Tax Reform’s Impact on International Taxation
By Rose Moore, CPA and Richard Gimbert, CPA
On December 22, 2017, President Trump signed the most comprehensive tax overhaul in the last 30 years, the “Tax Cuts and Jobs Act.” Much attention has been focused on the reduced corporate tax rate and changes to the individual deductions and tax rates. However, not as frequently discussed are the changes to foreign income reporting by corporations that move the United States to a more territorial tax regime.
Leveling the Playing Field
One of the current Administration’s major goals is to make the United States more globally competitive by “leveling the playing field” in trade. Currently, the United States taxes individuals and corporations on all income regardless of where the income is earned. Corporations can and have been avoiding this tax by maintaining foreign earnings offshore. Current U.S. laws highly restrict the ability to reinvest these earnings back in the U.S. without paying U.S. tax. This system, coupled with high corporate tax rates relative to other countries, puts the U.S. at a disadvantage in the global economy. The Tax Cuts and Jobs Act calls for the repeal of the Domestic Production Activities Deduction (DPAD) and a reduced corporate tax rate that is more on par with other developed countries. By doing away with DPAD, Congress is removing preferential treatment for companies that are manufacturing goods in the United States. However, one opportunity to extend fairness between exports and imports seems to have gone unconsidered in tax reform discussions. Congress did not appear to consider Value Added Tax (VAT) to increase revenue to offset tax cuts taken elsewhere.
As our VAT article notes, a vast majority of countries have instituted VAT systems to provide a significant source of revenues. Under these systems, exports are not taxed in the country of origin, but are taxed by the destination country. Without a VAT, the U.S. is not generating revenue when goods are imported into the country, but U.S. exporters are paying a VAT when their goods reach their destination. Instituting an import VAT could serve as an avenue to close the revenue gaps resulting from the recently enacted tax reform legislation. Instead, Congress attempted to mitigate the revenue lost by reducing or eliminating deductions available to individuals and corporations. The Tax Cuts and Jobs Act also repeals the corporate Alternative Minimum Tax (AMT). Although this reduces complexity and corporate tax rates, this tax represented a large revenue source that the U.S. government is hoping to be offset by overall increased growth and activity.
Wary of VAT
Individual taxpayers and retailers of lower priced imported goods are wary of a VAT system as it is very similar to a sales tax that is passed on to the consumer. The United States could ease these fears by instituting a credit available to lower-income earners, similar to what Canada has done. When Canada implemented a VAT in the 1990’s, the Harmonized Sales Tax (HST), it recognized the need to mitigate the impact of the additional tax on low income individuals and implemented the Individual HST credit for lower income earners. The Canadian Revenue Agency automatically determines if the taxpayer is eligible for this refundable credit, achieving the goal of simplified filing for individuals, and mails a quarterly check to the low-income earner. The purpose of this credit is to maintain revenue neutrality for individual taxpayers.
How to limit VAT?
A second fear shared by many taxpayers regarding a VAT is how to limit its reach. However, the very legislation that creates a VAT could inherently include the appropriate limitations and parameters within which the VAT system exists and operates. For example, the new law could be drafted so that only imports from another country would be subject to VAT, and such imports would be subject to the same VAT rate applicable to U.S. exports to that same country. This tax could achieve one of the main campaign pledges of the President by leveling the trade playing field and could also raise revenue that can be structured to have minimal impact on low earners.
The Tax Cuts and Jobs Act is an ambitious move towards staying competitive in the global economy. While a VAT was not included as a new source of revenue to offset some of the cuts, it will be interesting to see whether the Administration or Congress consider VAT in future legislation.
If you have any questions, please feel free to reach out to Brady Ware’s International Tax Team or contact:
Rose Moore at [email protected] or 614-384-8431
Rick Gimbert at [email protected] or 678-350-9518.