We live in a global economy with more free trade agreements than ever before. Over time, nations have become more and more integrated, however, some nations such as the United Kingdom have taken a step back, a la Brexit. And more recently, it appears the United States may be taking that step back as well, following the announcement of its proposed tax reforms.
In recent months, the US has released ‘the House Tax Blueprint’ (HTB), initialising what could be the largest package of US tax reforms since 1986.
These changes could have a huge impact on Australian businesses.
Major drivers for reform
The US statutory corporate tax rate is 35%. This comparatively high rate alone is enough to tempt US companies to move IP and jobs offshore to lower taxed jurisdictions and encourage certain offshore tax arrangements, all of which is perfectly legal. Amazon for example, as disclosed in its recent win against the IRS in the US Tax Court over a USD 1.5 billion tax dispute, moved IP to its Luxembourg unit to benefit from lower tax rates .
Recently elected United States President Donald Trump considered this to be ‘getting away with murder, tax-wise’ and is but one example of what is driving tax reform in the US.
Summary of reforms
The 35 page overview proposes several highly significant (and what some tax consultants may consider radical) changes to tax law. This is including, but not limited to, a reduction in the corporate tax rate from 35% to 20%, 100% expensing of capital asset expenditure, no deductions for net interest, and applying interest on carry forward tax losses in an effort to move towards a cash flow based system.
Relevant to the international tax scene, however, is the HTB’s additional proposal on imports and exports, the curiously-named ‘border adjustment’. The border adjustment included:
- Removing tax deductions for goods imported to the US;
- Allowing US companies to exclude exports from their taxable income; and
- Moving towards a ‘destination based’ tax system.
The border adjustment taxes were not part of the recently announced reform package, however, pundits are predicting they were specifically excluded from the first package to assist the package to pass through first. If passed without amendment, this could provide incentives for US companies to ‘return home’ to produce, manufacture and export in the US, particularly as there is also a 10% discounted tax rate on offer for repatriation of funds back to the US, and those continuing to export to the US would face much higher US tax costs.
Implications for Australia of the potential application of the border adjustment tax reforms
The US is Australia’s second highest two-way trade partner according to DFAT (2017) during the 2015-16 period, with $69.2 billion in trade between the two nations .
So what effect would the tax law changes potentially have on Australia in the short term?
- Reduction in cost of US products
The US is Australia’s second largest supplier by nation, with AUD 47.3 billion worth of goods and services imported during 2015-16. Australia’s largest imports from the US include:
- Passenger motor vehicles (AUD 2.4 billion),
- Aircraft, spacecraft and parts (AUD 1.39 b billion),
- Telecom equipment and parts (AUD 1.08 b billion), and
- Medical instruments (AUD 1.07 billion). 
If US companies were able to exclude exports from their taxable income then Australian entities importing from the US and even Australian consumers could see lower prices as the US companies look to pass on tax savings to increase their global competitiveness.
- Disincentives for US companies importing goods
The removal of tax deductions for goods imported to the US would spell very bad news for Australian exporters as their tax costs on US sales would skyrocket and act as a significant disincentive to entering the US market.
This is particularly troublesome as the US is Australia’s third largest export market.
As an example, the US takes in AUD 2.48 billion or 28% of Australian beef exports. To remain profitable the prices on those exports would have to increase to cover the additional tax costs and US companies could look domestically for the supply of beef instead .
Australian manufacturer exporters may look to mitigate these effects by moving substantial manufacturing processes to the US itself so that any non-deductible imports into the US were low value raw materials, rather than the value-added final goods themselves. An enormous change in their global supply chain.
Another example is Australian start-up fashion companies in the US, which could not be moved to the US without incurring other significant costs. The question of whether the US would even be able to compete on price on a global scale in industries like textiles, or whether this would only hurt certain industries remains to be seen.
It’s possible these changes would only have a temporary impact as economic forces take effect and markets reach a new equilibrium. However, there is the possibility that this would have long lasting effects on both the US and Australian economies. Alternatively, there may be new tax planning opportunities as the proposal moves towards becoming a Bill. Either way, given the economic seriousness of Australia’s trade with the US, this is definitely something to keep an eye on.
Seem confusing or scary? If you are concerned about how this may affect you, Crowe Horwath as part of Findex, offers a fully integrated financial service offering for Australian individuals and businesses and would be happy to help.
By Sam Neale
Senior Partner – Tax