Corporate Tax 2020 Comparisons

Last Updated January 15, 2020

Law and Practice

Authors



Anderson Mori & Tomotsune is one of the largest and most diversified law firms in Japan offering full corporate services, and has one of the most established and acclaimed tax practices in Japan. It regularly advises on complex cross-border and domestic transactions, with the principal objective of achieving practical and tax-efficient solutions for clients. The firm also has a proven track record and considerable know-how in tax audit representations, advice and support in response to tax audits by the authorities. International clients appreciate its strategic advice on the full range of their business activities, including inbound investments and the establishment of subsidiaries, branches, representative offices and other business bases in Japan. Clients include foreign law firms, tax accountant corporations and tax accountants.

Japanese entities and foreign enterprises doing business in Japan generally adopt a corporate form. Four types of corporations are available under the Companies Act, with kabushiki kaisha (stock corporation; referred to as a KK) being the most commonly used. Another popular form, particularly for subsidiaries of foreign companies, is godo kaisha (referred to as a GK or LLC, though the latter term is somewhat misleading since a GK is not tax transparent).

A KK is owned by its shareholders and has directors, auditors and other officers. The directors execute the business of the KK, either individually or via the board of directors.

A GK is owned and managed by the members, and its governance structure is simple compared to a KK.

From a Japanese tax perspective, both KKs and GKs are taxed as separate entities. Please note that no transparent (pass-through) taxation is available for a GK. For US tax purposes, however, a GK is eligible to check-the-box and may elect to be taxed as a transparent (pass-through) entity.

Partnerships

Under the Japanese Civil Code, the basic tax transparent entity is a kumiai (partnership), formed by multiple partners and based upon a contractual relationship. The partners of a kumiai do not have limited liability and are directly responsible for the entity’s obligations.

There are other specific types of kumiais: toushi jigyo yugen sekinin kumiai (investment business limited partnership or LPS) and yugen sekinin jigyo kumiai (limited liability partnership or LLP), both of which have general and limited partners. Investment business limited partnerships are commonly used in Japan as private equity investment vehicles. Limited liability partnerships are commonly used for small businesses where the partners wish to enjoy transparent (pass-through) taxation, while the lack of a corporate identity is not a back-draw from a legal or business point of view.

From a Japanese tax perspective, all types of partnerships are transparent (pass-through) entities. They are not treated as independent taxpayers, and their partners are taxed directly on income they derive from the partnership’s business.

Generally, since it would be deemed to be doing business in Japan through the other partners, a foreign investor who is a partner in a Japanese partnership is considered to have a permanent establishment in Japan. However, subject to certain conditions and requirements, there are exemptions from this permanent establishment rule.

Silent Partnerships

Another type of frequently used investment plan that could be called a “partnership” is a tokumei kumiai (silent partnership or TK). However, a TK is not quite a separate entity, but rather a contractual relationship between a “TK Operator” and a “TK Investor”. Under a TK agreement, the TK Investor makes capital contributions to the TK Operator, the TK Operator runs a business under its own name and for its own account, and the TK Operator distributes the profits or allocates the losses to the TK Investor.

From a Japanese tax perspective, the profits distributed by the TK Operator are deductible for corporate tax purposes; therefore, this scheme may be able to achieve an effect similar to transparent (pass-through) taxation. The distribution of profits from the TK Operator to its overseas TK Investors is subject to withholding tax at a rate of 20.42%.

Pay-through Corporations

Under certain circumstances, certain types of corporations are allowed to deduct dividends paid to investors from their taxable income. A toshi hojin (investment corporation) is mostly used for J-REITs, and a tokutei mokuteki kaisha (special purpose corporations or TMK) is mostly used for securitisation. Both aim to encourage investment.

A corporation’s residence is determined based upon the place of its incorporation. Japanese tax law does not follow the “place of management and control” rule.

Since only the residence of the partners matters for the purposes of transparent (pass-through) taxation, residence is a moot issue with respect to transparent entities.

Japanese corporations are subject to national corporation tax and local inhabitants and enterprise taxes. Some other minor taxes are omitted herein.

The national corporate tax rate is 23.2%. Other tax rates vary depending upon various factors, such as the amount of paid-in capital. Taking other taxes into consideration, the overall effective tax rate is approximately 30%.

A foreign corporation that has a permanent establishment (such as a branch office) in Japan is taxed with respect to its taxable income attributable to such permanent establishment, substantially in the same manner as Japanese corporations. Even if a foreign corporation has no permanent establishment in Japan but earns certain types of income that are subject to corporate taxation (such as gains from the sale of land), it is taxed in the same manner as Japanese corporations on such income, though local taxes are not imposed; thus, the final effective tax rate is equal to the national corporate 23.2% rate.

For corporate tax purposes, taxable income is calculated by adjusting the income for corporate accounting purposes with various rules under the tax law. Major adjustments are as follows:

  • exclusion of dividend income received from Japanese corporations;
  • exclusion of dividend income received from foreign subsidiaries;
  • limitation on deductibility of remunerations paid to directors and officers of the corporation;
  • limitation on deductibility of donations or gifts made by the corporation;
  • limitation on deductibility of entertainment expenses; and
  • deduction of net operating loss carry-forwards from prior fiscal years (see 2.4 Basic Rules on Loss Relief).

Each of these regimes has complicated and detailed rules consisting of general principles, various exceptions and further carve-outs.

Tax credit is available for certain R&D expenses.

The Tokyo metropolitan government, in co-operation with the Japanese national government, provides a regime called the Asian headquarters special region, where a foreign-owned Japanese subsidiary can enjoy special tax credit or accelerated depreciation deductions for investments made in machinery and buildings, together with a total exemption from local transactional taxes.

Some other incentives are omitted herein.

There are numerous special taxation measures specifically applicable to particular industries or transactions (such as financing), for businesses or certain small corporations.

Loss in a particular fiscal year can be carried forward for the ten coming fiscal years (for the fiscal years beginning on or after 1 April 2018), subject to filing “blue-form” tax returns (tax return filing specifically authorised by the Japanese tax authorities as being compliant with proper accounting based upon a double-entry bookkeeping system). The annual amount of the deduction is limited to 50% of the amount of income for the same fiscal year. Other details regarding restrictions on the utilisation of this provision are omitted herein.

Interest payable by a Japanese corporation is generally deductible as an expense. There are special rules to limit the deductibility of interest with respect to cross-border transactions, as follows.

Thin Capitalisation

If a Japanese corporation owes debt against a foreign corporation that is a controlling shareholder thereof (owning directly or indirectly 50% or more of the total number of shares), the "thin capitalisation" rules apply. In such cases, interest payable upon the portion of the debt exceeding three times the shareholder’s equity in the Japanese corporation is not deductible. The thin capitalisation rules also apply to financing by third parties with a guarantee provided by the controlling shareholder.

Earnings Stripping

If the net amount of the interest paid to certain foreign related parties of a Japanese corporation in a fiscal year exceeds 50% of such corporation’s income (calculated under a certain formula) in that fiscal year, the excess portion of the interest will not be deductible.

Transfer Pricing

Transfer pricing rules also apply to interest payable to foreign related parties of a Japanese corporation. In such cases, the interest rate is deemed to be at arm’s length and the portion thereof exceeding the arm’s-length rate is not deductible.

Japanese corporate tax law has a consolidated taxation regime. Subject to the approval of the tax authorities, a Japanese corporation (a consolidated parent company) can choose to file a consolidated tax return with all (but not part) of its wholly owned direct and indirect Japanese subsidiaries. Whether they are consolidated parent companies or consolidated subsidiaries, foreign corporations cannot be included in the consolidated group.

Upon entering into the consolidated taxation regime, certain assets of all the consolidated subsidiaries shall, in principle, be marked-to-market, and such consolidated subsidiaries must report taxable income (or losses) accordingly. Under the consolidated taxation regime, the taxable income of a member of the consolidated group is offset against the losses of another member.

A similar taxation regime, referred to as the “group taxation regime”, applies to transactions among Japanese corporations (not including foreign corporations) that have direct or indirect 100% share ownership. Under the group taxation regime, income, gains, expenses and losses arising from certain types of transactions between group corporations are deferred until such gains and losses have been realised vis-à-vis non-group member parties.

Unlike some other jurisdictions, Japanese corporate tax does not distinguish between ordinary income and capital gains.

Japanese corporations are taxed on capital gains arising from the sale of assets in the same manner as on other income. Foreign corporations that have a permanent establishment in Japan are subject to substantially the same taxation for gains resulting from the sale of assets that are attributable to the permanent establishment. In principle, foreign corporations that have no permanent establishment in Japan are not taxed on capital gains arising from the sale of assets, but would be taxed on gains in the following circumstances (detailed requirements and exceptions are omitted herein):

  • Subsidiary shares – if a foreign corporation, together with its affiliates or through a partnership, (i) owns or owned 25% or more of the total shares of a Japanese corporation at any time during a period of three years on or before the close of the fiscal year of the foreign corporation in which the sale of such shares took place, and (ii) sells 5% or more of the total shares of the Japanese corporation in that fiscal year.
  • Real estate holding company shares – if a foreign corporation owns shares issued by a corporation (regardless of whether it is Japanese or non-Japanese) whose total assets consist at least 50% of real estate located in Japan or of shares of another real estate holding company, gains resulting from the sale of such shares are subject to Japanese taxation, if the foreign corporation (together with its related persons) owned more than 2% (5% if listed) of the shares in the real estate holding corporation at the end of the fiscal year immediately preceding the year of the sale.

The above consequences may be modified by applicable tax treaties.

Consumption Tax

Consumption tax (VAT) is payable by individual or corporate taxpayers engaged in the sale of goods or the provision of services in Japan (unless such activity is specifically designated as tax exempt). The tax rate is 10%. With regard to consumption tax on imports, please see Customs Duty below.

As long as they engage in the sale of goods or the provision of services Japan, foreign individual or corporate taxpayers are also subject to consumption taxes, regardless of whether or not they have a permanent establishment in Japan for income or corporate tax purposes. In the case of certain cross-border digital or electronic service transactions conducted by foreign enterprises that are classified as business-to-business (rather than business-to-consumer) transactions, the consumption tax liability is shifted to the Japanese recipient of such services (a so-called “reverse charge” mechanism).

Withholding Tax

Certain items of revenue derived by Japanese resident individuals and corporations are subject to income tax withheld at the source by the payer. Withholding tax is imposed on some domestic payments, such as interest and dividends, salary and remuneration. For withholding tax with respect to revenue derived by non-Japanese residents and foreign corporations, see 4.1 Withholding Taxes.

Local Enterprise Tax

Local enterprise tax is imposed by local governments on enterprises located in their local area.

Transactional Taxes

Transactional taxes may apply based upon the type and nature of the transaction. Significant transactional taxes include stamp duty, real property acquisition tax, registration and licence tax, fixed property and city planning taxes, and motor vehicles tax, motor vehicles acquisition tax and motor vehicles weight tax.

Customs Duty

Customs duty and import consumption taxes apply when dutiable or taxable goods are imported into Japan, and are payable by the importer of record. The rate of the customs duty differs depending upon the articles to be imported. The rate of the import consumption tax is 10%.

Please see 2.8 Other Taxes Payable by an Incorporated Business.

Closely held local businesses usually operate in the form of corporations, or as sole proprietorships.

In most cases, individual rates are higher than corporate rates, though individuals are taxed when they eventually receive dividends, profit distributions or remunerations from the corporation.

Accumulated earnings of certain closely held corporations are subject to surtax at progressive rates (10%, 15% and 20%), in addition to regular corporate tax. However, surtax does not apply to small closely held corporations that have a stated capital of up to JPY100 million, unless they are wholly owned by certain large corporations.

With regard to Japanese resident individuals, capital gains arising from the sale of shares of a closely held corporation are subject to taxation at the rate of 20.315%, separately from all other income.

With regard to non-resident individuals that have a permanent establishment in Japan, capital gains arising from the sale of shares of a closely held corporation that is attributable to the permanent establishment are subject to taxation at the rate of 20.315%, separately from all other income.

With regard to non-resident individuals that have no permanent establishment in Japan, capital gains are – in principle – not subject to Japanese taxation, other than in the cases mentioned under 2.7 Capital Gains Taxation. If those exceptions apply, the capital gains are subject to separate taxation at the rate of 15.315%, and the taxpayer must file a tax return for them. Treaty relief may be available, depending upon the jurisdiction of the non-resident individual.

Taxation and the tax rate on capital gains arising from the sale of shares of a publicly traded corporation are the same as for those of closely held corporations, as mentioned in 3.4 Sales of Shares by Individuals in Closely Held Corporations. Treaty relief may be available for non-resident individuals that have no permanent establishment in Japan, depending upon the jurisdiction of the non-resident individual.

Withholding taxes are imposed upon various payments made by a Japanese party to a foreign individual or corporation. If the non-resident individual or foreign corporation has no permanent establishment in Japan, in most cases only withholding tax is applicable. Typical cases where withholding tax is imposed are as follows:

  • Dividends – dividends payable by a Japanese corporation are subject to withholding tax at a rate of 20.42%.
  • Interest – interest on loans (where the loan proceeds are employed in Japan) is subject to withholding tax at a rate of 20.42%. Interest on debt securities issued by a Japanese corporation is subject to withholding tax at a rate of 15.315%.
  • Royalties – royalties on intellectual property (where the technology is employed in Japan) are subject to withholding tax at a rate of 20.42%.

The above source rules and withholding tax rates under Japanese law may be modified by applicable tax treaties.

Popular treaty jurisdictions include Belgium, Hong Kong, Ireland and Singapore (in alphabetical order). One of the reasons for their popularity is that none of these treaties contains detailed limitations on benefits (LOB) provisions, unlike those with the USA and the Netherlands. LOB provisions are an obstacle when a third-country resident investor wishes to establish an investment vehicle in a treaty country. Taxpayers should closely compare the treaty provisions with respect to dividends, interest, royalties, capital gains and “other income”.

However, if one of the principal purposes of the taxpayer is to take advantage of the treaty benefits, then it should bear in mind that the so-called MLI (the Multilateral Convention to Implement Tax Treaty Measures to Prevent Base Erosion and Profit Shifting) contains a provision prescribing a “principal purpose test”, which overrides the treaty provisions and could deny treaty benefits.

Use of a tax treaty by a non-treaty country resident may be challenged by the LOB provisions of the applicable treaty, the MLI’s “principal purpose test provisions” or domestic tax law provisions, such as those concerning the “substantial (beneficial) owner”.

Transactions between a Japanese corporation and its affiliated overseas company are always potentially subject to transfer pricing taxation, so careful preparation is necessary prior to commencing such transactions. Disputes with the Japanese tax authorities over transfer pricing issues may be brought to an administrative quasi-judicial body (National Tax Tribunal) and subsequently to the courts (the taxpayer is required to file an appeal to the National Tax Tribunal prior to filing a lawsuit), or may be subjected to a mutual agreement procedure between the government of Japan and the competent tax authorities of the country which is party to the relevant tax treaty, if any.

Depending upon the conditions of the limited risks distribution agreement, the Japanese tax authorities may scrutinise and challenge the pricing between the supplier and the distributor, such as when the price actually charged by the overseas supplier is higher than the price that should have been charged based on the risk allocation under the limited risks distribution agreement.

The Japanese government takes the position that Japanese transfer pricing rules and the enforcement thereof should be in line with OECD standards. For example, Japanese transfer pricing rules adopt the “best method” rule and the “range” of arm’s-length pricing.

If a mutual agreement is reached with the counterparty country following an application for a mutual agreement procedure to dispute a transfer pricing assessment in Japan, it is general practice that a compensating (or corresponding) adjustment is made in order to eliminate double taxation.

Foreign corporations that have a permanent establishment in Japan are taxed in substantially the same manner as Japanese corporations.

Non-resident individuals are taxed on capital gains under the same rules as described in 2.7 Capital Gains Taxation.

Generally, a disposal of indirect holding in Japanese corporations is not subject to capital gains taxation in Japan. However, in certain situations, a change of control of a non-Japanese corporation that holds shares in Japanese corporations may trigger Japanese tax liabilities.

First, as mentioned under 2.7 Capital Gains Taxation, a disposal by a foreign corporation of shares in a real estate holding company is subject to capital gains taxation in Japan if the foreign corporation (together with its related persons) owned more than 2% (5% if listed) of the shares in the real estate holding corporation at the end of the fiscal year immediately preceding the year of the sale. A “real estate holding company” is a corporation (either Japanese or foreign) whose assets at any time within the 365-day period prior to the disposition of its shares are made up by 50% or more of either real estate in Japan or shares of other real estate holding corporations.

Secondly, a change of control in a Japanese corporation, together with some additional triggering events (eg, a Japanese corporation being a dormant company starting a new business following the change of control), may cause the forfeiture of net operating loss carry-forwards thereof. This forfeiture rule would also apply in the event of an indirect change of control in the Japanese corporation – ie, a change of control in a foreign corporation that is holding more than 50% of the shares of the Japanese corporation.

The determination of the income of foreign-owned Japanese corporations selling goods or providing services to third parties is not made pursuant to any particular formulas. Some foreign-owned Japanese corporations providing services only to group companies use the “cost plus” method in the determination of their income. However, there is no legal basis for the “cost plus” method, nor any assurance that such practice would be approved by the tax authorities.

There is no established standard to determine the amount of management or administrative expenses incurred by non-Japanese affiliates that are deductible by Japanese corporations. The general guideline is that the Japanese corporation must establish the following:

  • that the management or administrative services are actually provided;
  • that the service is provided and the fee is payable pursuant to a management service agreement; and
  • that the amount of fees is appropriate in light of the benefits the Japanese corporation receives from such management or administrative services.

The deduction by a Japanese corporation of interest of related party borrowing from a foreign affiliate is subject to constraints pursuant to the thin capitalisation rule, the earnings-stripping rule, and the transfer pricing rule, as described under 2.5 Imposed Limits on Deduction of Interest.

As Japanese corporate taxation adopts worldwide income tax obligations, a Japanese corporation is subject to Japanese income tax with respect to its worldwide income at the same rates as its domestic income. Subject to the exception mentioned in 6.3 Taxation on Dividends from Foreign Subsidiaries, Japanese taxation does not take the geographic source of the income into account.

See 6.3 Taxation on Dividends from Foreign Subsidiaries.

Dividends received by Japanese corporations from their foreign subsidiaries are exempt from Japanese taxation with respect to 95% of the amount thereof, provided that the Japanese corporation holds 25% or more (subject to reduction by applicable tax treaties) of the total issued shares or voting rights of its foreign subsidiary for at least six months prior to the date that the liability to pay dividends is fixed (ie, the date that the determination to pay dividends is made). This exemption does not apply if the payment of the dividends is treated as deductible by the foreign subsidiary.

The remaining 5% of dividends paid by the foreign subsidiary, which are taxable, are deemed to represent local expenses attributable to the exempted dividends.

Where dividends from a foreign subsidiary are exempt, any foreign tax imposed on – or withheld from – the dividends cannot be credited to Japanese tax or deducted from taxable income.

Where the exemption mentioned above does not apply, dividends from foreign subsidiaries are included in the worldwide income taxable in Japan, in which case foreign tax imposed on – or withheld from – such dividends can be credited to Japanese tax or deducted from taxable income.

If the intangibles developed by a Japanese corporation were used by a non-local affiliate or transferred to a non-local affiliate, the Japanese corporation will be taxed as if it received arm’s-length royalty or price payment, as the case may be, from the non-local affiliate.

The income of certain foreign subsidiaries that are directly or indirectly held by a Japanese corporation or a Japanese individual is taxed in Japan, pursuant to certain complicated CFC taxation rules. Where these rules apply to foreign subsidiaries, a portion of the income of such foreign subsidiary is added to the taxable income of the parent corporation (or Japanese individual). An outline of the Japanese CFC taxation is set forth below.

However, since Japanese corporate taxation adopts a worldwide income regime, the income of foreign branches of Japanese corporations is included in the taxable income of the Japanese corporation without applying the CFC taxation rules.

Japanese CFC Taxation Rules

The Japanese CFC taxation rules apply and a portion of the income of a foreign subsidiary would be added to taxable income of the Japanese shareholders if (i) the shareholding tests are met, (ii) there is no exemption because the threshold tax rates are not met, and (iii) the active business income exemption does not apply, as follows:

  • The shareholding tests are met if:
    1. Japanese resident individuals and/or Japanese corporations (including the Japanese taxpayer in question) collectively own, directly or indirectly, more than 50% of the total number of issued shares, voting rights or rights to receive dividends of a foreign corporation; and
    2. the Japanese taxpayer owns, directly or indirectly, 10% or more of the total number of issued shares, voting rights or rights to receive dividends of that foreign corporation.
  • The threshold tax rates are not met if the effective income tax burden (rather than the face or nominal tax rate) of that foreign subsidiary in a given fiscal year is lower than 30% for certain shell-company CFCs and cash-box-company CFCs, or 20% for all other CFCs. Please note that, generally, income and gains of foreign subsidiaries that are locally tax-exempt would lower the effective income tax burden, but the exemption of dividends received from companies in which the receiving subsidiary holds shares not below a certain threshold holding ratio would not lower the effective income tax burden (such treatment is allowed only for dividends).

In response to the tax rate reduction in the United States, pursuant to the Japanese 2019 tax reform, the following categories of foreign subsidiaries are excluded from the definition of shell-company subject to the 30% threshold:

    1. certain qualified share holding companies;
    2. certain qualified real estate holding companies; and
    3. certain qualified companies established for the purpose of holding interest in natural resource development projects.
  • Active business income exemption: even where the Japanese CFC rules are applicable pursuant to the above points, if the foreign subsidiary meets all components of certain active business criteria (ie, (a) through (d) below), such application is limited to certain specified categories of passive income enumerated below (rather than total, including active, income).

The active business criteria are: (a) the principal business of the CFC is not within the category of financial investments in shares, bonds or leasing of vessels (except for certain local subsidiary management businesses); (b) the CFC is managed and administered in the jurisdiction of its incorporation; (c) the CFC maintains physical fixed premises, such as offices and factories in the jurisdiction of its incorporation; and (d) depending on the type of business, the CFC deals with unrelated third parties representing more than 50% of its total business transactions (eg, wholesale, banking, insurance, transportation, aircraft leasing), or the CFC does business principally within the jurisdiction of its incorporation (eg, real property leasing, manufacturing, etc).

Passive income, which is still subject to aggregation even if the active business income exemption applies, includes the following:

  • dividends and capital gains from portfolio shareholding (meaning shareholding except where the holder’s shareholding ratio in the relevant shares is 25% or higher for at least six months);
  • interest on deposits, bonds and loans (excluding interest on certain qualified group-financing);
  • income from derivative transactions (excluding certain qualified hedges);
  • foreign exchange gains (excluding those from the ordinary course of business);
  • royalties and gains from the disposition of IPs (except where the IP is developed on its own); and
  • rent from leasing real and fixed properties (except for the leasing of real and fixed properties located in the jurisdiction of incorporation of the CFC).

See the outline of CFC taxation under 6.5 Taxation of Income of Non-local Subsidiaries Under CFC-Type Rules.

A Japanese company’s gains from the sale of shares in foreign subsidiaries are included in the taxable income, and are subject to ordinary corporate income taxation in Japan.

There are three anti-avoidance rules that apply to a limited number of specific situations.

The first is the anti-avoidance rule that applies to certain closely held corporations (ie, corporations where more than 50% of shares are held by three shareholders or fewer). This rule may be invoked by the tax authorities if they determine that an act or accounting (ie, accounting in response to the act) of the closely held corporation (ie, the subject taxpayer) results in an unjust reduction of its corporate tax liability. In such cases, the tax authorities may disregard the legal form of the transaction adopted by the taxpayer and impose taxes based upon a different legal form which they consider appropriate. The term “unjust reduction” is interpreted to mean that the act or accounting in question is economically unreasonable, and would not have been conducted or undertaken by a reasonable person from a sound economic perspective other than for the purposes of tax avoidance.

The second anti-avoidance rule relates to corporate reorganisation transactions (eg, mergers, divestures, share exchanges, etc). It may be invoked by the tax authorities if they determine that an act or accounting of a party to a corporate reorganisation results in an unjust reduction of the tax liabilities of that party, the other parties to the transaction or their respective shareholders. In such cases, the Japanese tax authorities are entitled to disregard the legal form of the transaction adopted by the party and impose taxes based upon a different legal form which they consider appropriate. For the purpose of this rule, the term “unjust reduction” was interpreted by a recent landmark Supreme Court decision to mean either that the act or accounting in question is economically unreasonable and would not have been conducted or undertaken by a reasonable person from a sound economic perspective other than for purposes of tax avoidance, or that by the act or accounting the taxpayer has abused the intent of the relevant tax provision regarding corporate reorganisation rules.

The last anti-avoidance rule relates to the Japanese consolidated taxation regime; if an act or accounting of a taxpayer who is a member of the Japanese consolidated group results in an unjust reduction of the tax liabilities thereof, the Japanese tax authorities are entitled to disregard the legal form of the transaction adopted by the taxpayer and impose taxes based upon a different form which they consider appropriate. There has been no published judicial precedent regarding the interpretation of the term “unjust reduction” in the context of this and, therefore, it remains unclear.

There is no law, regulation or administrative rule expressly providing for a regular or ordinary routine audit cycle, and it is left to the sole discretion of the competent tax offices (for medium and small corporations) or the Regional Tax Bureau (for large corporations).

While there is a general tendency to perform tax audits with respect to large corporations more often than smaller ones, the national Japanese tax authorities have launched an initiative applicable to larger corporations whereby, if (i) due diligence and top management interviews demonstrate a good corporate governance structure of the larger corporation that ensures tax compliance, and (ii) such larger corporation agrees to voluntarily disclose significant tax information, then the next audit cycle would be extended by one year.

To date, Japan has implemented the following BEPS Actions:

  • Action 1: the imposition of consumption tax upon digital or electronic services transactions conducted by foreign enterprises that have no base in Japan;
  • Action 2: the introduction of a provision to prevent the double exemption of dividends by denying the tax exemption of dividends from foreign subsidiaries if the dividends are deductible from the taxable income of the foreign subsidiary under the local tax law;
  • Action 3: an amendment to the CFC regime, in line with BEPS Action 3, with a view to focusing on the substance of the business conducted by the CFC;
  • Action 4: an amendment to the earnings-stripping rules (which will come into effect on 1 April 2020), lowering the threshold percentage rate from 50% to 20%;
  • Action 6: amendments to tax treaties with a number of economically developed countries (such as the USA, the UK, the Netherlands, Switzerland and Germany) to implement various anti-abuse measures suggested by BEPS Action 6, such as the limitation on benefits (LOB), the principal purpose test (PPT) and the beneficial-owner concept;
  • Action 7: an amendment to the definition of the agent permanent establishment in the income tax law and the corporate tax law, with a view to preventing evasion from being captured by such definition of agent permanent establishment through artificial measures;
  • Actions 8-10: an amendment to the transfer pricing regulations to incorporate the so-called “commensurate with income” standard with respect to certain hard-to-value intangibles;
  • Action 13: an amendment to the transfer pricing documentation rules to introduce the requirements of master file, country-by-country reporting and local file; and
  • Action 16: joining the MLI (the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting) and recently completing the ratification procedures. As a result, the MLI has been effective since 30 September 2019 with respect to the tax treaties that Japan has entered into with Ireland, the United Arab Emirates, Israel, India, Ukraine, the United Kingdom, Australia, the Netherlands, Canada, Singapore, Sweden, Slovakia, New Zealand, Norway, Finland, France, Poland and Luxembourg.

In addition, Japan considered the following BEPS Action but did not take steps to adopt it in the near future:

  • Action 12: the introduction of mandatory disclosure rules regarding tax planning.

In general, Japan has been following the BEPS initiative and has implemented most of its action plans. The author is not aware of any other targets Japan is seeking to achieve.

The international tax regime has a high public profile in Japan. In the context of outbound investment by Japanese corporations, enhancement of the CFC taxation rules (Action 3) and the country-by-country reporting for transfer pricing (Action 13) attracted attention as the cost for the administration of – and compliance with – tax reporting requirements is expected to increase significantly. In the context of inbound investment by foreign financial investors, the lowering of the threshold proportion of the interest deduction under the earnings-stripping rules (to go into effect as of April 2020) is expected to affect investors’ choices regarding the source of funding.

Historically, the Japanese government has been very positive towards the BEPS initiative, and most of its action items have been implemented. However, the author believes that, in the near future, the Japanese government may end up having to listen more carefully to voices of the domestic private sector prior to making a further decision to implement these initiatives under Japanese domestic tax law.

Japan has not introduced any aggressively competitive tax regime to attract foreign investments, such as so-called harmful tax competition. While it is true that Japan seeks to design a globally competitive corporate tax regime (eg, via a series of reductions of the effective corporate tax rate from 2016 onward), such steps are taken primarily in order to enhance the competitiveness of Japanese corporations doing business worldwide. Accordingly, such policy is unlikely to be adversely affected by the BEPS initiative.

The author does not believe that any of the Japanese tax systems that were introduced with the intention to render the Japanese taxation more competitive are more vulnerable to aggressive tax saving schemes than other areas of the tax regime.

Japan has already implemented the BEPS recommendation (Action 2) to prevent double exemption from taxation on dividends derived from hybrid instruments (see 9.1 Recommended Changes).

In addition, Japan has taken steps to deal with hybrid entities, by agreeing to amend numerous tax treaties with developed countries (eg, the USA, the UK, the Netherlands) in order to introduce specific provisions intended to cope with hybrid entities. Japan has also adopted the rule concerning tax-transparent entities under article 3(1) of the MLI.

Japan has a territorial tax regime only with respect to dividends from certain foreign subsidiaries, under which the amount equivalent to 95% of the dividends is exempt from taxation in Japan (see 6.3 Taxation on Dividends from Foreign Subsidiaries). Otherwise, worldwide income taxation applies to all of the income of Japanese corporations.

Interest deductibility restrictions are not directly incorporated in the territorial tax regime on dividends from foreign subsidiaries. However, the 5% of dividends from foreign subsidiaries that is taxable is regarded as representing local expenses, including interest, attributable to the exempt dividends.

While Japan generally maintains worldwide income taxation, it has also adopted strong CFC taxation rules (see 6.5 Taxation of Income of Non-local Subsidiaries Under CFC-Type Rules). The current CFC taxation rules are not very popular with the private sector, not because they impose unreasonable tax burdens, but because they impose onerous administrative and compliance responsibilities on Japanese corporations. The provision allowing exemption from CFC taxation by meeting the active business criteria is essential to the sustainability of foreign economic activities by Japanese companies, because a number of economically significant jurisdictions have lowered their tax rates to close to, or even below, the threshold under the Japanese CFC rules. Accordingly, a “sweeper” CFC rule that would further increase the administrative and compliance burden is not likely to be supported.

The double taxation convention limitations with respect to benefit and anti-avoidance rules to be introduced by the MLI are likely to have a moderate impact on investments in or from developing countries, because Japan has already introduced various anti-avoidance concepts, such as the limitation on benefits (LOB) and “beneficial owner” provisions in the language and interpretation of tax treaties, particularly those entered into with developed countries.

However, the “principal purpose test” to be introduced by the MLI is expected to have more of a practical impact, because the term “principal purpose test” has not yet been explicitly included in the language or formal interpretation of bilateral tax treaties.

The BEPS action plans have been a primary driver in Japan to introduce various documentation requirements. While these requirements are not regarded as having added substantial tax liabilities on the Japanese private sector, they have certainly triggered a radical increase in onerous administrative and compliance burden on the subject taxpayers.

The latest development in the area of transfer pricing is the introduction of the so-called “commensurate with income” standard with respect to certain hard-to-value intangibles. While the transfer price taxation of profits from intellectual property is difficult in Japan, as elsewhere, there have been more controversies with intangibles than with anything else, particularly in connection with tax avoidance.

Japan has amended its transfer pricing documentation rules to introduce the master file, the country-by-country reporting and the local file, in line with BEPS Action 13.

To remove the disparity between digital and electronic service providers operating in Japan and from outside of Japan, and in response to BEPS Action 1, the Japanese consumption tax law was amended to impose the tax on foreign enterprises that have no base in Japan.

Furthermore, Japan amended the definition of a permanent establishment in its tax legislation to be in line with the provisions of the MLI and to capture local warehouses used by EC operators.

As far as is known, there are currently no publicly disclosed specific plans to introduce either the digital taxation discussed by the OECD (ie, the allocation of taxing rights to market and user jurisdictions) or global minimum taxation in 2020. However, the tax reform proposal recently published by the Liberal Democratic Party (dated 12 December 2019) mentions the discussion by the OECD. Furthermore, in light of the past stance of the Japanese government, once these initiatives are adopted by several developed countries, the Japanese government may adopt them as well.

Traditionally, Japan taxed offshore IP owners either when the IP developed by a Japanese corporation was transferred to an offshore affiliate (transfer pricing) and/or when royalties were paid (transfer pricing and withholding tax). Other than the withholding tax rate applicable to the payment of royalties, there is no distinction between owners in tax havens and in jurisdictions having tax treaties with Japan.

Legislative action to implement the BEPS action plans has almost come to the final stage, but the enforcement of the taxation schemes introduced by such legislation has just started. It is hoped that the tax authorities exercise caution not to impose an excessive administrative and compliance burden on the Japanese private sector, as it has traditionally been rather compliant and did not aggressively engage in tax planning.

Anderson Mori & Tomotsune

Otemachi Park Building
1-1-1 Otemachi
Chiyoda-ku
Tokyo 100-8136
Japan

+81 3 6775 1000

www.amt-law.com
Author Business Card

Law and Practice in Japan

Authors



Anderson Mori & Tomotsune is one of the largest and most diversified law firms in Japan offering full corporate services, and has one of the most established and acclaimed tax practices in Japan. It regularly advises on complex cross-border and domestic transactions, with the principal objective of achieving practical and tax-efficient solutions for clients. The firm also has a proven track record and considerable know-how in tax audit representations, advice and support in response to tax audits by the authorities. International clients appreciate its strategic advice on the full range of their business activities, including inbound investments and the establishment of subsidiaries, branches, representative offices and other business bases in Japan. Clients include foreign law firms, tax accountant corporations and tax accountants.