Import-Export Tax Idea Presents State Constitutional Pitfalls

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By Che Odom

States could run afoul of the Constitution by following a federal border-adjustments plan advocated by House Speaker Paul Ryan (R-Wisc.) to tax imports and exempt exports.

The commerce clause, and even the equal protection clause, could factor in how states respond to whatever bill is finally presented by Ryan and other congressional members.

Border adjustments, part of Ryan’s broader tax blueprint, haven’t yet been introduced in the House. President Trump has said he thinks they are “complicated,” but hasn’t said he opposes the idea.

Many details are unclear, such as how border adjustments would apply to direct sales from foreign businesses to U.S. individuals.

Some state tax experts, however, say not all states will be impacted the same way if the adjustments become law. And constitutional pitfalls loom large depending on whether and how they conform to federal law.

Commerce Clause

States such as California, New York and Texas that require “combined” or “unitary” reporting of business income, which counts income from all business units inside and outside the state, could find border adjustments a particularly complicated matter.

The problem is the foreign commerce clause and the U.S. Supreme Court’s 1992 ruling in Kraft General Foods Inc. v. Iowa Department of Revenue and Finance, Steve Wlodychak, a principal at Ernst & Young LLP who focuses on state, local and federal tax issues, told Bloomberg BNA.

“As I read that ruling, states can’t discriminate in the tax treatment of foreign companies, and that goes even if the state merely follows the federal treatment of a transaction,” Wlodychak said.

Dividends at Issue

In Kraft, Iowa required the taxpayer to report taxable income based on an Internal Revenue Code that excluded foreign dividends from a deduction. Iowa’s conformity to the code meant that it also taxed foreign dividends, but not those received from domestic companies.

“The same principle should theoretically apply to border adjustments,” Wlodychak said. “Inputs from foreign companies would not be deductible while inputs from U.S. domestic companies would.”

And he said it’s unclear whether that would be constitutional.

‘Piggy-Backed’ Base

But if the federal legislation limits federal income tax deductions, such as the cost of goods sold for goods imported into the country, a state income tax that simply uses the federal tax base may not violate the commerce clause, according to Kirk Lyda, a Dallas-based partner in Jones Day’s tax practice.

In Kraft, Iowa didn’t tax dividends from domestic subsidiaries doing business outside Iowa, “notwithstanding the fact that Iowa largely piggy-backed off the federal tax base,” he said.

However, “if a state imposes its income tax on a unitary combined basis, the analysis would become more complex, as cases since Kraft have noted,” Lyda said.

Questions Abound

Indeed, an unanswered question surrounding the border-adjusted tax is whether companies would apply the adjustment to the entity level or the business as a whole, according to Peter Michalowski, national practice leader of PwC LLP’s state and local tax practice.

Other constitutional provisions prohibiting discrimination against foreign commerce, such as the equal protection clause, might also come into play for states, depending on what Congress enacts, Lyda said.

Sales Factor

Another interesting question relates to calculating the sales factor for purposes of calculating income, Wlodychak said.

States typically allow the use of generally accepted accounting principals for determining gross revenue or that reported on Internal Revenue Service Form 1120, he said.

“If export revenues aren’t even reported or otherwise excluded from the determination of gross receipts, would that mean that the sales factor denominator would be diluted by the exclusion of exports in the factor?”

States would have to modify their determination of gross receipts for factor-apportionment purposes or maybe not because of the border adjustability feature in determining the gross receipts in the first place, he said.

“I am not sure of the answer,” he said.

To contact the reporter on this story: Che Odom at

To contact the editor responsible for this story: Ryan C. Tuck at

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