By Samukele Ncube (Intern, Dawson Strategic)

February 13, 2017

Over the past few months, there has been a spotlight on border adjustment taxes as a result of the recently proposed U.S. reform blueprint “A Better Way: Our Vision for a Confident America” (The Blueprint), which was put forward by the Republican Party (GOP). This plan outlines a dramatic change to the American corporate taxation system, which will look at slashing taxes from a top rate of 35% to a flat rate of 20%. This change will have numerous effects, both domestically in the United States and internationally.

What is a Border Adjustment Tax?

A border adjustment is a tax that is applied when a payment for a good or service crosses national borders. Many countries already have similar systems in place, which currently operate in the context of value-added tax (VAT). Under the VAT system, a tax is placed on a product at each stage of production where value is added, and then again at final sale when the consumer purchases the end product.

A border adjustment tax, however, is applied based on where a product is consumed, rather than where it is produced. To briefly illustrate this concept, if a domestic company manufactures products for exports, those products would not be taxed under the border adjustment tax as they would be consumed elsewhere. However, if a foreign company were to manufacture products intended for domestic consumption, those products would be taxed as they would be consumed within national borders.

Border adjustments, unlike tariffs and subsidies, are not a part of trade policy. They are adjustments that seek to incentivize domestic companies to increase their exports, theoretically resulting in a level playing field for both domestic and overseas competition. Border adjustment taxes are believed to eliminate the incentive for companies to move their most profitable production activities abroad in order to benefit from lower foreign tax rates. However, these taxes can be quite complex and difficult to implement due to varying opinions on their efficacy, and this is particularly true in the case of the proposed border adjustment tax put forward by the GOP of the U.S.

 The proposed U.S. border adjustment tax

In June 2016, the GOP proposed a border adjustment tax as part of the “A Better Way” plan. Currently, U.S. corporations are taxed at a 35% rate, based on their global net income. Under the proposed plan, corporations would be taxed in their domestic revenue – less their domestic costs – at the low rate of 20%. The resulting net effect would be in favour of exports rather than imports. However, there are some notable concerns about this proposed policy. In addition, many of America’s trading partners currently use the VAT system, which would make cross border trade complex due to the existence of two different taxation systems for international corporations.

 The implications for Canada

The U.S. is, currently, Canada’s largest trading partner. Due to Canada’s large interdependence on the U.S., any trade policies or programmes that are put forward by the American government have a heavy impact on Canada. When the proposal first came out, groups representing the automotive and retail industries in Canada wrote a letter stating the blueprint would create “huge business challenges” for companies that rely on global supply chains. Everyday items would also see an increase in price, not to mention automobiles and trucks.

 The tax reform blueprint has received both criticism and praise from various groups. As of now, little is known about the form in which such a border adjustment tax could take. There is also the added obstacle of determining whether or not such a tax reform would be compliant under World Trade Organization (WTO) regulations. However, President Donald Trump appears to be inching closer to backing this proposed border adjustment tax which will make this a continued topic of interest for the upcoming months.