Uncertainty about tariffs and changes in the tax code make decisions to invest in additional capacity more challenging. Manufacturers will need the right kind of help and insights to adapt to uncertainty.
It’s a White House tradition, like the Thanksgiving turkey pardon. When one party takes over from the other, incoming presidents reverse the policies of their predecessors. President Biden moved into the White House on January 20 and, as expected, began issuing executive orders.
To the surprise of many White House observers, he chose to leave President Trump’s tariffs in place.
The U.S. maintains tariffs on 66 percent of Chinese exports, with an average rate of 19 percent. As a result, Americans pay more for consumer goods, such as bicycles, luggage and televisions. They also pay more for raw materials used by American OEMs. In response, China has levied tariffs on American goods — about 58 percent of U.S. exports to China have tariffs averaging 21 percent.
Differences of style instead of substance
These tariffs were at the heart of President Trump’s “America First” agenda. That agenda aimed to reduce trade deficits, reverse jobs offshoring and rebuild American manufacturing. In a classic example of unintended consequences, it led to the current trade war with China. It also resulted in collateral damage, with tariffs on Canadian and European aluminum and steel, and withdrawal from or renegotiation of global trade agreements.
It appears that President Biden shares President Trump’s strategic objectives on trade, while differing on tactics. One approach was frankly adversarial and ready to disrupt longstanding alliances. The other is more nuanced, but equally opposed to China’s trade practices and the effects of globalization on the American middle class.
Thus, Biden has kept Trump’s tariffs in place, which means retaliatory tariffs remain in place too. This policy, intended to help domestic manufacturers build market share, has led to higher production costs. OEMs pass these costs along to consumers, leading to a weaker position in both export and domestic markets.
Prospects for the Made in America tax plan are uncertain
American manufacturers, ready to tap rebounding markets for growth, are left to watch and wait. This uncertainty is compounded by prospects for Biden’s Made in America tax plan. The plan, according to the administration, will make American manufacturers more competitive. It eliminates offshoring incentives, reduces profit shifting and offers incentives for clean energy production.
The new tax plan also proposes tax hikes on corporations and high-income households to pay for the administration’s American Jobs Plan. Notable provisions include:
- Raising the corporate tax rate from 21 to 28 percent
- A global minimum tax rate for U.S. multinationals at 21 percent
- Eliminating expense reductions related to offshoring jobs
- Providing a tax credit for onshoring jobs
- Creating tax incentives for sustainability — carbon recapture and sequestration, long-distance power transmission lines, more protection from weather-related catastrophes
- Increased funding for IRS audits of corporate taxes
Democrats and Republicans have a 50-50 split in the Senate, with Vice President Kamala Harris providing the tie-breaking vote. With the Republicans united against tax hikes, and Democrats struggling to hold their coalition together, the bill’s passage is uncertain. Democrats will try to pass tax hikes with this year’s final use of a budget reconciliation bill.
Will the FDII deduction remain in effect?
The Tax Cut and Jobs Act, passed by Republicans in 2017, offered American exporters a tax break on goods and services sold overseas. The write-off, a deduction for foreign-derived intangible income (FDII), cut the tax rate from 21 percent to approximately 13 percent. The intent was to encourage American companies to hire domestic workers, expand manufacturing and store intellectual property in the U.S.
To date, the FDII hasn’t spurred increased major capital investments here in the U.S. One reason may be that the tax rate eventually rises from 13 percent to 16 percent. Another is that the World Trade Organization may challenge FDII as an illegal export subsidy. Challenges would take years to resolve, leaving the deduction in place during that time. Changes wouldn’t be retroactive.
In this instance, business considerations take precedence over tax implications. Some large American companies have offshored operations for other reasons. These include lower labor costs, proximity to foreign customers and, ironically enough, the U.S.-China trade war.
Next steps for American manufacturers
If CEOs need certainty before investing in new U.S. production capacity, they’re likely to be disappointed. The COVID-19 pandemic has thrust the global economy into an extended period of extreme uncertainty. Companies adding production capacity must reckon with reduced consumer demand, inventory shortages and supply chain disruptions.
Pre-COVID, manufacturers planning to build new plants or add machinery had the luxury of evaluating the business case slowly and carefully. They could assess customer demand and market factors, weighing them against strategic growth objectives. They could map out the tax consequences of their investments and plan accordingly.
This annual planning process, with crafted agreements on strategy, budgets and operations, may not provide companies with enough flexibility. Instead, CEOs must set an accelerated operating tempo, driving organizations to recognize and respond to market changes sooner. This requires more frequent assessments and pushes decision-making downward. Giving key managers the authority to revise assumptions and adjust tactics makes companies more agile and responsive.
Agile, flexible tax advisors can help
The game isn’t just changing for American OEMs. Their tax advisors must also adapt to the new global marketplace and operating conditions. Business considerations generally take precedence over tax considerations, but tax strategy must support business goals.
This is particularly critical for U.S. multinationals contemplating American expansion. Their tax compliance is more complex and has to meet the regulatory demands of multiple jurisdictions. Accurate reporting and defensible valuations are essential, particularly with the IRS looking to collect underpaid taxes from large corporations and well-compensated management.
The right tax advisors can help maintain compliance without error or wasted effort, while controlling tax exposure. With this part of the operation in experienced hands, CEOs can manage the challenges of profitable growth.
Windham Brannon has spent years providing tax services to companies doing business domestically and overseas. Our experience and insights make us well-suited to serve manufacturers ready to invest in additional production capacity. To discuss your company’s business objectives and tax strategy, contact manufacturing and distribution practice leaders Greg Spangler and Daniel Pullman.
