A Border Adjustment Tax Will Hurt US Retailers

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A Border Adjustment Tax Will Hurt US Retailers

Earlier this month, some US department store chains reported that their weak sales trends continued during the critical holiday season. For the past two years or so, among US apparel and home-focused retailers, only off-price merchants such as TJX Companies have consistently performed well.

The US government has introduced tax reforms last week. One of the few potential bright spots for retailers is corporate tax reform. A reduction in the corporate tax rate could boost their cash flow, allowing them to return more cash to shareholders. That said, some US tax reform proposals have included a "border adjustment," which could send retailers' tax bills skyward.

What's the tax plan?

During the presidential campaign, Trump supported cutting the corporate tax rate significantly as part of his overall plan to boost the economy. Trump has suggested lowering the federal corporate tax rate to as little as 15% from 35% today. However, congressional Republicans have presented an alternative plan calling for a "border-adjusted" tax. This would pay for the reduction in the corporate tax rate by making imports non-deductible.

That would be terrible for US retailers as a very large proportion of the items they sell are imported. Further complicating matters, Trump's nominee for Treasury Secretary -- Steven Mnuchin -- has stated repeatedly that any tax reform shouldn't add to the federal deficit. It may be possible to fudge the numbers a bit using "dynamic scoring" that incorporates an optimistic forecast of GDP growth, but a revenue-neutral tax reform plan is likely to have winners and losers.

Obviously, retailers can't move many jobs to other countries if their stores are here. Meanwhile, their suppliers have been overseas for many years. If corporate tax reform only penalises companies that move jobs offshore in the future, then retailers would be big beneficiaries, because they all have effective tax rates of 35%-40% today.

Here's How Under Armour Can Be Impacted By The Proposed 'Border Adjustment Tax'

As the Trump administration takes charge, talks of "border adjusted tax" are now taking centrestage. Part of the House GOP's corporate tax reform plan, this change would lead to a 20% tax on goods sold in the US but manufactured overseas which are imported into the country. While the reform plan also proposes the reduction of corporate taxes on profits from the current 35% to 20%, it clearly favours exports over imports. Retailers such as Under Armour, who manufacture a significant percentage of their products overseas and depend on the domestic market for sales, can be severely impacted by this proposed change in taxes.

In 2015, Under Armour launched an initiative called "Project Glory" under which it is looking to manufacture products closer to the markets where they are sold. However, before this project was launched, 65% of its products were made in China, Jordan, Vietnam and Indonesia.

While a shift to local production is on the cards, it might not be possible for the company to shift its entire production to the US (where it sells nearly 85% of its goods) to benefit from the proposed new tax policy. Given that a significant portion of its production happens outside the US, Under Armour is likely to be impacted negatively from the border adjustment tax, if it is enacted.

Economists argue that the new tax policy would lead to a sharp rise in the value of the US dollar - anywhere from 20-25%. These should lead to a decrease in the costs for retailers and they would not be impacted negatively from this policy. However, adjustment in the value of the dollar might be a long term process and affected by several other factors. An immediate impact of the new tax policy would be a significant increase in the post-tax value of goods imported from overseas manufacturing facilities, impacting the margins of these companies negatively.

Under Armour is heavily dependent on the domestic market for its revenues and a significant portion of its products are manufactured overseas. Given this mismatch, the new tax policy would affect profitability.