Potential Implications of a Destination-Basis Tax System for U.S. Retailers

Masked in myriad suggestions for comprehensive tax reform is a proposal that could have a significant impact on the U.S. retail industry. The plan, contained in the House Republicans tax blueprint A Better Way: Our Vision for a Confident America, seeks to change the way corporations are taxed. While the plan would cut the corporate tax rate from 35% to 20%, it also suggests transforming our tax regime from a worldwide approach to a destination-basis tax system with border adjustments. It is these border adjustments that retailers are watching most closely.

Let’s examine this further. Currently, U.S. retailers are taxed in the U.S. on worldwide income at a 35% rate, and to the extent that taxes are paid in foreign jurisdictions, retailers are allowed a foreign tax credit to avoid having the same income taxed twice. Historically, companies have been allowed a deduction for the cost of producing or acquiring a product for resale, regardless of where the product is made. This tax deduction may not exist if the proposed blueprint comes to fruition.

This so-called destination-basis tax system would tax retailers on their sales to U.S. customers while excluding foreign sales from U.S. tax entirely. This means sales of imported goods would be fully taxable while the sales of exported products would be exempt from tax.

Take a look at the graphic below for an illustration of the border adjustment concept:
 
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There is rumbling that this proposal could have a significant impact on retailers who have substantial sales of imported products unless adjustments are made to the business model. With retail margins compressed already, losing the deduction for the cost of imported goods could very well result in the tax on the sale of the item exceeding the margin, unless retailers increase selling prices. Alternatively, retailers could embrace the “buy American” concept to ensure a tax deduction. In either scenario, retailers would need to find a way to offset increased costs.

So where is this headed? While there are mixed views on these types of border adjustments, there is sure to be a great deal of discussion and debate about the shape of tax reform. In fact, a broad retail-backed coalition, including the Retail Industry Leaders Association and more than 120 other trade groups, launched a campaign called “Americans for Affordable Products,” centered on how a border-adjusted tax could boost prices for consumers, according to a recent Bloomberg article.

It’s important to pay close attention to the details in the wave of tax reform proposals in order to understand the implications for the retail industry. As the proposals continue to be debated, we’ll be watching to help you stay up-to-date and plan for future policy changes.