Border Taxes and the Maquiladora Program

While the House Republicans are pushing that Destination Based Cash Flow Tax, President Trump has other ideas as do the Senate Republicans. Trump wants to encourage U.S. net exports by simply placing a 20% tariff on goods from Mexico while some in the Senate want to simply reduce our corporate profits tax rate to 20% (Mexico’s corporate profits tax rate is 30%). Suppose we do both – keep the corporate profits tax but at a lower rate and impose tariffs on imports from Mexico. Not that I’m endorsing either but this GAO document was interesting with its title:

International Taxation: IRS' Administration of Tax-Customs Valuation Rules in Tax Code Section 1059A (Letter Report, 02/04/94, GAO/GGD-94-61).

What is section 1059A?

Congress enacted section 1059A in 1986 to improve IRS' enforcement of transfer pricing regulations. Section 1059A was designed to prevent the federal government from being whipsawed by an importer, on property acquired from a related party, who claims a low valuation for customs purposes and a higher valuation for tax purposes ... The legislative history of the section indicates that the section was intended to address the Tax Court holding of Brittingham v. Commissioner. In this case, IRS determined that a U.S. importer paid more than an arm's length price for ceramic tile imported from a related party in Mexico. The purchase price exceeded the value reported for customs duty purposes.

This case dates back to intercompany pricing when John Kennedy happened to be President. Imagine you were a homeowner way back then and you purchased $100 in ceramic tile that cost the Mexican affiliate of a multinational $60 to produce and $20 for the U.S. affiliate to distribute. The $20 in profits would have been taxable partly in Mexico and partly in the U.S. depending on the transfer pricing policy, which we was set at $66 for Mexican income tax purposes and U.S. customs purposes. But somehow this multinational got away with telling the IRS that the intercompany price was $80 for U.S. income tax purposes. So it got away with a low customs duty charge and having about 70% of its profits tax-free for income tax purposes. Nice trick I guess. So yea – section 1059A was sort of a good idea. But here is where this gets weird:

According to IRS officials, since 1986 IRS has raised section 1059A issues in nine audits. Furthermore, when raised in audits, its application has been primarily directed at taxpayers operating under the maquiladora program--U.S.-owned manufacturing and assembly operations in Mexico (maquiladoras) that export their products back to the United States. About 2,100 maquiladoras exported products to the United States in 1991 ... In response to our inquiry on legislative options, IRS' Office of Chief Counsel concluded in a January 7, 1993, letter that the issue addressed in the technical advice memorandum is not a tax problem. Rather, it believed that the problem is with customs valuation that results from a loophole in customs legislation. The letter concluded the issue should be resolved by amending customs law.

So the remedy is to ask any multinational declaring inconsistent transfer pricing to pay more customs duties? And the focus was on Mexican maquiladoras? I bet you caught the irony of the fact that this document was issued in 1994 just as NAFTA kicked in eliminating most tariffs on imports from Mexico. One should also remember that even before NAFTA that the entire point of the maquiladora program was to allow U.S. multinationals to import goods manufactured in Mexico duty free.