Ethanol Today — January-February 2017
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How Will Tax Reform And Border Adjustability Affect Your Business?
Brian Keuhl

As the 115th Congress begins in Washington, DC, comprehensive tax reform is set to be one of the top priorities for congressional leadership and for the new Trump administration. K·Coe Isom believes there is a high likelihood that comprehensive tax reform legislation will become law during 2018 and that much of the debate and formulation of the legislation will occur throughout this year. Because of this, it is critical that you are engaged in this discussion now and that you begin planning for how tax reform could affect your profitability and competitiveness.

In the U.S. House of Representatives, tax reform discussions will be based on the Republican Tax Reform Blueprint released by Speaker Ryan in June of 2016. This Blueprint proposes to lower the top corporate tax rate to 20 percent, provide for the immediate expensing of capital purchases, and place significant limits on the deduction of interest expenses.

One of the most significant changes proposed by the Blueprint would be for the U.S. to adopt a tax system that includes “border adjustability.” Under border adjustability, the U.S. would move toward a destination-based tax system similar to a value-added tax (VAT) used by many other countries (except with continued deductibility for wages). A VAT is a type of consumption tax that is placed on a product whenever value is added at a stage of production and at final sale.

Under border adjustability, if a U.S. plant were to sell ethanol or distillers grains to a domestic purchaser, the revenue from those sales would be taxed as income. However, if the plant were to sell ethanol or distillers grains overseas, the revenue from those sales would not be treated as income under the Internal Revenue Code (I.R.C.).

By extension, if a U.S. refinery or blender were to purchase ethanol from a domestic plant, the cost of that purchase would be deductible as a business expense. By contrast, if the refinery or blender were to purchase ethanol from Brazil or other foreign sources, the cost of that purchase would not be deductible as a business expense under the I.R.C.

The practical effect of this new tax structure is to increase the cost of imports by 25 percent. If a U.S. company were to purchase $100 of ethanol from a domestic producer, the true cost of that purchase would actually be $80 since the cost of that purchase would be deductible as a business expense and would reduce the purchaser’s income tax by $20. By contrast, if one were to purchase $100 of ethanol from a foreign producer, the actual cost of that purchase would be $100 since it would not be deductible as a business expense. As a result, the foreign-sourced ethanol would have an effective cost 25 percent higher than domestic-sourced ethanol.

While this sounds like a great thing for domestic producers (and not such a good thing for importers), proponents of border adjustability argue that the real cost increase on imports will be negligible or non-existent since the U.S. dollar will strengthen as a result of this change to the U.S. tax code thereby offsetting any cost increases.

Putting aside the concerns that a strong U.S. dollar would make agricultural exports less competitive, other analysts, are not optimistic that appreciation of the U.S. dollar will perfectly offset increased prices on imports. Among their concerns is that many U.S. trading partners, including China, have currencies that do not float freely. Because of concerns that the tax system would disadvantage industries reliant on imports, some of the nation’s largest importers including retail stores and the petroleum industry have begun lobbying against the border adjustability plan.

Another key concern with border adjustability is that it could trigger retaliatory tariffs under the World Trade Organization (WTO). Under the WTO, countries are permitted to adopt a tax that is border adjustable if it is an “indirect” tax. By contrast, a border adjustable “direct” tax is considered an export subsidy that is prohibited by WTO rules. While the House Republican plan argues that the U.S. border adjustable tax would be indirect and thus WTO compliant, others are convinced that the tax would be direct and would violate WTO rules. Regardless, it is a near certainty that if the U.S. adopts the border adjustability proposal, the law will lead to WTO challenges. This, in turn, could result in retaliatory tariffs being placed on U.S. sourced ethanol and other agricultural products.

With these concerns about border adjustability and with large retailers and the petroleum industry lining up against the proposal, it may be tempting to assume that border adjustability will end up on the cutting room floor when Congress finalizes the rewrite of the tax code. There is good reason why that may not be a safe assumption. Since the U.S. is a large net importer, shifting toward a border-adjusted tax system is projected by the Tax Policy Center to generate almost $1.2 trillion in federal revenue during the first decade. Given this, border adjustability is best seen as integral to the House Republican tax plan—without the federal revenue generated by border adjustability, Congress will not be able to reduce taxes to the pledged 20 percent corporate rate.

So how will comprehensive tax reform affect your business? The only way to answer this question is to conduct an analysis that considers your individual circumstances. If you are a U.S. company currently paying income taxes, you will want to consider the combined effect of all of the proposed tax code changes (lower rates, immediate expensing of equipment, border adjustability, etc.). You will also want to consider the effect of changes in the strength of the U.S. dollar and potential retaliatory tariffs that could impact your business. If you are a foreign corporation that currently does not pay U.S. income taxes, you will want to recognize that the revenue from your imports may become subject to U.S. taxation and that purchasers of your products may no longer be able to deduct such purchases as business expenses. Fortunately, whether you are a U.S. or foreign company, there are many steps you can take today to position yourself to maximize your profitability and competitiveness under a new U.S. tax system.

As the United States’ leading agricultural accounting and consulting firm representing corn producers and the ethanol industry, K·Coe Isom recognizes that the outcome of the tax reform debate will have dramatic effects on many businesses. Our objective is to help customers analyze and understand how tax reform could affect their operations, while helping them to design adjustments to their businesses to best position them for growth in the coming years.

K·Coe Isom’s federal affairs team in Washington DC has been working behind the scenes with Congress and with key organizations such as the National Corn Growers Association to analyze the effects of tax reform and to shape legislative proposals to protect our industries’ interests.

If you have questions about border adjustability or if you would like a tailored analysis of how tax reform could affect your business and help with a plan to position you for such changes, please contact Donna Funk, Director of K·Coe Isom’s Ethanol Practice at 800-303-3241 or by email at funk@kcoe.com.
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