A Taxing Issue for Ethanol Producers?

by Brian Kuehl and Donna Funk (K·Coe Isom) Will a possible US tax reform and border adjustability affect ethanol producers in the US? -- ... There is a high likelihood that comprehensive tax reform legislation will become law during 2018 and that much of the debate and formulation of the legislation will occur throughout this year.

Because of this, it is critical that ethanol producers are engaged in this discussion now and that they begin planning for how tax reform could affect their profitability and competitiveness.

In the US House of Representatives, tax reform discussions will be based on the Republican Tax Reform Blueprint released by speaker Paul Ryan in June of 2016.

Under border adjustability, if a US plant were to sell ethanol or distillers grains to a domestic purchaser, the revenue from those sales would be taxed as income.

However, if the plant were to sell ethanol or distillers grains overseas, the revenue from those sales would not be treated as income under the Internal Revenue Code (IRC).

By extension, if a US refinery or blender were to purchase ethanol from a domestic plant, the cost of that purchase would be deductible as a business expense. By contrast, if the refinery or blender were to purchase ethanol from Brazil or other foreign sources, the cost of that purchase would not be deductible as a business expense under the IRC.

The practical effect of this new tax structure is to increase the cost of imports by 25%. If a US company were to purchase $100 (€95) of ethanol from a domestic producer, the true cost of that purchase would actually be $80, since the cost of that purchase would be deductible as a business expense and would reduce the purchaser’s income tax by $20. By contrast, if one were to purchase $100 of ethanol from a foreign producer, the actual cost of that purchase would be $100, since it would not be deductible as a business expense. As a result, the foreign-sourced ethanol would have an effective cost 25% higher than domestic-sourced ethanol.

While this sounds like a great thing for domestic producers (and not such a good thing for importers), proponents of border adjustability argue that the real cost increase on imports will be negligible or non-existent, since the US dollar will strengthen as a result of this change to the US tax code, thereby offsetting any cost increases.

Putting aside the concerns that a strong US dollar would make agricultural exports less competitive, other analysts are not optimistic that appreciation of the US dollar will perfectly offset increased prices on imports. Among their concerns is that many US trading partners, including China, have currencies that do not float freely.