Sunday, February 5, 2017

Border Adjustment Tax - The Tax That's Set After the Year is Over

Business folks like certainty.  Actually, they not only crave certainty and predictability, but the very existence of their businesses depend on it.  Businesses need to finance their operations, which requires certainty to attract capital.  Businesses need predictability to attract talent with the prospect of financial growth and wealth building.  The decision to invest also mandates a clear vision of the future.

That's why business is called investing, not gambling.  Business was never meant to be a game of chance.

However, under the BAT, business becomes a game of chance.  Let's examine the five elements in your business' results that will affect your BAT taxes:

1.    Net Taxable Income or "Economic Profit":  This term is well-understood by accountants and business people alike.  What profit will your company make in a period, such as a year? Many businesses rely on budgets or plans to predict profits, and spend according to the plan. Obviously, these plans are also used with lenders to attract financing.  Although many decisions are rolled up in this line, it represents the difference between revenue and expense (including amortization of CapEx based on the then current law), by and large.  A basic concept understood by all.

2.    Net Interest Expense.  This is an add-back to Net Taxable Income under the BAT.  This number can be projected for most businesses.

3.    Domestic CapEx:  Capital Expenditures are generally a controlled and predictable (planned) expense.  A predictable add-back.

4.    Imported COGS:  This sum cannot predicted precisely but will trace revenue trends pretty closely in most businesses.  Revenue, however, is NOT that easily predicted.  Many businesses find revenue the most difficult line item to predict in large part because they don't control it. Customers control it.  In any event, each dollar of imported COGS will add $0.25 in additional tax, so each dollar stings.  Since customers dictate sales, the more you sell, the more you owe - whether or not you actually make an economic profit. Unpredictable effects.

5.    Export Sales Deduction:  Again, customers control sales, so export sales can swing wildly from plan depending the arbitrary timing of sales.  Thus, tax relief from export sales depends entirely on timing, most likely not in your control.  Unpredictable.

Today's planning processes involve certainty because we only owe a percentage of Net Taxable Income.  It will not rise above 39.6% for the Federal piece.  So no matter what falls to the bottom line, you can easily predict and prepare to pay your taxes. They will never exceed a certain percent of income and will never exceed income.  Thus, you are always assured of the ability to pay this most critical bill.

Under the BAT, you have no such assurance.  The factors that drive our tax bill up to 165% based on 2016 results will generate a different set of numbers for a different company with the exact same revenue, profit and import percentage.  The "rate" (or size of tax invoice) is not knowable until after the year is done.  Even if you are raising prices in the hope of generating enough cash to fund the bill, you will never know if you've raised enough until AFTER the time period to raise the money HAS ELAPSED.


Let me illustrate how this could happen.

Consider two companies, with the following economic attributes in common.  I am going to simplify the illustration by ignoring the interest rate and CapEx effects (deeming them immaterial).

Company A and Company B generate the following results:

Revenue                                  $25,000,000
COGS (100% imported)             $15,000,000
Net Taxable Income                  $  2,500,000
Pre-BAT Fed. Tax Rate             39.6%
Post-BAT Fed Tax Rate            25%

The only difference is that Company A exports 15% of revenue and Company B exports 60% of revenue.  These numbers can swing wildly at the end of the year, of course.

Our fearless leaders, Paul Ryan and Kevin Brady, intone that export jobs are better than import jobs. I have no idea why this is, but presumably, that point of view would favor Company B, the larger exporter.  However, please note that otherwise, these companies are identical.  They both make all of their products overseas, and presumably both stock in this country for redistribution. One company found a larger market outside the U.S., the other serves the U.S. more than other countries, perhaps because of its product category.

The Federal Tax bill for the two companies vary wildly:

Company A

Net Taxable Income                  $  2,500,000
Add back COGS                       $15,000,000
Deduct Export Sales                ($  3,750,000)
Adjusted Tax Base (sum)           $13,375,000
Federal Tax Bill (25%)                $  3,437,500  (137.5%)

Company B

Net Taxable Income                  $  2,500,000
Add back COGS                       $15,000,000
Deduct Export Sales                 ($15,000,000)
Adjusted Tax Base (sum)           $  2,500,000
Federal Tax Bill (25%)                $      625,000  (25%)

This, apparently, is the new concept of "tax equity".

And if you are employed by Company B, you keep your job and get a bonus.  Good year!

And if you work for Company A, start looking for a job.  Too bad most jobs are being filled by robots now . . . .

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