“Advantages, inconveniences and uncertainty”

Let´s stop worrying about the erosion of the tax bases and profits shifting to low-tax territories. Let us forget abuse in interest payments to other jurisdictions (problem 1), the relocation of patents to avoid taxation (problem 2), transfer pricing (problem 3). Is BEPS dead?

Moreover, as a treat: Let´s eliminate the complexity of our corporate income taxes in the treatment of assets depreciation (problem 4); and “inefficiency” in the treatment of the various sources of financing business activity (problem 5) -eliminating the difference between deductible interests and non-deductible dividends; even if the existence or not of this problem actually depends on the mechanisms of integration with the personal income taxation-; while avoiding the displacement of production by national companies to other territories (problem 6).

Recently we mentioned in this Blog the surprising possibility of introducing taxes on robots as a “solution” to problems caused by technological innovation and the displacement of many traditional jobs. Actually this other proposal is still more “fantastic”, by what it promises and, perhaps, because of its distance from reality.

The fact is that this proposal exists. We may be skeptical or not, but it is worth reflecting on it. In this link, you can find its detailed exposition, although it must take into account, in addition, that it is not only an academic concept. A version of this proposal constituted a relevant element of the program that the current chief executive of the world’s first power has presented for the elections and it is being debated in the House of Representatives of the United States.

In a much summarized (and, therefore, necessarily incomplete) form, the alternative proposal is based on two elements.

On the one hand, the tax base would be calculated on the cash flow, understood as the difference between payments and incomes for (real) non-financial activities. Interests would not be considered, nor those charged nor those paid (goodbye to problems 1 and 5) and the purchase of fixed assets would be fully deductible at the time of payment (problem 4 solved).

On the other hand, a “Border Tax Adjustment” (BTA) would take place, similar to which is made in VAT, consisting in that payments abroad and imports in general would not be deductible (goodbye to problems 2 and 3), while export revenues would be exempted (solution to problem 6).

Fantastic.

Against so many “advantages”, could it cause some problem?

This tax would replace the current corporate income tax, by which it is equivalent to a subsidy to exports in a percentage equal to the rate of such tax. At the same time, it introduces an extra levy on non-deductible imports (a “tariff”, by the same percentage). Trade agreements would be seriously affected and, in principle, this could trigger “trade wars” (problem 7).

In its theoretical configuration – and accompanied by a reduction in the taxation of wages-, this is equivalent to a single-rate value added tax, taxing consumption “at destination”. That is, it would stop being a direct tax on income to become a tax on consumption (problem 8), with the related distributive consequences. On the other hand, the proposals tend to omit specifying what would be the relationship with the assessment of the personal income, which would be essential to determine much of its effects on equity and efficiency.

By not taxing the profit in classical terms, it might be outside the scope of the current provisions of agreements to avoid double international taxation, distorting the decisions of investment and location (problem 9). In this regard, it should remember its resemblance with the process followed by the IETU tax (the Mexican “single rate business tax”). As a minimal tax complement to the income tax in Mexico between 2008 and 2014 and investigated by the USA as to its possible accreditation, it was put into doubt because of the characteristics of its base (very similar to the cash flow proposal, without deduction of royalties or interests, but with immediate deductibility of investments).

The transition from one model to another would have quite a few management inconveniences (problem 10: what to do with investments in assets already made; how to treat financing decisions prior to its entry into force, etc.). There are also economic issues (problem 11: what would be its effect on businesses currently dependent on imports for valid economic reasons; how would the price rise in importations be shifted to domestic prices; how would the currency exchange rates react, etc.).

Finally, how would react the other countries? (Problem 12): is the proposal equally interesting for all of them? How to deal with natural resources exports, should they be exempted from taxes in the country of origin? What happens to countries dependent on tourism, in which domestic prices are essential for the functioning of their balance of payments, being an equivalent to their exports? Etc.

Ultimately, the DBCFT perhaps would resolve many problems, but… Would it avoid creating many others? We still have time to analyze, discuss, and reflect. Let us do it before it is too late.

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