The deliberate absence of the Border Adjustment Tax from the Joint Statement on Tax Reform released by congressional leaders and the Trump administration was intended to make a tax reform package more palatable to lawmakers who were suspicious of its resemblance to a value-added tax.
While its removal may make it easier to pass a final bill, it also poses problems in the loss of revenue that it would have generated, according to observers.
“The abandonment of the BAT is particularly significant, given its prominent role in the House Republican Blueprint,” said Marc Gerson, former majority tax counsel to the House Committee on Ways and Means and now chair of law firm Miller & Chevalier. “It will have a dramatic impact on any future tax reform proposal developed by the congressional tax-writing committees, and may have wide-spanning impacts on the proposed tax rate reductions, the extent of enhanced cost recovery, and other key components of any future proposal. Given that the revenue raised by the BAT is now off the table, consideration will need to be given to additional revenue-raisers and perhaps the overall revenue impact of a tax reform package.”
Eric Solomon, former assistant secretary of tax policy at the Treasury Department, and currently co-director of national tax and co-director of the Americas Tax Center for Big Four firm EY, agreed. “The main focus of the debate will shift to whether tax reform will be revenue-neutral, what cost recovery rules will be adopted, whether business interest deductions will be limited, what base erosion provisions will be included, and what middle-class tax relief will be provided,” he said.
“Most of us think that there is a strong likelihood that tax reform will pass,” said Mark Kendall, financial services tax partner at EY. “There are a few key items that are well known. What is not known are the details.”
“Everyone expects a significant drop in the corporate tax rate,” he said. “But to drop 1 percent in the rate, you have to increase revenue by $100 billion over a 10-year window. That’s a big number to get the sort of rate relief they want. That’s why BAT was such a big component of the House Blueprint.”
“The other big issue is how they will deal with base erosion in general. BAT dealt with that by providing an incentive to have activities performed here in the U.S., so they will need to deal with that as part of the switch from a worldwide to a territorial system,” Kendall continued. “If the tax rate is set low enough, they don’t have to worry about it, because there will be no incentive to move activities outside the U.S. But if the rate isn’t set low enough, it won’t drive U.S. growth the way they anticipate, and base erosion will be an issue.”
UNCERTAINTY, AND WORSE
The Joint Statement issued by the “Big Six” — House Speaker Paul Ryan, Senate Majority Leader Mitch McConnell, Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn, Senate Finance Committee Chairman Orrin Hatch, and House Ways and Means Committee Chairman Kevin Brady — is not altogether clear on deductibility of business interest, according to Kendall.
“One thing they did mention is that we can expect ‘unprecedented capital expensing,’” he said. “It’s not entirely clear to what extent this would affect interest deductibility. In the banking world, a big part of business is making loans, so to the extent it curtails that it would be a negative. There is currently a world of unknowns. Specifically EY is urging financial services organizations to prepare for every possible outcome.”
According to EY, they should:
- Monitor developments in the tax landscape and broader marketplace.
- Model an array of scenarios and conduct hypothetical analyses on potential impacts to their business models.
- Plan for possible outcomes to ensure preparation and readiness, and embrace “no regrets” planning scenarios.
- “There will be a lot of changes among clients on tax accounting issues, such as the potential write-down of deferred tax assets. It’s better to think about those now, rather than later,” Kendall explained.
Observed Michael Greenwald, partner and corporate and business tax practice leader at Top 100 Firm Friedman LLP: “Business owners want to do their job without having something looming over them that could affect them for years to come. And the uncertainty makes our jobs as advisors more difficult.”
“It’s interesting that tax receipts for individuals slowed down considerably in 2017. You can trace that back to the end of 2016, when the advice all of us gave was to postpone transactions or defer income because of the possibility of tax reform and lower rates,” Greenwald continued. “People that were in a position to do that did so, with the result that the government took in less money than they anticipated. That’s one of the reasons that the debt ceiling issue is coming up sooner.”
Greenwald believes there will be some modified version of full expensing: “The problem is that it presumes that, other than the tax consequences, all businesses are indifferent whether to use debt or equity for financing business growth. That’s not necessarily true. Small and midsized businesses don’t have easy access to the capital market, and offering them the ability to write off acquisitions of property or equipment may not be meaningful if they can’t get the cash to pay for it.”
“The other ‘big issue’ being discussed as part of reform is the idea of business tax integration — that rates should be the same regardless of the form of business entity,” said Greenwald. “In theory it’s a good idea, but in practice it would make things more complicated.”
HITTING GIVING?
Audrey Sherrick, a partner at Friedman LLP, noted that despite charitable contributions being retained as an itemized deduction under the proposal, the combination of a decrease in the number of other itemized deductions, a decrease in the number of tax brackets, and an increase in the standard deduction would affect charitable giving.
“Since taxpayers only claim itemized deductions if the total of those deductions exceed the standard deduction, it would dramatically reduce the number of people who benefit from itemized deductions — charitable deductions in particular,” she said.
“One of the biggest aspects of the Joint Statement is that there is no mention of revenue neutrality one way or the other,” said Dustin Stamper, a director in Grant Thornton’s Washington National Tax Office. “It’s really more of a question of procedure — it makes it more difficult to get something permanent without revenue neutrality. That’s why we’ve been trying to parse out what they mean by ‘placing a priority on permanence,’ but it certainly seems to give them a lot of wiggle room. They’re not saying tax reform is definitely going to be permanent. They don’t have to make the whole package permanent. And parts of it can be long-term.”
“My best guess is that the use of the phrase ‘unprecedented expensing’ means something much better than the bonus depreciation we currently have,” said Stamper. “And the use of the phrase likely means that limits on the business interest deduction are still alive. To the extent we get close to full expensing on a substantial number of assets, the typical trade-off would be to eliminate the business expense deduction.”
“We would expect transitional relief and grandfathering, so potential borrowers might want to consider borrowing now rather than later,” he advised. “Likewise, if full expensing becomes part of the code, businesses might want to delay any capital expenditures.”
A CLOSING WINDOW
There are a limited number of days left in the legislative year with a lot of “must-do” items other than tax reform, noted Howard Wagner, national tax services managing director at Top 100 Firm Crowe Horwath LLP. “Nevertheless, there’s no expiration date for tax reform that says they can’t keep working into 2018, but public statements from the Big Six say they want to move quickly in the fall,” he said. “If there’s consensus in the Republican caucus that comes out of nowhere and everyone agrees on a detailed plan, they could do it very quickly. But large, comprehensive vehicles tend to have a lot of component parts that members have to work their way through to see whether it works for their constituents. I would be shocked if such a large, comprehensive package came together at the last minute that everyone supports.”
“The disallowance of the deduction for business interest is what to watch,” he advised. “Other than border adjustment, that’s the big revenue-raiser. Disallowance of the deduction would be a significant tax increase for most businesses.”
Both the individual and corporate Alternative Minimum Tax would be eliminated under tax reform, Wagner observed. “That raises the question as to what to do about AMT credits,” he said. “If AMT is eliminated, hopefully there will be a mechanism to allow a business to use a prior year’s AMT credits. Both the Trump and the Ways and Means plans talk about eliminating all credits other than the R&D credit, so the question is, how will you deal with credit carryforwards if the underlying credit is eliminated?”
There is some doubt as to how low the corporate rates will end up in a final bill, according to Wagner. “Congressional staff who are writing the bill have to grapple with real numbers,” he said. “And we’re hearing that there’s a real concern that they might not be able to get the rates as low as hoped for without other revenue coming in.”
An overhaul of the U.S. tax system, especially in the international context, is long overdue and would have a positive effect in lessening inversion activity among U.S. multinationals, according to Elliot Galler, an associate in the international corporate tax practice at Withers Bergman LLP. “With U.S. corporate rates remaining steady for almost 20 years while many countries around the world lowered their rates to attract business, U.S. multinationals have too much to lose by remaining U.S.-parented,” he said. “Inversions are more likely to be thwarted by tax reform than by introducing more anti-inversion rules.”
