and enforcement can be resolved.
But, given the far-ranging impact the DBCFT is
likely to have, any such solutions should be the product
of careful analysis and consideration through proper
administrative and legislative institutions. The Tax Reform
Act of 1986 (TRA) offers a successful model of
how our tax system could be substantially transformed.
DAILY TAX REPORT ISSN 0092-6884 BNA 2-16-17
It was a truly bipartisan effort in which the disparate interests
of various stakeholders were filtered through
the political process, but it took more than four years
and many legislative drafts, amendments and hearings
to finally enact TRA in 1986.
The DBCFT concept shows real promise and could
fundamentally transform our tax system to be fairer,
more efficient and neutral, and less burdensome. But
that will happen only if the process is done right. A tax
system devised without sufficient deliberation and input
from stakeholders might fail to meet these goals.
2-16-17 COPYRIGHT 2017 BY THE BUREAU OF NATIONAL AFFAIRS, INC. DTR ISSN 0092-6884