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Politics & Policy

KPMG Analysis on Tax-Base Erosion: Senate vs. House

During the battle against the Border Adjustment Tax, the Senate was always the most responsible party. The tax writers on the House side, on the other hand, created and, for far too long, fully embraced that bad idea (thus delaying significantly the necessary unification around tax reform in our broadly defined movement).

The same can be said about anti–base-erosion provisions that are now in both the House and Senate proposals. You can read all about it in this very informative KPMG document about the Senate tax-reform bill. The whole document is worth spending time reading, but the anti–base-erosion section starts around p. 127. The report notes:

Both the House bill and the Finance Committee bill include a number of international tax incentives and anti-base erosion provisions aimed at achieving this goal. Significantly, each mark includes a novel levy focused on deductible payments by large U.S. groups to foreign affiliates. In the House bill, this was the Sec. 4303 Excise Tax on “Specified Amounts.” The Finance Committee bill’s corollary proposal is a new base-erosion-focused minimum tax (the “BEMT”) that differs in several key respects from the House proposal.

I could spend many words lamenting the fact that Senate and House tax writers (and the bean counters at the Joint Committee on Taxation) don’t appreciate how a lower corporate tax rate will reduce the incentive to engage in tax avoidance. But I won’t. Instead, I will note that while the BEMT in the Senate bill is not a good idea (it discriminates against companies that do business in low-tax jurisdictions), the excise tax in the House plan is egregious, and much worse. As KPMG explains:

The inclusion of cross-border product flows where the payments were recovered through COGS was a surprising feature of the Excise Tax. Under the BEMT, however, U.S. payments treated as COGS (Cost of Goods Sold) do not appear to be within scope, except for inverted groups (which are given more restrictive treatment in a number of the Finance Committee bill provisions). The treatment of cross-border payments for COGS is a key difference between the affected classes of taxpayers for the two proposals. For example, payments for inventory by foreign-owned U.S. distributors of goods that are manufactured outside the United States would be subject to the Excise Tax but would not be subject to the BEMT.

I like how KPMG notes that the inclusion of the House’s excise tax was “surprising.” No kidding. After the gigantic battle we had just had about the BAT, the House went ahead and introduced a BAT-like provision, which would apply a 20 percent tax on currently deductible payments made from a U.S. corporation to related business units that are outside of the country if the corporations don’t submit their foreign subsidiaries to our tax jurisdiction. In that case, when companies account for the cost of production of the final good in the U.S., they wouldn’t be able to deduct the cost of materials or other goods used in the process of production if made outside the U.S. With today’s supply chain being global, it would affect many companies — including those who have no intention of inverting abroad.

Same kind of tax provision, same results, as Matthew Kandrash explains in a recent piece:

Similar to the aforementioned BAT, industries from technology to pharmaceutical to automotive would be negatively impacted by this provision — and consumers would see prices in these areas rise dramatically. For example, if a car part is made in Mexico by a Mexican subsidiary of an American company, then that part would be taxed 20 percent when purchased by the U.S. company. The automotive company would be forced to raise the price of the car to offset these tax increases — passing the cost on to consumers — similar to what would happen under the BAT.

Foreign companies that operate in the U.S. and significantly contribute to the U.S. economy will also be punished by the provision. According to Bloomberg BNA, this provision would “force certain foreign corporations that have no connection to the United States other than selling or licensing or providing services to a U.S. affiliate to become (quasi-) net basis U.S. taxpayers with respect to the income generated from such transactions.” For instance, Samsung and Toyota could both be taxed 20 percent on goods, services, and intellectual property that is imported into the U.S. for sale.

Additionally, according to Reuters, some companies could end up paying the tax twice. Even if the company paid the excise tax in the United States, it would then pay it in the country where the foreign affiliate operates. Again, these companies have no choice but to pass the costs onto consumers, and will no longer be competitive against international businesses.

To be sure, its scope is smaller than the original BAT and it would raise significantly less revenue, especially after being stripped of most of its power during markup. But its features are unmistakable, and the outcomes are too. While it didn’t exempt from the corporate tax profits from export, this excise tax would still have some of the punishing aspects of the BAT.

With the House bill’s 4303 excise tax, companies didn’t fail to notice the destination-based consumption tax’s nose under the tax-reform tent. However, now is the time to wonder what will happen when the House and the Senate are ready to iron out differences. I suspect that any inclusion of a BAT-like provision, limited or otherwise, will seriously jeopardize the passage of a tax reform.

Proponents justify these bad provisions because they help make it possible to shift from worldwide taxation to territorial taxation. That’s a very good idea in theory, as Dan Mitchell explains, but it may not be desirable in practice if accompanied by bad ideas that have the potential to become very bad features of the tax code.


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