Apparel Sourcing Intelligence - Worldwide

The so-far obscure US tax proposal threatening all American apparel importers.

It’s a safe bet that few readers have paid much attention to the idea of “destination-based” profit taxes. They need to start doing so: right now.

Till now, an idea discussed only by the wonkiest of US policy wonks. But, according to Goldman Sachs, it threatens the profits of apparel importers more than any other sector of the US economy –  and it’s now being seriously proposed for immediate discussion in the US Congress by Paul Ryan, the Republican Speaker of the House of Representatives.

Destination-based profit taxes aren’t among the anti-import proposals from Donald Trump and his team. It’s not even clear whether Trump backs the concept, or the details Ryan proposes.

But, whereas the Trump team are mainly preoccupied with discouraging imports from Mexico and China, Ryan’s ideas would penalise all importers.

What do destination-based taxes do?

Most countries tax corporations by taking a percentage of their net profit. The Republican party proposed, back in June 2016 when Trump looked unlikely to get elected, that the US should change this. They argued that US corporations with net imports should, in effect, not be allowed to claim the cost of importing as a business expense.

Imagine a company (Clothesco Inc) with $100 million in sales and $90 million in costs. It makes $10 million profit. At America’s current federal tax rate of 35% that would mean a $3.5 million tax liability.

But if $45 million of those $90 million costs  were imports and it had no exports – typical for most apparel retailers – under the destination-based system it would pay tax on $55 million.

Now the Republicans are proposing huge cuts in profit tax rates: from 35% to 15%, so  Clothesco would pay “just” $8.25 million in tax. But that’d still be 82.5% of its $10 million profis.

Is the idea serious?

Totally. Of course, the plan isn’t for the US government to get 82% of Clothesco’s profits: it’s to force Clothesco (and  every other US brand or retailer) to stop importing – and America simply hasn’t got the capacity to manufacture all the garments Americans buy.

Even if the idea gets through Congress, debate will take forever, there’ll be lots of discussion about special cases, implementation would be delayed or staggered to allow the country to build up manufacturing capacity – and US companies have shown extraordinary resilience over the past few decades in ducking federal profit taxes anyway.

Much of the debate in Congress is likely to be about how to make such an idea feasible. But it’s not clear it’ll get through Congress anyway.

Will Congress buy the idea?

Who knows? Trump’s team published a different plan a couple of months after the official Party programme Ryan’s now touting. The team’s convinced other countries manipulate profit taxes to give their exporters an unfair advantage, but the Trump plan is a lot vaguer than the official programme about how to deal with this.

One possibility, of course, is that Trump’s team sort of get behind the Ryan plan – not so much because they believe in it, but because it’s a terrific weapon in trade negotiations. “Make the changes in NAFTA we want”, Trump’s negotiators might say to Mexico, “or we’ll get behind destination-based profit taxes and that will really damage your exports.”

Businesses like Walmart will lobby furiously against destination-based taxes and lots of Congresspeople will have convincing arguments about why it’s against US interests. The chances of the idea becoming law are far from certain.

On the other hand: it’s demonstrates precisely what Trump voters have been saying for years. If America really wants to stop importing so much, the world’s most powerful government could easily legislate imports out of existence.

Does this affect my business today?

If you’re an American importer, rely on US importers, or sell to the US, it’s probably going to be years before destination-based taxation applies to the products or services you trade in. It very well might never become part of the US tax code.

But, right now, it’s highly likely the plan may start moving through the US Congress in a few weeks, and it’s going to attract significant support. So you have to think very hard indeed about the wisdom of investing cash or resources developing business that may well be taxed beyond viability in a few years’ time.

Obviously, if the idea were to be implemented, it would have the biggest impact on our industry of any single idea since Hargreaves invented the spinning jenny in 1764. But simply the start of serious discussions will transform many people’s priorities.

2017 keeps looking even more interesting than it did last time we looked. In China, they think it’s a curse to live in interesting times. Looking at destination-based taxation, you can see why.

Have a great Christmas: for lots of you it’s looking like it’s going to be a very tricky New Year.