February 16, 2017

House Leadership Corporate Tax Reform Plan: Destination-Based Cash-Flow Tax With a Border Adjustment


Speaker of the US House of Representatives Paul Ryan has indicated that House Republicans intend to introduce comprehensive tax reform legislation in Congress this spring. In June 2016, House Speaker Ryan, Representative Kevin Brady (Chair of the House Ways and Means Committee) and other House Republicans released an outline of their tax reform plan (the Blueprint). The Blueprint proposes a major overhaul of US federal income tax law, including the replacement of the current corporate income tax with a destination-based cash-flow tax (a DBCFT), with a "border adjustment." The "border adjustment" concept (as described more fully below) in respect of the DBCFT is one of the most controversial items in the Blueprint. Proposed legislative text is not yet publicly available. Accordingly, the precise mechanics of the Republican tax proposals described in the Blueprint (including, in particular, the DBCFT) remain unknown at this time. Even in the absence of proposed language, however, the potentially momentous impact of the imposition of a DBCFT with a border adjustment has sparked widespread political, commercial, and academic interest and debate. Certain of the key issues related to this proposal are summarized below.

Current US Corporate Income Tax Law

Under current law, a US corporation generally pays US federal income tax on its worldwide net income at a current maximum tax rate of 35 percent. A US corporation generally may deduct business expenses, such as cost of goods sold, wages, interest paid, and depreciation, in determining its net taxable income. Taxation of a non-US corporation, by contrast, generally depends on the source of the income derived and whether such income is considered to be "effectively connected" with the conduct by such corporation of a US trade or business. This "effectively connected" income (including, as such, certain income from real estate transactions) is subject to US income tax as if the non-US corporation were a US person. In general, however, other income earned by a non-US corporation is only subject to tax (a withholding tax on the gross amount paid) if it is derived from US sources.

The Blueprint

The Blueprint proposes a number of changes to US corporate federal income tax law, including:

  • reducing the corporate tax rate to 20 percent;
  • generally allowing an immediate deduction for capital expenditures (instead of depreciation);
  • adopting a territorial tax system that generally taxes only income derived from US activities, including by exempting from tax dividends paid by non-US subsidiaries;
  • disallowing deduction of net interest expense; and
  • replacing the current corporate income tax with a DBCFT with a border adjustment.

DBCFT With a Border Adjustment

The Blueprint proposes a cash-flow-based approach to corporate taxation that is intended to replace the current corporate income tax. The Blueprint proposes to achieve this cash-flow based approach by eliminating all deductions available to a corporation other than deductions for wages paid and for business investments in tangible and intangible assets. The DBCFT concept is consistent with the notion of switching to a territorial tax system.

According to the Blueprint, the DBCFT will apply on a "destination basis," which means that "products, services and intangibles that are exported outside the United States will not be subject to US tax regardless of where they are produced. It also means that products, services and intangibles that are imported into the United States will be subject to US tax regardless of where they are produced." The Blueprint aims to achieve destination-based taxation by implementing a "border adjustment" as a key feature, which means, as stated in the Blueprint, that "tax is rebated when a product is exported to a foreign country and is imposed when a product is imported from a foreign country." For example, in general, if a US retailer purchases goods from a US manufacturer for $200, sells such goods within the United States for $1000, and pays $100 in wages, then such retailer would be taxed under the DBCFT on $700. If the US retailer instead were to purchase such goods from a non-US manufacturer, then such retailer would be taxed under the DBCFT on $900 because the border adjustment would deny the deduction for the goods purchased by the US retailer from the non-US manufacturer. If, however, the US retailer were to export such goods, then it would not be liable for any tax under the DBCFT as a result of the border adjustment.

The Blueprint states that the policy behind the border adjustment is to allow the United States to compete on a level playing field by countering border adjustments made by its trading partners in applying such partners' value added taxes (VATs). A VAT generally is a tax imposed on the value added at each stage of the production and distribution of goods and services. A VAT generally differs from the DBCFT described in the Blueprint in that a VAT does not permit deductions based on wages paid. Border adjustability, however, is a key feature of a number of VATs that have been implemented throughout the world, and the Blueprint argues that the fact that US corporate income tax does not currently make border adjustments is tantamount to "a self-imposed unilateral penalty on US exports and a self-imposed unilateral subsidy for US imports."

World Trade Organization Issues

The implementation of a DBCFT with a border adjustment may face challenges under rules promulgated by the WTO. The WTO administers the various WTO trade agreements, handles trade disputes under these agreements, and fosters cooperation among member governments. The WTO has specific rules that pertain to border adjustments involving imports of goods (and imports of services, if a country has committed to provide a given service sector non-discriminatory treatment). The WTO also includes rules related to border adjustments connected to the export of goods.

Under the rules related to goods exports, so-called "direct taxes" that exempt exports from tax are considered to give rise to a prohibited export subsidy. For these purposes, "direct taxes" are defined as taxes on wages, profits, interests, rents, royalties, and all other forms of income, as well as taxes on the ownership of real property. By contrast, border adjustments to "indirect taxes," i.e., sales, excise, turnover, value added, franchise, stamp, transfer, inventory and equipment taxes, border taxes and all taxes other than direct taxes and import charges, are not viewed as prohibited export subsidies. As such, in order to determine whether the border adjustment gives rise to a prohibited export subsidy, it must be determined whether the DBCFT is a "direct tax" or an "indirect tax."

The drafters of the Blueprint clearly intend the DBCFT to qualify as an "indirect tax," and, as such, to avoid being classified as a prohibited export subsidy under WTO rules. As discussed above, the DBCFT appears to have much in common with a VAT, except that the DBCFT allows a deduction for wages paid. It is arguable that, like a VAT, the DBCFT qualifies as an "indirect tax." On the other hand, the DBCFT's allowance of a deduction for wages paid appears similar to an income tax, which is considered to be a "direct tax." In any event, until the legislative text is released, it will not be possible to assess whether the proposal does or does not qualify as a "direct" or "indirect tax" under WTO rules.

The DBCFT may also raise WTO issues, due to its potentially less favorable treatment of imports of goods or services, compared to their domestic counterparts. If the calculation of the tax, for example, permits more deductions for domestic US sales of goods or services than imports can enjoy, this could generate WTO claims in addition to any export-related concerns. Moreover, the WTO has specific rules that apply to imports of services. These rules generally permit border adjustments only with respect to "direct taxes," which are defined for these purposes as "all taxes on total income, on total capital or on elements of income or of capital, including taxes on gains from the alienation of property, taxes on estates, inheritances and gifts, and taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation." If the DBCFT does not qualify as a "direct tax" within the meaning of the term as it relates to imports of services, then it could be considered a discriminatory tax on imports under WTO rules. It is unclear at this point whether the DBCFT would be characterized as a "direct tax" for purposes of applying the WTO rules regarding imports of services.

To the extent that the DBCFT with a border adjustment is categorized as a prohibited export subsidy or a discriminatory tax on imports, member countries may bring a WTO complaint against the United States, which could result in significant adverse countermeasures against the United States. Other US tax provisions (including, in particular, former rules on so-called Domestic International Sales Corporations and Foreign Sales Corporations) have been subject to successful challenge under WTO rules. Certain practical considerations may discourage such complaints, including political and commercial concerns that other countries may have about bringing such a suit against the United States. However, the Europeans have overcome their hesitation in the past, so they, and others, may do so again.

Impact on US Tax Treaties

The United States currently has negotiated numerous bilateral income tax treaties that are aimed at reducing cross-border double-taxation. If the current corporate income tax is replaced by a DBCFT with a border adjustment, it is not clear whether the DBCFT would qualify as an eligible "income tax" that would be covered under these treaties. Indeed, it may be difficult for the United States to argue that the DBCFT is an indirect tax for WTO purposes and a "direct (income) tax" for tax treaty purposes. As such, current US income tax treaties may need to be re-negotiated in order for a DBCFT to be covered.

Economic Impact

A number of economists believe that the implementation of a DBCFT with a border adjustment would, to some extent, result in the appreciation of the value of the US dollar in response to increased foreign demand for US goods and services and decreased US demand for foreign goods and services. To the extent that the US dollar appreciated as a result of the implementation of the DBCFT, non-US manufacturers of goods and services imported into the United States generally would bear the burden of the tax. To the extent that the US dollar did not appreciate, US consumers of imported products generally would bear the burden of the tax, as the tax generally would be passed on through price increases. The magnitude and timing of any appreciation of the US dollar that may result from the implementation of the DBCFT is subject to vigorous academic debate. Significant appreciation of the US dollar would, moreover, have a wide-ranging global impact that is not limited to foreign manufacturers of imported goods, e.g., it would affect countries with currencies that are pegged to the US dollar.

The border adjustment component of a DBCFT generally should increase tax revenue when the country imposing the tax has a trade deficit (because there will be a broader tax base), and it generally should decrease tax revenue when the country imposing the tax has a trade surplus (because there will be a narrower tax base). The United States currently has a trade deficit, which is one of the reasons that implementation of a DBCFT with a border adjustment could offset tax revenue lost by reducing the corporate income tax rate, at least in the short-term. If, however, the United States were to have a trade surplus, then implementation of a DBCFT with a border adjustment would reduce tax revenue if tax rates are not correspondingly increased.

Political Support/Opposition

The Republican tax reform plan faces a number of political challenges. The passage of any comprehensive tax reform legislation is a rare occurrence. (The most recent such law was enacted in 1986.) Moreover, the tax reform plan is not universally supported by Republican congressmen; a number of Republican senators have expressed concern, in particular, about the border adjustment element of the DBCFT. However, conditions may be relatively propitious for passage of some version of a comprehensive plan, because Republicans do currently control a majority of both the House and the Senate. Moreover, House Speaker Ryan has indicated that the tax reform legislation will be introduced through the budget reconciliation process, which requires only a simple majority to pass, giving rise to the possibility of passage without needing bipartisan support.

In addition to the challenge of gaining sufficient congressional support, President Trump's position regarding the border adjustment component of the DBCFT is unclear. The president has described the border adjustment concept as "too complicated" but then softened his stance without any specifics. Rumors also have circulated that he may be writing his own tax plan. Accordingly, the political landscape could continue to shift.

Business Support/Opposition

The border adjustment proposal has generated tremendous interest in the business sector. Within the past few weeks, two opposing coalitions have been formed. On one hand, Americans for Affordable Products, a coalition generally comprised of US-based retailers, was formed in opposition to the proposed DBCFT with a border adjustment. Americans for Affordable Products cites increased cost of essential items, such as clothing, food, and gas, to American consumers as a negative outcome of a DBCFT with a border adjustment. On the other hand, the American Made Coalition, which generally is comprised of US-based manufacturers, was formed in support of corporate tax reform, including the implementation of a border adjustment of business taxes. The American Made Coalition views a DBCFT with a border adjustment, along with other corporate tax reform, as essential to encourage American jobs, investment, and manufacturing. These competing business interests certainly will contribute to framing the debate that will ensue when tax reform legislation is introduced in Congress later this year.

We will continue to monitor the progress of the proposed DBCFT and will issue updates.


Claire Reade
Claire E. Reade
Senior Counsel
Washington, DC
Gus Weinkam
Gus Weinkam
Senior Associate
Daniel Wilson
Daniel Wilson
Senior Associate
Washington, DC
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