A Central Focus

IntlTrade

International Tax Regulations and Implications for U.S. Manufacturers

By Matthew Walsh

Throughout his presidential election campaign, then candidate Donald Trump often stated that global trade is hurting United States workers by driving manufacturing jobs out of the country. In response, he promised to change the rules and revisit regulations surrounding trade and taxes in an effort to make imports less attractive and bring American manufacturing jobs back into the United States. Now that the new president is in office, tax reform is a central focus in Washington. The new expansive trade policies that directly impact manufacturers and the movement of goods coincide with new tax rules, that will likely further impact imports and exports. To help U.S. manufacturers better understand the impact of potential new policies, let’s examine the three aspects of global tax regulations that most directly affect manufacturers and the movement of goods.

Import / export impacts from VAT

President Trump, along with his economic advisors, claim that when American manufacturers export goods into a country with a value added tax (VAT), they are at a distinct disadvantage since VAT is imposed on those imports. However, manufacturers in those same countries exporting into the United States do so tax free and then receive a credit from the country they are exporting from when those goods leave the country. As a result, the claim is that manufacturers outside of the United States enjoy a large tax advantage. But that is not exactly the case.

To illustrate why manufacturers outside of the United States do not actually have a large tax advantage as described, let’s look at how a VAT system works: VAT is a tax on consumption, just like the sales taxes imposed in the United States. Both VAT and sales taxes are a tax on the sale of an item or taxable service. In both systems, the cost burden is ultimately placed on the final consumer. However, the two systems do operate differently. In a sales tax system, tax is only charged at the time of the sale and to the final consumer. In a VAT system, the tax is imposed and remitted along each stage of the supply chain, for the “value added” along with each stage. Here’s an example:

Country A has a 10% VAT rate:

Lumber Company cuts down a tree and sells it to Wholesaler for $110 ($100 tree cost + $10 VAT cost). Lumber Company remits $10 to the country tax authority.

Wholesaler processes the tree and sells it to Manufacturer for $220 ($200 tree cost + $20 for VAT cost). Wholesaler shows on its tax return that it collected $20 in VAT from Manufacturer, and is allowed to recoup the $10 paid to Lumber Company, as that was Wholesaler’s input tax.  Wholesaler pays $10 to the tax authority and retains the other $10, the input tax credit.

Manufacturer builds a chair from the lumber and then sells it to Retailer for $330 ($300 chair cost + $30 VAT cost). When filing its tax return, Manufacturer shows $30 in VAT collected, but claims an input credit for the $20 he paid to Wholesaler. Manufacturer pays $10 to the tax authority.

Retailer sells that chair to you and charges you $440 ($400 chair cost + $40 VAT cost). Now, Retailer can claim the $30 input tax credit when he files his tax return. The tax authority has collected $40, but it has done so incrementally at each stage in the supply chain. 

Country B has a 10% sales tax rate.

At the sale in each stage from Lumber Company to Wholesaler to Manufacturer to Retailer; the buyer would provide what is called a resale certificate, which indicates they are not the final consumer and would pay no tax.  However, when you, the final consumer, buy the chair from Retailer for $400, you are charged $40 in sales tax – exactly the same as in the VAT system – which Retailer remits to Country B’s tax authority.

In a VAT system when the good is exported, the manufacturer does not collect VAT from the U.S. retailer, because export transactions are not subject to VAT. It does still get to claim input tax credits and receive what it had paid in input taxes. When that chair is ultimately sold to you in the United States, you still pay the $40 sales tax.

If a manufacturer in the United States sells into the VAT system, then the $30 VAT is collected on the sale to the retailer, but when it is sold in that country, the consumer will still pay $40 in VAT to the retailer. The retailer reclaims the $30 in input VAT, but ultimately it is the same result. As a result, there isn’t a disadvantage to a U.S. manufacturer selling into a country that imposes a VAT; likewise, there is no impact on U.S.-based jobs.

Import tariffs

One proposal President Trump has continually spoken of is to impose tariffs on goods imported into the United States from certain countries that he feels have policies creating a disadvantage for goods manufactured domestically. Proponents argue the imposition of tariffs on goods imported from these countries would drive up the cost and incentivize American consumers to turn to options manufactured in the United States.  This approach should then help drive the need for more U.S.-based manufacturing jobs. 

Opponents counter that countries impacted would respond in kind by raising tariffs on U.S. manufactured goods. As countries react to these tariffs and impose their own new or higher tariffs, the threat of sparking a global trade war emerges, which ultimately hurts all parties, with little impact on job growth. Opponents further argue that as these tariffs are country-specific, U.S. consumers could still look for other foreign-made options. Finally, there is also a threat that the United States could be sanctioned by the World Trade Organization for imposing barriers to global trade. So, while tariffs appear to be an easy, quick approach, this tactic is generally not considered the best approach for job creation.

Border adjustment tax

Another proposal making its way through Congress is a Border Adjustment Tax (BAT). In its simplest terms, the BAT imposes a tax on all imports of goods and services by not allowing an income tax deduction for those costs - which are fully deductible now. However, this approach would allow those costs to be deducted on goods and services exported. The BAT system taxes goods and services where they are consumed. Proponents say it acts similar to a VAT, though using income tax rules to power the system. Since the BAT would increase the costs of imports, proponents argue it would incentivize American manufacturers and others to source their supplies and goods domestically. Considering the tax benefits of exporting and the costs savings of sourcing in the United States, the result would be increased demand for American manufactured goods that would drive new employment.        

BAT opponents argue, though, that the tax would drive up costs as these taxes would be passed along, and the incremental new employment benefit would be offset by higher prices all consumers would have to pay. Since U.S. manufacturers often source raw materials or component parts from outside the country, the additional costs of those imported materials would be ultimately passed on to the American consumer - even for U.S. manufactured items.  

Industries are split; big exporters are in support, but those that are typically big importers are opposed. While recently the President has said he doesn’t support the BAT, the idea is still being debated and reviewed in D.C.

Tax policy changes impact on global supply chains and employment

Global trade is a complex system. Manufacturers look at many factors in determining where to source materials or set up a manufacturing facility. There are also many companies with established global supply chains, sourcing goods and services from around the world. So can – and will – companies shift their manufacturing production back to the U.S. in response to changes in tax policy? While taxes and tax policy are factors that companies consider when setting up their operations, many more factors are involved. 

If these proposed tax policy changes do motivate manufacturers to move operations back to the United States, it would not happen quickly. Contracts would need to be rewritten or unwound; facilities would need to be refurbished or built, and new suppliers relationships would have to be cultivated. Assuming these tax changes do spur U.S. manufacturing as intended, that doesn’t necessarily mean a significant amount of new jobs will actually be created. In fact, a study from Ball State University found that 88% of manufacturing jobs lost between 2000 and 2010 were due to technology - not international trade. In sum, even if proposed tax changes are implemented and manufacturing does increase in the United States the impact on job growth in the industry is not guaranteed.

With more than 17 years of experience in tax compliance, Matthew Walsh oversees solutions for global indirect tax law compliance at Sovos. Visit sovos.com for more information

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