Why is everyone talking about the Border Adjustment Tax (BAT)?
The year was 1986. Top Gun was in theaters, Whitney Houston was on the radio, kids asked Santa for the original Nintendo, and tax reform was passed. A lot has changed in 31 years. Namely, Donald Trump is now the guy instigating tax reform instead of the guy on the cover of Fortune assuring readers he’ll make a killing in spite of it.
Some experts say tax reform is more likely to happen now than at any other time in the last three decades due to Republicans controlling the Executive and Legislative Branches of our government. Because of this, every new detail of the Republicans’ proposed tax plan is being scrutinized and carefully analyzed. President Trump has not yet announced his full tax plan, but it is expected that many of the ideas proposed by the Republicans will be incorporated. He says he will present it within the new few weeks. One thing we know already, however, is that the reform documents may include plans for a Border Adjustment Tax (BAT), which was initially proposed by House Republicans.
For me, the easiest way to understand the BAT is to look at a basic income statement. If you clicked on the link, you saw that the expenses don’t yet include taxes. So, we’re talking about net income before taxes here (revenues minus expenses equals net income before taxes). What the BAT would do, is keep companies from being able to count any goods they import as an expense. This would drive the net income before taxes amount up significantly for companies that import heavily. In conjunction with BAT, the corporate tax rate would drop from 35% to 20%, but massive corporations like Wal-Mart that import like crazy could still see meaningfully higher tax bills. I say “could” because some argue that this plan would cause the US Dollar to strengthen, making imports cheaper, and offsetting the effects of the BAT. For companies that produce and sell their items within the US, this is a win all the way around. For companies that export their goods to be sold in other parts of the world, it depends on how you look at it. Under the BAT, the profit on goods that are exported wouldn’t be taxed at all. Theoretically, this would be great because instead of paying a 35% tax, these companies would pay nothing. The only kicker would be if the US Dollar strengthens significantly, the value of foreign sales could decrease and ultimately reduce the USD-converted profit.
With that overview, let’s talk about the BAT in conjunction with the midstream space. There has been a fair amount of chatter surrounding all the possible effects. A few concerns I’ve seen raised repeatedly are those coming from refiners. Many refiners are still set up to process the heavier imported crude. Continuing to import with the BAT in place would theoretically drive costs up. Refiners say they’d have no choice but to pass these on to consumers.
The other big concern is for pipelines carrying oil from Canada. Examples are Kinder Morgan (KMI)’s Trans Mountain Pipeline System, TransCanada (TRP)’s Keystone, and Enbridge Inc (ENB)’s Alliance Pipeline. The thought is that with a 20% tax on oil coming from our northern friends, it may not make sense to import at the same volume we do today. Anyone else scratching their heads about Keystone XL?
The problem is that with so many moving parts, it’s virtually impossible to nail down an exact forecast of how this will affect midstream energy. For MLPs, the tax issues aren’t necessarily going to impact them directly since they are already exempt from paying federal income taxes at the entity level. However, we can’t say there would be zero effect because if corporate tax bills go down across the board, the tax advantages afforded to MLPs could become less impactful on a relative basis. Nevertheless, it generally looks like the BAT could be a good thing for MLPs. If we are primarily using oil and gas produced within our borders, this might mean more infrastructure would need to be built. However, the price of oil, global demand, and strength of the US Dollar are all wild cards that could totally change the equation. Also, it’s possible the BAT doesn’t become law. Opposition is already ramping up against it and we still haven’t even seen the final draft of Trump’s tax plan. Some speculate he may not be as committed to the BAT as most people think, citing a Wall Street Journal interview where he said, “Any time I hear ‘border adjustment,’ I don’t love it.”