The Corporate Tax Planning Law Review: Japan
Japan has continued to lower its corporation tax rate in recent years. The corporation tax rate was 23.2 per cent in 2021,2 whereas it was 30 per cent in 2010. The purpose of the reduction is to induce investment from overseas and to improve the competitive edge of Japanese corporations by enabling their utilisation of more funds for investment and payment of wages.
While the Japanese government has continued to reduce the corporation tax rate, it has shown a severe attitude towards tax avoidance, which erodes the Japanese tax base. Japan has implemented several tax law amendments in response to the OECD's base erosion and profit shifting (BEPS) report and is also actively implementing measures such as comprehensive anti-abuse rules to tackle unfair acts of tax avoidance.
In contrast to the decreasing corporation tax rate, the rate of consumption tax was raised from 5 per cent to 8 per cent in 2014 and further increased to 10 per cent in 2019, which has led to the enhanced importance of consumption tax in corporate tax planning matters.
i Entity selection and business operations
In Japan, corporations are used for conducting business, and partnerships, such as general partnerships, limited liability partnerships and investment limited partnerships, are sometimes selected for performing certain types of business, especially investment business. Anonymous partnerships, whereby an anonymous partner provides funds to the business operator, are also often chosen – in particular for asset investment.
Corporations are basically subject to corporation tax on their income, and their shareholders are basically subject to corporation tax or income tax as applicable on dividends therefrom. However, shareholders of corporations may be exempt from corporation tax on all or part of their dividends depending on their shareholding ratio, as explained in Section II.ii below, and although individual shareholders are subject to income tax on dividends, a deduction for dividends received is available for individual shareholders.3
Certain corporations, such as specified purpose corporations and investment corporations, are eligible for deductions for the payment of dividends for corporation tax purposes as long as certain requirements are satisfied.4 The dividends from these corporations are not eligible for an exemption from the tax on those dividends or for a deduction for dividends received at the recipients.
Partnerships are considered to be pass-through entities for tax purposes, and partners are subject to corporation tax or income tax as applicable on the income earned by the partnership.
Domestic income tax
However, if any corporation tax or similar tax on overseas income is paid outside Japan, the corporation may be eligible for a foreign tax credit.7
Furthermore, if a domestic corporation owns 25 per cent or more of the shares of an overseas corporation for six months or more, 95 per cent of the dividends received from the overseas corporation are excluded from the income of the domestic corporation.8
Corporation tax is imposed on the income of a corporation.9 The amount of corporation tax is calculated by multiplying the amount of income by the corporation tax rate.10 The amount of a corporation's income is calculated by making certain adjustments to the amount calculated in accordance with accounting standards that are generally accepted as fair and appropriate.11
Foreign corporations are subject to Japanese corporation tax only on certain Japanese-source income.12 The scope of Japanese-source income subject to corporation tax depends on whether the corporation has a permanent establishment in Japan. A foreign corporation without a permanent establishment in Japan will be subject to corporation tax only on income such as that arising from owning or managing assets in Japan and income arising from sales of real property in Japan.13 A foreign corporation with a permanent establishment in Japan is subject to corporation tax on not only such income but also income attributable to the permanent establishment.14
In addition, a foreign corporation is subject to withholding income tax on certain Japanese-source income basically regardless of whether it has a permanent establishment in Japan.15 If such income is also subject to corporation tax, the amount of withholding tax may be deducted from the amount of corporation tax to be paid.16
Japan has entered into tax treaties with a number of countries and regions, as explained in Section III.iii below, and it is therefore often necessary to review the tax treaties to analyse Japanese taxation on foreign corporations.
Japan has thin capitalisation rules and earnings stripping rules, both of which limit deductions of interest payments. Under the thin capitalisation rules, in general, if the amount of debt owed to a foreign controlling shareholder or a certain third party exceeds three times the amount of equity, then interest payments by a Japanese corporation on the excess debt are non-deductible.17
Under the earnings stripping rules, if the covered net interest payment exceeds 20 per cent of the adjusted income, the deduction of the excessive amount of the interest payment is restricted.18 Covered net interest payments mean interest payments minus non-covered interest payments and deductible received interest payments.19 Non-covered interest payments include interest payments that are subject to Japanese income tax or corporation tax on the recipient.20
ii Common ownership: group structures and intercompany transactions
Ownership structure of related parties
Group taxation regime
Domestic corporations that are under a perfect controlling relationship21 (a domestic corporation that belongs to such a group of corporations is hereinafter referred to as a '100 per cent group corporation') are subject to the group taxation regime. The group taxation regime is automatically and compulsorily applied to 100 per cent group corporations without the need to file an application therefor, unlike the consolidated tax filing system or group tax relief system, which is explained below.
The major rules under the group taxation regime are as follows.
- Deferral of recognition of capital gain or loss of certain assets:22 when certain assets23 are transferred between 100 per cent group corporations, the recognition of capital gain or loss arising from the transfer of those assets by the transferring corporation shall be deferred until the taxable event,24 such as the retransfer of the assets, occurs at the transferee corporation.
- No deduction of donation25 and no income from donation:26 when a donation is made between 100 per cent group corporations, such donation is not deductible by the donor corporation and does not constitute income of the donee corporation.
- Transfer of assets at book value by qualified distribution in kind:27 when dividends (including deemed dividends) are paid in kind from a 100 per cent group corporation to another 100 per cent group corporation, the paying corporation is considered to transfer it at the book value immediately before the payment of the dividends.
- No income from dividends received from a 100 per cent group corporation:28 dividends paid from a 100 per cent group corporation to another 100 per cent group corporation do not constitute income of the recipient corporation.
- No capital gain or loss from transfer of shares of a 100 per cent group corporation to another 100 per cent group corporation:29 if a 100 per cent group corporation transfers shares issued by another 100 per cent group corporation to such another 100 per cent group corporation, no capital gain or loss is recognised.
Consolidated tax return filing system (group tax relief system)
The consolidated tax return filing system is applied to a domestic corporation and all of its direct or indirect wholly owned domestic corporations. Under this system, all the income of the corporations that belong to the same consolidated group is consolidated after making certain adjustments and the corporation tax is imposed on the consolidated income.
The consolidated tax return filing system is applied only when an application therefor is filed and approved by the Commissioner of the National Tax Agency (NTA).30
The consolidated tax return filing system has been abolished and the group tax relief system is effective instead for any taxable year that starts on or after 1 April 2022. Accordingly, we explain the details of the group tax relief system below.
Under the group tax relief system, each corporation that belongs to a group of domestic corporations under the perfect controlling relationship31 calculates the amount of corporation tax on its income and files a tax return for this corporation tax while it is possible to offset income against losses or net operating losses among the group members.
The group tax relief system is also applied only when an application therefor is approved by the Commissioner of the NTA.32
When the application for the group tax relief system is started, (1) some of the assets owned by corporations in the group, except for certain corporations, are re-evaluated at fair market value and the re-evaluation profit and loss will be subject to corporation tax;33 (2) the net operating loss of the corporations whose assets are re-evaluated and certain other corporations in the group may not be used after the application commences;34 and (3) certain other limitations apply.
In addition, points (1), (2) and (3) above also apply to any corporation that joins the group after the application for the group tax relief system is started in certain cases.35
Controlled foreign company rules
Japan adopts controlled foreign company (CFC) rules wherein if more than 50 per cent of the shares of a foreign corporation are directly or indirectly owned by a Japanese-resident individual, Japanese corporation or related non-Japanese-resident individuals, or a foreign corporation is substantially controlled by a Japanese-resident individual or Japanese corporation, the foreign corporation is classified as a 'foreign related corporation'. If there is a Japanese-resident individual or Japanese corporation that holds 10 per cent or more of the shares of a foreign related corporation or meets certain other requirements, all or part of the income of the foreign related corporation is included in the income of the shareholder, basically in accordance with the shareholding ratio, and is subject to Japanese tax.36
There are three types of foreign related corporation: (1) specified foreign related corporations; (2) taxable foreign related corporations; and (3) partially taxable foreign related corporations, and the details of the income inclusion rule depend on the type.
If a foreign related corporation falls under a specified foreign related corporation, all the income of the corporations is subject to the income inclusion rule after making certain adjustments unless the tax burden ratio is 30 per cent or more.37 Specified foreign related corporations include the following three types of corporation:
- paper company: if a corporation satisfies neither of the following requirements, it will fall under the category of a paper company in principle:38
- the substance test: the corporation has an office or other fixed facility necessary for conducting the main business; or
- the management and control test: the corporation manages, controls and operates the business in the country or region where its head office or main office is located;
- cash box: a 'cash box' is a corporation that satisfies both of the following requirements:39
- corporation in a blacklisted country: this means a corporation whose head office or main office is located in any of the countries or regions designated by the Minister of Finance42 as countries or regions whose cooperation with the international effort for the exchange of information regarding tax is significantly insufficient.
Foreign related corporations other than specified foreign related corporations are classified as taxable foreign related corporations43 and are subject to the income inclusion rule after making certain adjustments unless the tax burden ratio is 20 per cent or more44 if they do not satisfy any of the following economic substance tests:
- business test: the corporation's main business is not owning shares, providing industrial property or leasing vessels or airplanes;45
- substance test: the corporation has an office or other fixed facility necessary for conducting the main business in the country or region where its head office or main office is located;
- management and control test: the corporation manages, controls and operates the business in the country or region where its head office or main office is located; and
- non-related-party test or country of location test: the corporation satisfies the non-related-party test or country of location test depending on the industry area of the corporation:
If all the economic and substance tests are satisfied, the foreign related corporation is a partially taxable foreign related corporation and only certain passive income is subject to the income inclusion rule after making certain adjustments unless the tax burden ratio is 20 per cent or more or a certain other exception is applied.48
Domestic intercompany transactions
The payment of consideration for intragroup services is basically deductible if the amount of the payment is fair.
However, if the group taxation regime is applied, there will be some limitations applied to payments such as no deduction of donations, as explained above.
Exclusion of dividends received from profit
When a domestic corporation receives dividends from another domestic corporation, all or part of the dividends will not be included in the profit for the purpose of corporation tax. The amount excluded from the profit is defined as follows, depending on the classification of shares for which the dividends are paid:
- shares of a wholly owned subsidiary:49 full amount of dividends;50
- shares of a related corporation:51 amount of dividends for those shares minus the amount of interest on debt regarding the shares;52
- shares other than those that fall under points (a), (b) or (d): 50 per cent of the amount of dividends for the shares;53 and
- shares not held for control:54 20 per cent of the amount of dividends for the shares.55
International intercompany transactions
Article 66-4, Paragraph 1 of the Act on Special Measures Concerning Taxation provides that when a Japanese corporation conducts a sale of assets, a purchase of assets, a provision of services or other transaction with its foreign affiliate and the amount of consideration received for the transaction is less than an arm's-length price or the amount of consideration paid for the transaction exceeds an arm's-length price, the transaction is deemed to be conducted at an arm's-length price for the purpose of applying laws concerning corporation tax with regard to the income of the Japanese corporation in the business year.
The main methods for calculation of the arm's-length price are:
- the comparable uncontrolled price method;
- the resale price method:
- the cost-plus method:
- the profit split method;
- the transactional net margin method; and
- the discounted cash flow (DCF) method.56
The tax reform that took place in 2019 introduced several important amendments based on the OECD's BEPS project, which apply to any business year commencing on or after 1 April 2020.
In particular, the DCF method was adopted as a transfer pricing method. The use of the DCF method is not limited to intangible property transactions.
- intangible property that is unique and used to create high added value;
- the arm's-length price should be calculated based on the expected profits; and
- the matters on which the calculation of the arm's-length price is based include an extremely uncertain element.
If the matters on which the calculation of the arm's-length price is based differ from the actual facts, the NTA may deem the arm's-length price to be the price calculated by taking into consideration the facts and function of the parties to the transactions and other matters, except in the following cases:
- the calculated arm's-length price is no more than 20 per cent higher or lower than the actual price;59
- the taxpayer submits, by the specified deadline, documents that describe the content of the matters on which the calculation of the arm's-length price is based, such as expected profit, and documents to certify that:60
- it was difficult to foresee the cause of the difference because the cause was a natural disaster or similar event; or
- the price was calculated appropriately by taking into consideration the possibility of the occurrence of difference; or
- the taxpayer submits, by the specified deadline, documents to prove that the actual profit arising from actions, including the use of specific intangible property, is no more than 20 per cent higher or lower than the expected profit during the judgement period, which is generally the five-year period from the start date of the first business year when the revenue arising from those actions from an unrelated party is recorded for the first time.61
Earnings stripping rules and thin capitalisation rules
Please see Section II.i above.
Exclusion of dividends received from overseas affiliates from profit
Under the Corporation Tax Act (CTA), the dividends received from certain overseas affiliates are excluded from profit for the purpose of the CTA.62
This exclusion system applies to dividends received from an overseas affiliate that satisfies the following requirements:63
- a Japanese corporation that holds 25 per cent or more of the issued shares of the overseas affiliate; and
- the period during which point (a) is satisfied had continued for six months or more until the date when the obligation to pay the dividends became definitive.
When this exclusion system is applied to dividends from the overseas affiliate, 95 per cent of the amount of received dividends before the deduction of foreign withholding tax will be excluded from the profit.64
iii Third-party transactions
Sales of shares or assets for cash
Sales of shares for cash
When shares are sold for cash, the profit and loss arising will be subject to corporation tax.67 Sales of shares for cash by individuals will be subject to a fixed and reduced income tax rate;68 however, sales of shares for cash by corporations will be subject to ordinary corporation tax.
As explained in Section II.ii above, all or part of the dividend received by a corporation may be excluded from profit for the purpose of corporation tax.69 Accordingly, when a corporation sells shares of a target company, the corporation sometimes attempts to have the target company pay out as many dividends as possible to reduce the profits arising from the sales of shares or to even recognise a sales loss.
However, a recent tax reform introduced new rules to limit the use of such a scheme.
Under the new rules, when (1) a Japanese corporation receives dividends from another corporation70 that has a specified controlling relationship71 with the first-mentioned corporation as of the resolution date72 for the dividends, and (2) the sum of the amount of covered dividends73 and the amount of dividends made within the same business year from the same corporation exceeds 10 per cent of the largest amount among the book values of shares of such other corporation held by the first-mentioned corporation immediately before each base timing for such dividends,74 the book value of shares will be reduced by the amount of dividends that is excluded from the profit for the purpose of corporation tax.75
Please note that the new rules set forth above will not be applied in the following cases:
- when a Japanese ordinary corporation, cooperative association or Japanese resident has owned 90 per cent or more of the issued shares of another corporation (limited to ordinary corporations and excluding overseas corporations) since the date of establishment of such other corporation until the date when the specified controlling relationship is established76 ('specified controlling relationship date');
- when the dividend is paid from the amount of profit surplus earned on or after the specified controlling relationship date;77
- when the covered dividends are received after 10 years or more have passed since the specified controlling relationship date;78 or
- when the sum of the amount of the covered dividends and the amount of dividends paid within the same business year does not exceed ¥20 million.79
It should also be noted that there are rules to prevent the circumvention of the new rules so that the application of the rules is not unfairly avoided.80
Sales of assets for cash
When assets are sold for cash, the profit or loss arising is subject to corporation tax, in principle.
However, there are some rules that limit the recognition of losses arising from sales of certain assets. For example, there are restrictions on the recognition of loss arising from the transfer or certain other events regarding certain assets that are succeeded from a merged corporation, etc., pursuant to a qualified corporate reorganisation or certain assets that have been held by the surviving corporation, etc., since before the controlling relationship between the merged corporation, etc., and the surviving corporation, etc., came to exist.81
If taxable assets for the purpose of consumption tax are sold for cash, consumption tax will be imposed on the sales.
Tax-free or tax-deferred transactions
Dispositions of businesses or assets in tax-deferred transactions
When a corporation transfers its assets and debts, it is deemed to transfer them at fair market value and subject to corporation tax on income arising from the transfer. The same applies to a transfer of assets and debts pursuant to corporate reorganisation under the Companies Act, such as a merger or company split, and contribution in kind or distribution in kind, in principle.82
However, if a corporation transfers assets and debts pursuant to a tax-qualified merger or tax-qualified company split and tax-qualified contribution in kind or tax-qualified distribution in kind, they are deemed to be transferred at book value and the recognition of capital gains and losses is deferred for the purpose of corporation tax.83 The requirements for qualification differ depending on the relationship between the parties, which is classified into basically the following three types:84 (1) a perfect controlling relationship85 exists between the parties; (2) a controlling relationship86 exists between the parties; or (3) no controlling relationship exists between the parties.
In the case of a tax-qualified merger, the net operating loss of the merged corporation is succeeded to by the surviving corporation, and the net operating loss of the surviving corporation may continue to be used, except in certain cases.87
Tax-deferred share-for-share exchange
When a share issued by a corporation is transferred in exchange for a share issued by another corporation, the transferring corporation is considered to transfer the share that it owned at the fair market value of the share that it received and is subject to corporation tax on the capital gain.
However, if a share-for-share exchange is conducted in a share delivery that is a type of corporate reorganisation introduced as of 1 March 2021,88 the taxation on the capital gain is deferred to the extent that 80 per cent or more of the consideration delivered to the shareholders consists of the shares of the corporation that becomes the parent company upon the share delivery.89
Furthermore, if a corporate reorganisation such as a merger is conducted between corporations and results in a share-for-share exchange by shareholders of one of the corporations, taxation on the capital gains of the shareholders is deferred to the extent that only shares of the other corporation or its wholly owning parent corporation are delivered as consideration for the corporation reorganisation, in principle, regardless of whether the reorganisation is tax qualified.90
Real estate for real estate exchanges
If a corporation exchanges real estate for other real estate, the corporation is deemed to transfer the real estate that it owned at fair market value and subject to tax on capital gains.
However, if the exchange satisfies certain requirements (e.g., both the transferred real estate and acquired real estate have been held by the owner for one year or more, and the acquired real estate is used for the same purpose as the transferred real estate), a corporation is eligible for advanced depreciation of the acquired real estate within the advanced depreciation limit.91
There are several important exceptional rules that are applied to corporate reorganisations that involve cross-border transactions.
First, when a contribution in kind is implemented between a foreign corporation and a domestic corporation, it needs to satisfy additional requirements to be tax qualified.92
Second, a foreign corporation without a permanent establishment in Japan is not eligible for deferral of tax on share-for-share exchanges resulting from share delivery or certain other types of corporate reorganisation.93 However, it should be noted that, under the CTA, foreign corporations are not subject to tax on transfers of shares of Japanese corporations except in limited cases (e.g., share transfers subject to the 25 per cent or 5 per cent rule and transfers of shares of real estate corporations). Furthermore, the taxation on share transfers subject to the 25 per cent or 5 per cent rule, etc., may be exempted under an applicable tax treaty.
Finally, a domestic corporation and a foreign corporation with a permanent establishment in Japan that receive shares of a corporation in a specified tax haven country by a share-for-share exchange as a result of certain non-tax-qualified corporate reorganisation cannot benefit from deferral of tax on a share-for-share exchange.94
iv Indirect taxes
The importance of consumption tax increases as its rate is raised. The rate of consumption tax was raised from 8 per cent to 10 per cent in October 2019 in Japan.95
Consumption tax is imposed on (1) transfers of assets in exchange for consideration as a business in Japan and specified purchases conducted by business operators and (2) pickup of freight from overseas from bonded areas.96
However, transactions such as transfers or leases of land, transfers of securities and interest on deposits are excluded from taxable transactions.97
In addition, export transactions are exempt from consumption tax.98
An invoice system will commence from 1 October 2023, wherein the purchaser needs to reserve the qualified invoice delivered by the seller to deduct consumption tax imposed on the purchase for the purpose of consumption tax. Only a business operator who is registered as a business operator issuing a qualified invoice can issue a qualified invoice.
International developments and local responses
i OECD-G20 BEPS initiative
Most of the OECD BEPS recommendations have been implemented in Japan, including the following.
- BEPS Action 1: in 2015, the Consumption Tax Act was amended to enable the imposition of consumption tax on digital services provided from overseas to Japanese residents.
- BEPS Action 2: in Japan, the dividends from overseas corporations received by a Japanese corporation are almost entirely exempt from corporate tax under certain conditions; however, after the amendment to the CTA in 2015, this exemption no longer applies to dividends that are deductible from the income of the overseas corporation under the tax law of its jurisdiction.
- BEPS Action 3: in 2015, the Japanese CFC rules were significantly amended. Some of the amendments were implemented to bring the rules into closer consistency with BEPS Action 3. For example, Japan has introduced a de facto control test to supplement the legal test and the economic test to determine whether a foreign corporation is controlled.
- BEPS Action 4: in 2019, the Japanese earnings stripping rules were amended to make them more consistent with the recommendations on BEPS Action 4 in many aspects. For example, the maximum amount of interest to be deducted used to be 50 per cent of the adjusted income, but the ratio has now been amended to 20 per cent.
- BEPS Action 6: Japan already has a limitation on benefits (LOB) or principal purpose test (PPT) clause in its tax treaties with some countries (such as France, the UK and the US). In 2018, Japan signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (Multilateral Instrument) (MLI) and chose to apply the PPT to tax treaties with certain other countries.
- BEPS Action 7: in 2018, Japan amended the permanent establishment rules to make them consistent with the recommendations for BEPS Action 7. The rules regarding agent permanent establishments and the exclusion of preparatory or ancillary activities from permanent establishments were amended.
- BEPS Action 8–10: in 2019, Japan amended its transfer pricing rules. After the amendment became effective, it is now possible to apply the DCF method. It is also possible to be applied commensurate with the income standard to hard-to-value intangibles, if certain requirements are met.
- BEPS Action 13: in 2015, the transfer pricing documentation rules were amended to make them consistent with BEPS Action 13. Japanese corporations that are ultimate parent corporations of a company group whose consolidated sales amount is ¥100 billion or more are required to file a country-by-country report, and Japanese corporations that belong to such a group need to file a master report with the Japanese tax authority. The local filing system in Japan has become more consistent with the BEPS recommendations through this amendment.
- BEPS Action 15: Japan signed the MLI in 2018. Certain provisions of the MLI are now applied to the tax treaties between Japan and some countries (e.g., Australia, France, Singapore and the UK).
ii EU proposals on taxation of the digital economy
Japan has not introduced its own system for taxation of the digital economy; however, Japan participates in the Inclusive Framework on BEPS, and almost all the members have joined the Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy. It is expected that Japan will also join this multilateral convention, mainly for implementation of the newly agreed taxing rights under Pillar One.
iii Tax treaties
Japan has executed 82 tax treaties, etc., which apply to 149 countries and regions in total as of 1 March 2022. Japan has tax treaties with most of its major trading partners; however, there are many countries in the African, Middle Eastern and Latin American regions that have not yet entered into tax treaties with Japan. Japan is also a party to the MLI.
Japan once had a policy of not executing tax treaties with tax haven countries; however, it has now changed its policy and has entered into tax information exchange agreements with many of those countries.
Notable typical or model provisions
Japan basically executes tax treaties based on the OECD Model Tax Convention. As Japan has changed from a country that received investment from overseas to a country that proceeds with outbound investment into foreign countries, it prefers to avoid taxation in the source country. In particular, under recently executed or revised tax treaties, withholding tax on interest, dividends and royalties in the source country is often exempt under certain conditions.
However, this exemption tends to cause treaty shopping and therefore Japan often includes LOB clauses or the PPT, or both, in each tax treaty. Japan chooses the PPT under the MLI.
Japan has also increased the number of tax treaties that include arbitration clauses.
Recent changes to and outlook for treaty network
As of 25 March 2022, there are two new tax treaties, with Colombia and Argentina, which have been signed but not become effective. In addition, the protocol to amend the tax treaty with Switzerland has been signed but not become effective.
Japan is currently formally negotiating tax treaties with Tunisia, Greece, Finland, Nigeria, Ukraine and Azerbaijan. As the amount of investment by Japanese companies overseas is increasing, Japan wishes to execute tax treaties with more countries.
i Perceived abuses
Recently, several cases have arisen in which the taxpayer has objected to the NTA's application of Article 132-2 of the CTA, which is a comprehensive anti-abuse rule to deny actions or calculations if corporation tax is unfairly avoided by corporate reorganisation.
The Supreme Court of Japan rendered a judgment on the interpretation of Article 132-2 of the CTA for the first time and upheld the NTA's application thereof on 29 February 2016.99 In this case, a Japanese corporation made another corporation its wholly owned subsidiary and conducted a tax-qualified merger to absorb the subsidiary shortly after that to succeed to a significant amount of net operating loss of the subsidiary. Under the CTA, if the controlling relationship does not continue from the date that is five years before the first date of the business year to which the merger date belongs, several requirements need to be satisfied to succeed to a net operating loss. One of the requirements is that any director of the merged corporation whose position is managing director or above is expected to become a director whose position is managing director or above in the surviving corporation after the merger. In order to satisfy this requirement, the representative director of the surviving corporation became a vice president of the merged corporation just approximately three months before the merger, who worked on a part-time basis and received no compensation. The Supreme Court of Japan held that there was no business purpose that could be reasonable grounds for acceptance of the vice president position except for reduction of the tax amount, and it unfairly reduced the amount of corporation tax by abusing the provisions for taxation regarding corporation reorganisation as a means for tax avoidance.
The Tokyo High Court also rendered a judgment to uphold the NTA's application of Article 132-2 of the CTA to deny succession of the net operating loss by qualified merger in another case on 11 December 2019.100
ii Recent successful tax-efficient transactions
The Ireland–Japan tax treaty case is one in which the taxpayer's position was successfully upheld.101
In this case, an Irish corporation entered into an anonymous partnership agreement as an anonymous partner with a Japanese branch of a Cayman corporation and received a distribution of profits from the Japanese branch pursuant to the anonymous partnership agreement. The Irish corporation took the position that the distribution constituted other income under the Ireland–Japan tax treaty102 and was exempt from Japanese withholding tax. The Irish corporation paid 99 per cent of the distributed profits to a limited partnership formed in Bermuda pursuant to a total return swap agreement and only the remaining 1 per cent was subject to tax in Ireland. The NTA denied the application of the Ireland–Japan tax treaty; however, the court affirmed the application thereof as the Irish corporation was an anonymous partner that had the legal right to receive distribution of profits pursuant to the anonymous partnership agreement while 99 per cent of the profit was paid to another person.
This case is an important precedent regarding whether a tax treaty is applicable; however, it should be noted that the Ireland–Japan tax treaty does not have a beneficiary clause and the conclusion may be different under a tax treaty that contains such a clause. Furthermore, the Ireland–Japan tax treaty currently has a PPT clause pursuant to the MLI and the conclusion may be different under the current Ireland–Japan tax treaty than the one subject to this case.
Outlook and conclusions
Japan recently implemented numerous countermeasures against tax avoidance, including those based on the BEPS report, while it promotes favourable economic activities by introducing a tax system to encourage the same. For example, the deferral of taxation on capital gains is introduced for share-for-share exchanges in share deliveries to promote efficient corporate reorganisations; however, the NTA actively applies comprehensive anti-abuse rules to reject unfair tax reductions through corporate reorganisations.
As stated above, Japan participates in the Inclusive Framework. It is expected that Japan will join the multilateral convention mainly for implementation of the newly agreed taxing right under Pillar One and also revise the domestic tax law to implement Global Anti-Base Erosion Rules under Pillar Two. Once this multilateral convention and tax law amendment are enforced, it will also be necessary to take these into consideration in corporate tax planning.
1 Hiroyuki Yoshioka is a partner at TMI Associates.
2 The effective tax rate of national tax and local tax imposed in connection with a corporation's income was 29.74 per cent in 2021, assuming that the corporation was subject to pro forma standard taxation with regard to corporation business tax and the standard tax rate of corporation business tax regarding income and local inhabitant tax regarding corporation tax.
3 Article 92 of the Income Tax Act (the ITA).
4 Article 67-15, Paragraph 1 of the Act on Special Measures Concerning Taxation etc.
5 The term 'domestic corporation' means a corporation that has a head office or main office in Japan (Article 2, Item 3 of the Corporation Tax Act (the CTA)).
6 Article 4, Paragraph 1 and Article 5 of the CTA.
7 Article 69 of the CTA.
8 Article 23-2 of the CTA.
9 Article 5 of the CTA.
10 Article 66, Paragraph 1 of the CTA.
11 Article 22, Paragraph 4 of the CTA.
12 Article 9, Paragraph 1 of the CTA.
13 Article 141, Item 2 and Article 138, Paragraph 1, Items from 2 to 6 of the CTA.
14 Article 141, Item 1(i) and (ii), Article 138, Paragraph 1 of the CTA.
15 Article 212, Paragraph 1 and Article 161, Paragraph 1, Items 4 to 11 and Items 13 to 16 of the ITA. Withholding tax on certain income attributable to permanent establishment may be exempt subject to complying with certain procedures (Article 180 of the ITA).
16 Article 144, Article 68 of the CTA.
17 Article 66-5, Paragraph 1 of the Act on Special Measures Concerning Taxation.
18 Article 66-5-2, Paragraph 1 of the Act on Special Measures Concerning Taxation.
20 Article 66-5-2, Paragraph 2, Item 1 of the Act on Special Measures Concerning Taxation.
21 The relationship between a person and a corporation where the person directly or indirectly holds all the issued shares or interest of a corporation (except the share or interest owned by the corporation) and the relationship between two corporations both of which have the first-mentioned relationship with the same person (Article 2, Paragraph 12-7-6 of the CTA).
22 Article 61-13 of the CTA.
23 Fixed assets and land, etc., which are classified as inventory assets, securities (except trading securities), monetary claims and deferred assets, except assets whose book value immediately before the transfer is less than ¥10 million and certain other assets (Article 61-13, Paragraph 1 of the CTA, Article 122-14, Paragraph 1 of the Enforcement Order for the CTA).
24 Taxable events include transfer, depreciation, re-evaluation, write-off and retirement (Article 61-13, Paragraph 2 of the CTA, Article 122-14, Paragraph 4 of the Enforcement Order for the CTA).
25 Article 37, Paragraph 2 of the CTA.
26 Article 25-2 of the CTA.
27 Article 62-5, Paragraph 3 of the CTA.
28 Article 23, Paragraph 1, Item 1 of the CTA.
29 Article 61-2, Paragraph 17 of the CTA.
30 Articles 4-2 and 4-3 of the CTA.
31 See footnote 21.
32 Article 64-9, Paragraph 2 of the CTA. A corporation that has already obtained approval for the application of the consolidated tax system is deemed to have obtained approval for the application of the group tax relief system as of the first day of the first business year starting on or after 1 April 2022, in principle (Article 29, Paragraph 1 of the Supplementary Provisions for the Amended Act).
33 Corporations in the group are required to re-evaluate certain assets at fair market value and the re-evaluation profit and loss will be subject to corporation tax unless they fall under 'corporations exempt from re-evaluation' (Article 64-11, Paragraph 1 of the CTA). The ultimate parent corporation will be a corporation exempt from re-evaluation if it is expected to continue a perfect controlling relationship with one or more of the other corporations in the group. Another corporation in the group will be a corporation exempt from re-evaluation if the corporation is expected to continue a perfect controlling relationship with the ultimate parent corporation.
34 As to corporations exempt from re-evaluation, (1) their net operating loss incurred in each business year before the business year during which the controlling relationship came to exist and (2) certain other net operating loss cannot be used if there has not been a continuous controlling relationship between the corporation and the ultimate parent corporation for more than five years or since the date of incorporation of the corporation, if it does not satisfy the requirements of jointly conducting the business with the ultimate parent corporation, and if it launched new business on or after the date of the acquisition of the controlling relationship by the ultimate parent company with the corporation (Article 57, Paragraph 8, Item 1 of the CTA). Please note that even if the net operating loss of a corporation may be used after the group tax relief system becomes applicable, it can be used only to the extent of the income of the corporation (Article 64-7, Paragraph 2 of the CTA).
35 When a corporation joins the group to which the group tax relief system is applied, that corporation is required to re-evaluate certain assets unless (1) the corporation is established as a subsidiary corporation that has a perfect controlling relationship with the ultimate parent corporation, (2) the corporation became a wholly owned subsidiary of a corporation in the group pursuant to a qualified share exchange, etc., or (3) the corporation satisfies requirements similar to those for a qualified corporation reorganisation when the ultimate parent corporation obtained a perfect controlling relationship with the corporation (Article 64-12, Paragraph 1 of the CTA). The net operating loss of the corporations whose assets are re-evaluated and certain other corporations in the group may not be used after the application thereof is started (Article 57, Paragraph 6, etc., of the CTA). Even if the net operating loss of the corporation may be used after the group tax relief system becomes applicable, it can be used only to the extent of the income of the corporation (Article 64-7, Paragraph 2 of the CTA).
36 Article 66-6, Paragraph 1 of the Act on Special Measures Concerning Taxation.
37 Article 66-6, Paragraph 5, Item 1 of the Act on Special Measures Concerning Taxation.
38 Article 66-6, Paragraph 2, Item 2(a)(1) and (2) of the Act on Special Measures Concerning Taxation. Certain holding companies, certain companies regarding real estate holdings and certain companies regarding projects for the development of resources, etc., are excluded from paper companies (Article 66-6, Paragraph 2, Item 2(a)(3), (4) and (5) of the Act on Special Measures Concerning Taxation).
39 Article 66-6, Paragraph 2, Item 2(b) of the Act on Special Measures Concerning Taxation.
40 Certain passive income includes (1) dividends, (2) interest, (3) consideration for leasing securities, (4) profit and loss arising from transfer of securities, (5) profit and loss regarding derivative transactions, (6) foreign exchange profit and loss, (7) income that accrues from the assets that incur the income from points (1) to (6) and is similar to such income, (8) consideration for lease of tangible fixed property, (9) royalties for intangible assets, and (10) profit and loss from transfer of intangible assets (Article 66-6, Paragraph 2, Item 2(a), Paragraph 6, Items 1 to 10. Please note that the contents of the passive income of the foreign related corporations that fall under foreign financing subsidiary are different.
41 This means the book value of all the assets that are recorded in the balance sheet as of the end of the business year, in principle (Article 39-14-3, Paragraph 10 of the Enforcement Order for the Act on Special Measures Concerning Taxation).
42 Article 66-6, Paragraph 2, Item 2(d) of the Act on Special Measures Concerning Taxation. The Minister of Finance has not yet designated any such country or region.
43 Article 66-6, Paragraph 2, Item 3 of the Act on Special Measures Concerning Taxation.
44 Article 66-6, Paragraph 5, Item 2 of the Act on Special Measures Concerning Taxation.
45 Certain holding companies and leasing vessels or aeroplanes, except bare boat charters, may satisfy the business test.
46 The non-related-party test applies to eight industry areas, including wholesale business and banking business.
47 The country of location test applies to all industry areas other than those subject to the non-related-party test.
48 Article 66-6, Paragraphs 6 and 10 of the Act on Special Measures Concerning Taxation.
49 Shares of the corporation paying dividends that has a perfect controlling relationship with the corporation receiving dividends during the calculation period for the amount of dividends (if this period exceeds one year, one year until the base date for dividends. Article 23, Paragraph 5 of the CTA, Article 22-2 of the Enforcement Order for the CTA).
50 Article 23, Paragraph 1 of the CTA.
51 Shares of the corporation paying dividends when more than a third of all the issued shares of the corporation are held by the corporation receiving dividends, etc., during the calculation period for the amount of dividends (if this period exceeds six months, six months until the base date for dividends. Article 23, Paragraph 6 of the CTA, Article 22-3 of the Enforcement Order for the CTA).
52 Article 23, Paragraph 4 of the CTA.
53 Article 23, Paragraph 1 of the CTA.
54 Shares of the corporation paying dividends when five per cent or less of all the issued shares of the corporation are held by the corporation receiving dividends, etc. (Article 23, Paragraph 7 of the CTA).
55 Article 23, Paragraph 1 of the CTA.
56 Article 66-4, Paragraph 2 of the Act on Special Measures Concerning Taxation, Article 39-12, Paragraph 8 of the Enforcement Order for the Act on Special Measures Concerning Taxation.
57 Article 66-4, Paragraph 8 of the Act on Special Measures Concerning Taxation.
58 Article 39-12, Paragraph 14 of the Enforcement Order for the Act on Special Measures Concerning Taxation.
59 Article 39-12, Paragraph 16 of the Enforcement Order for the Act on Special Measures Concerning Taxation.
60 Article 66-4, Paragraph 9 of the Act on Special Measures Concerning Taxation.
61 Article 66-4, Paragraph 10 of the Act on Special Measures Concerning Taxation.
62 Article 23-2, Paragraph 1 of the CTA.
63 Article 22-4, Paragraph 1 of the Enforcement Order for the CTA.
64 Article 23-2, Paragraph 1 of the CTA, Article 22-4, Paragraph 2 of the Enforcement Order for the CTA.
65 Article 142-2, Paragraph 7, Item 3 of the Enforcement Order for the CTA.
66 Article 39-2 of the CTA.
67 Article 61-2, Paragraph 1 of the CTA.
68 The income tax rate is 15 per cent (Article 37-10, Paragraph 1 of the Act on Special Measures Concerning Taxation, Article 37-11, Paragraph 1 of the Act on Special Measures Concerning Taxation). Local inhabitant tax at the rate of 5 per cent and special reconstruction income tax at the rate of 0.315 per cent are also imposed.
69 Article 23, Paragraph 1, Article 23-2, Paragraph 1 of the CTA.
70 Consolidated subsidiaries under the consolidated tax return filing system are excluded.
71 A specified controlling relationship basically means a controlling relationship between the corporations and the relationship between corporations where the same person has a controlling relationship with each corporation (Article 119-3, Paragraph 9, Item 2 of the Enforcement Order for the CTA).
72 The resolution date for dividends and other certain dates (Article 119-3, Paragraph 9, Item 1 of the Enforcement Order for the CTA).
73 A 'covered dividend' basically means the received dividend; however, certain deemed dividends, etc., are not included in covered dividends.
74 The base date stipulated in Article 124, Paragraph 1 of the Companies Act or certain other dates for determining the person who receives the dividends.
75 The amount of dividends that is excluded from the profit pursuant to Article 23, Paragraph 1, Article 23-2, Paragraph 1, Article 62-5, Paragraph 4 of the CTA (Article 119-3, Paragraph 7 of the Enforcement Order for the CTA).
76 Article 119-3, Paragraph 7, Item 1 of the Enforcement Order for the CTA.
77 Article 119-3, Paragraph 7, Item 2 of the Enforcement Order for the CTA.
78 Article 119-3, Paragraph 7, Item 3 of the Enforcement Order for the CTA.
79 Article 119-3, Paragraph 7, Item 4 of the Enforcement Order for the CTA.
80 Article 119-3, Paragraph 11 of the Enforcement Order for the CTA.
81 Article 62-7, Paragraph 1 of the CTA.
82 Article 62, Paragraph 1, Article 62-5, Paragraph 1 of the CTA. Certain corporate reorganisations or corporate actions to make another corporation a wholly owned subsidiary may result in taxation on built-in capital gains of certain assets (Article 2, Paragraph 12-16 of the CTA, Article 62-9, Paragraph 1 of the CTA). However, such taxation can be deferred if the corporate reorganisation satisfies the requirements for qualification (Article 62-9, Paragraph 1 of the CTA).
83 Article 62-2, Paragraphs 1 and 2, Article 62-3, Paragraph 1, Article 62-4, Paragraph 1, Article 62-5, Paragraph 3 of the CTA.
84 Distributions in kind may be tax qualified only if they are made to a domestic corporation that has a perfect controlling relationship with the distributing domestic corporation.
85 See footnote 21.
86 The relationship between a person and a corporation whereby the person directly or indirectly holds more than 50 per cent of the issued shares or interest of a corporation (except the shares or interest owned by the corporation) and the relationship between two corporations both of which have the first-mentioned relationship with the same person (Article 2, Paragraph 12-7-5 of the CTA).
87 Article 57, Paragraph 2 and Paragraph 3 of the CTA.
88 Share delivery is a procedure for a domestic corporation to make another domestic corporation its subsidiary. Upon the share delivery, a corporation may acquire shares of another corporation from the shareholders who agree to the share delivery in exchange for issuance of its own shares pursuant to the procedures set forth under the Companies Act.
89 Article 66-2-2, Paragraph 1, etc., of the Act on Special Measures Concerning Taxation. Only the taxation on the portion of capital gains that corresponds to the value of received shares is deferred.
90 Article 61-2, Paragraph 2 and Article 62-9, Paragraph 1 of the CTA; however, if a merger or split-type company split is not tax qualified, the shareholders of the merged corporation or splitting corporation will be deemed to have received dividends and subject to tax on such deemed dividends (Article 24, Paragraph 1, Item 1 of the CTA and Article 25, Paragraph 1, Item 1 of the ITA).
91 Article 50, Paragraph 1 of the CTA.
92 Article 2, Item 12-14 of the CTA.
93 Article 39-10-3, Paragraph 1 of the Enforcement Order for the Act on Special Measures Concerning Taxation, Article 37-14-3 of the Act on Special Measures Concerning Taxation.
94 Article 37-14-4 of the Act on Special Measures Concerning Taxation.
95 Article 29 of the Consumption Tax Act and Article 72-83 of the Local Tax Act. Some goods, such as food and beverages, except liquor and dining, are subject to the reduced tax rate of 8 per cent.
96 Article 4, Paragraphs 1 and 2 of the Consumption Tax Act.
97 Article 6, Paragraph 1 of the Consumption Tax Act.
98 Article 7, Paragraph 1 of the Consumption Tax Act.
99 Supreme Court Decision of 29 February 2016 (Minshu, Vol. 70, No. 2, p. 242).
100 Tokyo High Court, decision of 11 December 2019 (Zeimu-sosho-shiryo, Vol. 269, No. 13354).
101 Tokyo High Court, decision of 29 October 2014 (Zeimu-sosho-shiryo, Vol. 264, No. 12555).
102 Article 23 of the Ireland–Japan tax treaty.