This country-specific Q&A provides an overview to tax laws and regulations that may occur in Japan.
It will cover witholding tax, transfer pricing, the OECD model, GAAR, tax disputes and an overview of the jurisdictional regulatory authorities.
This Q&A is part of the global guide to Tax. For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/tax-second-edition/
How often is tax law amended and what are the processes for such amendments?
In Japan, tax laws are amended generally once a year, in the form of an annual tax reform. The process is generally like the following:
- By early fall of a calendar year, various industry groups provide input on their desired tax reform to the governmental authority to which such industry group is relevant (e.g., the Financial Services Agency in the case of banking and securities industry);
- By late fall, various governmental authorities (i.e., ministries and agencies) compile and publish their desired tax reform and provide them to the Ministry of Finance for its consideration;
- Along with the foregoing, the tax commission of the ruling party also considers its desirable tax reform, together with the Ministry of Finance, principally as a political matter;
- In early December, taking into consideration all of the foregoing, the ruling party as well as the Ministry of Finance publishes an outline for the next year’s annual tax reform;
- In February next year, the Ministry of Finance complies and publishes draft tax statute amending the current tax laws for the annual tax reform;
- In March, the draft tax statute is approved by the Japanese diet (to the extent that the ruling party has sufficient majority), and in late March is promulgated, together with the promulgation and publication of the enforcement cabinet orders and ministerial ordinances; and
- In general, the amended tax laws take effect as of April 1 of the year.
What are the principal procedural obligations of a taxpayer, that is, the maintenance of records over what period and how regularly must it file a return or accounts?
It is very common practice in Japan that corporate taxpayers adopt the so-called ‘blue-form’ tax return filing for their Japanese corporate income tax, which is a system of tax computation and return filing based upon double-entry bookkeeping system. Under this system, corporate taxpayers are required to keep their books and records for a fiscal year using double-entry bookkeeping system.
Then, based upon such books and records, corporate taxpayers prepare and file a corporation tax return, once a fiscal year, within three months (assuming one-month’s extension is secured per the prevailing practice) from the close of the relevant fiscal year. Similarly, for Japanese consumption taxes or VAT, corporate taxpayers keep books and records, and prepare and file a consumption tax return, once a fiscal year, within two months from the close of the relevant fiscal year. There are similar return filings for local taxes.
Corporate taxpayers are obligated to maintain such books and records for seven years, and have to provide them to the tax authority for inspection if tax audit is conducted.
Who are the key regulatory authorities? How easy is it to deal with them and how long does it take to resolve standard issues?
The Japanese regulatory authority responsible for the enforcement of tax laws is the National Tax Agency (NTA) of Japan. The actual day-to-day tax laws enforcement in front of the taxpayers is made by the regional taxation bureaus and the district tax offices, which are lower administrative bodies of the NTA. There are 12 reginal taxation bureaus over Japan (with the largest one being the Tokyo Regional Taxation Bureau) and numerous district tax offices. Generally, regional taxation bureaus are in charge of middle to large size of corporate taxpayers having stated capital of 100 million yen or more, while the rest is handled by district tax offices.
Dealing with these tax authorities involves two aspects: one is prior consultation and private advice that is typically sought before a transaction is undertaken, and the other is tax audit that is typically made after a tax return was filed. In the former case, it is generally easy to deal with the tax authority seeking its view, provided that its view is not binding and has no effect of estoppel. If the taxpayer wants a binding ruling, it must apply for an advance ruling in writing, however, this is not very common in practice as it generally takes substantial time (e.g., 6 months). As such, many taxpayers only undertake informal prior consultation even if it has no legally binding effect – practically this may suffice. So far as ‘standard’ issues are concerned, there are generally little difficulties in dealing with the tax authority. The process would generally take 1-2 months.
In the latter case of a tax audit, it is not uncommon that the position of the tax authority and that of the taxpayer are acutely different and extensive discussions are undertaken in the course of the audit, especially in cases involving alleged tax avoidance or in transfer pricing cases. Here, often ‘standard’ issues do not become a large issue because in many cases the outcome is clear without engaging in substantial debates. Rather, in tax audit, non-standard and unprecedented issues often become a key subject to be discussed. The length of tax audit varies from a case to case; routine tax audit on small taxpayers often finishes in less than a week, while transfer pricing audit on large corporate taxpayers often continues around two years.
Are tax disputes capable of adjudication by a court, tribunal or body independent of the tax authority, and how long should a taxpayer expect such proceedings to take?
Yes. If a taxpayer receives an assessment finding deficiency in tax as a result of the tax audit by the competent reginal taxation bureau or the district tax office, and if the taxpayer wants to dispute it, the taxpayer can file, within 3 months from the assessment, either (i) a request for reconsideration with the National Tax Tribunal, or (ii) a request for reinvestigation with the district tax office or the reginal taxation bureau that rendered the subject assessment. The first choice should be common in practice. The National Tax Tribunal is a quasi-judicial body that reviews the legality and appropriateness of tax assessments, which is claimed to be independent from the tax authority but is technically within the administrative organ of the tax authority.
The review of the National Tax Tribunal generally takes up to one year. If it renders a decision in favor of the taxpayer, the tax authority cannot appeal and the decision is final. If it renders a decision against the taxpayer, the taxpayer can file a lawsuit requesting cancellation of the assessment, with the district court having jurisdiction over the case, within 6 months from the decision of the National Tax Tribunal. The review of the district court generally takes 1.5 to 2.5 years. If either the taxpayer or the government loses the case, it can appeal up to the high court, where the review would generally take six months to 1.5 years. If either the taxpayer or the government loses the case at a high court, it can further appeal up to the Supreme Court, however, the appealing party has to obtain a writ of certiorari to have substantive review of the Supreme Court; otherwise the appeal is dismissed without considering merits. The review of the Supreme Court, including its review of whether a writ of certiorari should be given, generally takes 1.5 to 3 or more years. These district and high courts as well as the Supreme Court are not a special court for tax or administrative cases, but are an ordinary court that handles civil and criminal matters along with tax cases. In judicial proceedings in courts, an appeal by the government is not prohibited.
Are there set dates for payment of tax, provisionally or in arrears, and what happens with amounts of tax in dispute with the regulatory authority?
Yes. For example, for corporate taxpayers, corporation tax and consumption tax are due by the date of filing tax returns, i.e., two or three months after the close of the relevant fiscal year. In addition, corporate taxpayers make certain interim tax payments during the relevant fiscal year of corporation tax and consumption tax, which effectively are prepayments of the final tax that will be due by the tax returns for that fiscal year. In addition, withholding tax (which is imposed on certain prescribed types of payments such as remunerations of directors and employees, interest, dividends, etc.) is generally due to be paid by the 10th day of the month immediately following the month in which the subject payment was made.
Even if the taxpayer disputes a tax assessment, in prevailing practice, the taxpayer once pays the assessed tax in advance of the resolution of the dispute. This is because the taxpayer’s objection does not have an effect of suspending the enforceability of the assessment and accrual of delinquency tax; so taxpayers have to pay in advance in order to avoid attachments and other collection enforcement actions and paying delinquency tax. Technically there is a provision to postpone tax liabilities upon a petition to the tax authority, however, in practice, it is very rare that such postponement is granted. The exception to this rule is a transfer pricing assessment; that is, if a transfer pricing assessment is issued and if the taxpayer files an application for a mutual agreement procedure to resolve double taxation, the payment of the assessed tax will be suspended, upon an application by the taxpayer, until the resolution of the case through the mutual agreement proceeding, subject to provision of security to the government.
Is taxpayer data recognised as highly confidential and adequately safeguarded against disclosure to third parties, including other parts of the Government?
Generally yes. The officials of the tax authority are bound by and subject to the confidentiality obligations under law, and unlawful disclosure will constitute a criminal offence. Taxpayers’ information is not generally shared with other parts of the government. This should remain true even after the introduction of the various transfer pricing documentation requirements, i.e., master file, country-by-country reports and local file; that is, these information is also supposed to be protected by the confidentiality obligations owed by the authority officials.
However, it is at the same time true, as a matter of fact, that there often are press coverages over an assessment made upon a specifically identified taxpayer (which is clearly confidential information), even if the taxpayer itself does not make it public, if the information has a news value. Many practitioners suspect that some officials of the tax authority having contact with the press are the news source, while the tax authority never admits it.
Is it a signatory (or does it propose to become a signatory) to the Common Reporting Standard? And/or does it maintain (or intend to maintain) a public Register of beneficial ownership?
Yes, Japan is a signatory to the Common Reporting Standard, and has already promulgated and enforced its domestic legislation to implement the Common Reporting Standard. The NTA has released to the public detailed guidelines on what information will be disclosed and what due diligence should be undertaken by financial institutions as well as other details. There is no system of a public register of beneficial ownership; in practice the beneficial owner is identified through tax audit.
What are the tests for residence of the main business structures (including transparent entities)?
Main business structures used in Japan are overwhelmingly a corporation. Whether a corporation is a Japanese or foreign resident is classified by whether the corporation is incorporated under Japanese corporate and other laws. For example, a kabushiki kaisha (KK) or a godo kaisha (GK) is classified as a Japanese corporation for Japanese tax purposes, even if the Japanese corporation has a principal place of management and control outside of Japan.
Similarly, a corporation incorporated under the laws of other than Japan is classified as a foreign corporation for Japanese tax purposes, even if the foreign corporation has a principal place of management and control within Japan. This typically means that it is a foreign corporation that has a permanent establishment in Japan. In other words, Japanese tax laws only look to the jurisdiction of incorporation of the corporation, and give no regard to the principal place of management and control. Foreign companies that may not be technically a corporation, such as U.S. limited liability company, German GmbH and Dutch BV, are also treated as a foreign corporation for Japanese tax purposes.
As for transparent entities, Japanese transparent vehicles include kumiai, a Japanese partnership, although it is not an entity but is an aggregate of partners. Given the transparency, technically there is no concept of residency of a kumiai itself, but it boils down to the residency of each partner of the kumiai. Foreign transparent entities (e.g., Cayman Islands or Bermuda limited partnerships) are likely to be treated in the same manner. It should be noted, however, that some seemingly transparent foreign partnerships, such as U.S. limited partnerships, are likely to be treated as a foreign corporation (but not as a transparent entity) for Japanese tax purposes. The Japanese tax classification of foreign transparent entities is still not crystal clear in practice, even after the recent Supreme Court decisions that effectively held that a Delaware limited partnership is a foreign corporation but a Bermuda limited partnership is not, and the position of the Japanese tax authority may differ depending upon the specific structure of the partnership and the context (i.e., tax-avoiding or not) in which such partnership is used.
Can the policing of cross border transactions within an international group to be a target of the tax authorities’ attention and in what ways?
Yes. Cross border transactions within an international group have been one of the most important focus in the enforcement of Japanese tax law. Typically, pricing or profit allocation as to intra-group transactions is scrutinized based on Japanese transfer pricing regulations. Also, cross-border intra-group transactions are frequently scrutinized in terms of Japanese withholding tax (i.e., if there is any failure to withhold applicable withholding tax), consumption taxes (i.e., if there is any failure to report input tax by the foreign affiliate even if it has no PE in Japan) or thin-capitalization and earnings-striping rules (i.e., if the Japanese affiliate takes interest deduction in excess of these regulations). Moreover, cross-border reorganization or recapitalization transactions was a significant focus of the enforcement, as seen in certain two Japanese tax tribunal and court cases (the IBM case and the Universal Music case), where the Japanese tax authority tried to disallow the tax consequences achieved by the parties that are consistent with the individual provisions of Japanese tax law, by invoking certain general anti-avoidance statute applicable to closely-held corporations.
Is there a CFC or Thin Cap regime? Is there a transfer pricing regime and is it possible to obtain an advance pricing agreement?
Yes for all.
(1) As for the CFC rule, Japanese tax law has “anti-tax haven” rules, or a Japanese version of the CFC rules. These rules have been overhauled by the 2017 annual tax reform in response to the BEPS Action Plan 3, and will apply to Japanese shareholders from the fiscal years of the CFC beginning on or after April 1, 2018.
If the Japanese CFC rules apply, the Japanese corporation that is a shareholder of the CFC will be taxed upon its pro rata share of certain adjusted income of the CFC (to be calculated based on the CFC’s total income and gains) . In general, Japanese CFC rules apply if (i) Japanese resident individuals and Japanese corporations collectively own directly or indirectly more than 50% of the total issued shares, voting rights or rights to receive dividends of a foreign corporation; (ii) a particular Japanese resident individual or a Japanese corporation (which is the subject taxpayer) owns directly or indirectly 10% or more of the total issued shares, voting rights or rights to receive dividends of that foreign corporation; and (iii) the effective income tax burden (rather than the face or nominal tax rate) of that foreign corporation in a given fiscal year is less than (i) 30% for certain shell-company CFCs and cash-box-company CFCs or (ii) 20% for all other CFCs. Typical examples include Cayman Islands, Hong Kong and Singapore subsidiaries. It should be noted that tax-exempt income and gains in the foreign jurisdiction will lower the effective income tax burden; for example, if a Dutch subsidiary of a Japanese corporation is exempt from substantial amount of capital gains by the Dutch participation exemption, the effective income tax burden in that fiscal year could be less than 20%, despite the Dutch statutory corporate tax rate of 25%. That will make the Dutch subsidiary a CFC for that fiscal year. However, exemption of dividends received by the Dutch subsidiary from foreign companies by the participation exemption will not lower the effective income tax burden (this treatment is only limited to dividends).
Even if the Japanese CFC rules apply because all the conditions explained above are met, there is an active business income exemption. That is, if the CFC meets all of the following criteria, the Japanese CFC rules apply only to the extent of the CFC’s certain enumerated passive income (rather than the CFC’s total income including active income): (i) the principal business of the CFC is other than financial investments in shares, bonds or IPs or leasing of vessels, (ii) the CFC is managed and administered on its own within the jurisdiction of its incorporation, rather than from Japan, (iii) the CFC maintains physical fixed premises such as offices and factories within the jurisdiction of its incorporation that is necessary to do its business, and (iv) depending on the type of business, the CFC does business principally within the jurisdiction of its incorporation (e.g., manufacturing) or deals with unrelated third parties to account for 50% or more of the total business transactions (e.g., distribution, transportation). If all these elements are met, the CFC’s income to be aggregated with the Japanese shareholder’s income will be limited to passive income, such as (a) dividends and capital gains from shares (but excluding those where the shareholding ratio is 25% or more for 6 months), (b) interest on deposits, bonds and loans (excluding interest from certain qualifying group-financing), (c) income from derivatives (excluding certain qualifying hedges), (d) foreign exchange gains (excluding those arising in the ordinary course of business), (e) royalties and disposition gains from IPs (excluding those where the IP is developed on its own) and (f) leasing income from real properties and fixed properties (excluding real properties located and fixed properties used in the jurisdiction of incorporation of the CFC).
The active business income exemption has been expanded to a certain qualifying regional headquarters or intermediate holding company; that is, if a foreign subsidiary incorporated in the Asian-hub low-tax countries such as Singapore and Hong Kong operates as an Asian regional headquarters or as an intermediate holding company for the Japanese parent corporation, subject to certain requirements being met, the CFC will not be disqualified from meeting the condition (i) above (i.e., the principal business of the CFC is other than financial investments in shares), merely becuse it is a holding company.
(2) As to a thin cap regime or limitation on interest deduction, there are special rules limiting deductibility of interest as follows:
If the debt giving rise to the interest is owed to a foreign corporation, which is a controlling shareholder (owning directly or indirectly 50% or more of the total shares) of the Japanese corporation, the ‘thin capitalization’ rules apply, and, generally speaking, interest payable upon the portion of the debt exceeding three times the shareholders’ equity of the Japanese corporation will be nondeductible. The ‘thin capitalization’ rules apply not only in the case of direct financing by the controlling shareholder, but also in other similar cases, such as financing by third parties with a guarantee provided by the controlling shareholder.
Transfer pricing rules also apply to interest payable to affiliated foreign corporations of the Japanese corporation in order to require that the interest rate be arm’s length (i.e., the portion of the interest exceeding the arm’s-length rate will be denied deduction). One Japanese court precedent indicates that the arm’s-length interest rate generally refers to the rate available in the market for substantially similar finance transactions.
Further, as a result of the 2012 annual tax reform, a Japanese version of the ‘earnings stripping’ rules has been introduced, and applies from fiscal years beginning on or after April 1, 2013. There, if the ‘net’ amount of the interest paid to certain foreign related parties of the Japanese corporation in a fiscal year exceeds 50% of certain ‘adjusted income’ (substantially equal to EBITDA, i.e., taxable income before that interest deduction, depreciation, etc.) of that Japanese corporation in that fiscal year (i.e., interest paid to foreign affiliates is excessive as compared to the taxable income), the excess portion of the interest will not be deductible in that fiscal year. The excess portion will be carried forward for seven future fiscal years, however, and will be deductible to the extent the above conditions are met in the relevant future fiscal year. There is a certain de minimis exception, as well as an exception where the gross amount of interest paid to foreign related parties does not exceed 50% of the total gross amount of interest (including interest paid to third parties). The Japanese government is now reviewing whether these earnings stripping rules should be more tightened, in response to the BEPS Action Plan 4, by lowering the threshold percentage rate from 50% to some 10-30%.
It should be noted that interest deduction can be denied, even if none of the foregoing regimes is applicable, if the Japanese tax authority considers the relevant debt transaction as avoiding Japanese tax and invokes the anti-avoidance statute applicable to closely-held corporations in the corporation tax law. The Universal Music case mentioned above is an example.
(3) As to the transfer pricing regime, generally, the Japanese government is of the position that Japanese transfer pricing rules as well as enforcement thereof should closely follow the OECD standards. For example, Japanese transfer pricing rules recently repealed priority of the three basic methods (CUP, RP and CP) over other methods (PS and TNMM), and adopted the “best method” rule. In addition, it has been made clear that the concept of a “range” of arm’s length profit level can be used for Japanese transfer pricing purposes (provided that it means a “full range” predicated upon full comparability, rather than the statistical approach of interquartile range) for the purpose of issuing a transfer pricing assessment. In addition, as a matter of enforcement or transfer pricing audit, it is very common that taxpayers make defensive arguments by referring to the OECD Guidelines along with Japanese local laws and regulations, and the Japanese tax authority generally accepts such arguments as legitimate. Indeed, some tax treaties, e.g., that with the United States, expressly provide that transfer pricing enforcement shall be made in accordance with the OECD Guidelines.
It is possible to obtain an advance pricing arrangement (APA) from the tax authority, and it is a very common practice. However, as an APA requires substantial time, cost and burden to deal with the tax authority (e.g., for responding to information and document requests), taxpayers generally concentrate on intra-group transactions that have significant volume and a large amount of tax at stake in applying for an APA. It is not rare that an APA takes two or three years until concluded.
Is there a general anti-avoidance rule (GAAR) and, if so, how is it applied by the tax authority? Eg is the enforcement of the GAAR commonly litigated, is it raised by tax authorities in negotiations only, etc?
Japan does not have general anti-avoidance rules or GARR in a literal sense (e.g., rules which could apply to all or whatever circumstances or transactions), but does have anti-avoidance provisions applicable to some specific situations.
One is an anti-avoidance provision applicable to certain closely-held corporations (corporations controlled more than 50% by three or less shareholders); there, if an act or accounting of the subject taxpayer which is a closely-held corporation unjustifiably reduces the corporation tax burden of that taxpayer, then the Japanese tax authority is entitled to disregard the legal form of the transaction adopted by the taxpayer and to impose corporation tax based upon another legal form that the Japanese tax authority finds to be more natural and reasonable. For the purpose of this rule, the term “unjustifiably reduces” is generally interpreted to mean the situation where the act or accounting of the subject taxpayer is so extraordinary or strange that there is no reasonable business or financial reason to do such act or accounting other than for the purpose of tax avoidance.
Another one is an anti-avoidance provision applicable to corporate reorganization transactions (e.g., mergers, divestures, share exchanges, etc.); there, if an act or accounting of the subject taxpayer which is a party to a corporate reorganization transaction unjustifiably reduces the corporation tax burden of that taxpayer, the other parties to that transaction or their respective shareholders, then the Japanese tax authority is entitled to disregard the legal form of the transaction adopted by the taxpayer and to impose corporation tax based upon another legal form that the Japanese tax authority finds to be more natural and reasonable. For the purpose of this rule, the term “unjustifiably reduces,” as interpreted by a recent Supreme Court decision, means the situation where the taxpayer has abused relevant tax provision regarding the corporate reorganization rules.
Yet another one is an anti-avoidance provision applicable to the Japanese consolidated taxation regime; there, if an act or accounting of the subject taxpayer which is a member of the Japanese consolidated group unjustifiably reduces the corporation tax burden of that taxpayer, then the Japanese tax authority is entitled to disregard the legal form of the transaction adopted by the taxpayer and to impose corporation tax based upon another legal form that the Japanese tax authority finds to be more natural and reasonable. There has been no precedent on the interpretation of the term “unjustifiably reduces” and it remains unclear how that term will be interpreted by courts.
Recently, the first two anti-abuse provisions are very actively invoked by the tax authority in issuing assessments, claiming a need to secure an appropriate taxation by disregarding the legal form of the transaction adopted by the taxpayer. Practitioners are generally concerned about such tendency, because these anti-abuse provisions will often result in taxation that cannot be foreseeable from the text of the tax statute.
Are there any plans for the implementation of the OECD BEPs recommendations and if so, which ones?
Yes, Japan is very active in following the BEPS Action Plans so far published, as the country that chaired the relevant OECD Committee.
To date, Japan has implemented or will implement the following BEPS Action Plans by amending its domestic tax law or tax treaties:
(i) Action Plan 1: Japan has amended the consumption tax law to tax upon digital or electronic services transactions conducted by foreign enterprises having no base in Japan.
(ii) Action Plan 2: Japan has amended the corporation tax law so that Japan’s foreign dividend exemption system does not apply to dividends that are deductible under the local tax law of the jurisdiction of the foreign subsidiary (e.g., Brazil), in order to prevent double exemption.
(iii) Action Plan 3: Japan has overhauled its current CFC regime by amending the income tax law and the corporation tax law by the 2017 annual tax reform, in line with the BEPS Action Plan 3, to give more focus upon the substance of the business conducted by the CFC, as explained above.
(iv) Action Plan 4: As explained above, Japan is now reviewing whether the earnings stripping rules should be more tightened, in response to the BEPS Action Plan 4, by lowering the threshold percentage rate from 50% to some 10-30%.
(v) Action Plan 6: Japan has incorporated in its tax treaties particularly with advanced countries (such as the U.S., the U.K., the Netherlands, Switzerland and Germany) various anti-abuse measures suggested by the BEPS Action Plan 6, such as the limitation on benefits (LOB), the principal purpose test (PPT) and the beneficial owner concept.
(vi) Action Plans 8-10: Japan is reviewing whether it should incorporate the so-called “commensurate with income” standard as to certain hard-to-value intangibles, by amending its transfer pricing regulations, in line with the BEPS Action Plans 8-10.
(vii) Action Plan 13: 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 the BEPS Action Plan 13.
In addition, Japan will continue its review of whether it is necessary, and if so, by what measures the action plans should be implemented, as to the other action plans.
How will BEPS impact on the government’s tax policies?
Japanese multinational corporations are generally far less active in aggressive tax planning as compared to those in Western jurisdictions, and the Japanese government is not very much concerned about BEPS to be caused by Japanese multinational corporations. Rather, Japan seems to be of a view that the BEPS initiatives may be a good opportunity for Japanese multinational corporations to enhance their international competitiveness, where Western multinational corporations would have much more difficulty to continue their aggressive tax planning. As such, the main focus of Japan in terms of the BEPS initiatives seems to be to be in concert with the international community in the domestic adoption of the Action Plans and at the same time to take care so that the adoption will not cause overly onerous administrative burden on the side of Japanese multinational corporations (where they are not doing any aggressive tax planning). In any event, it is fair to say that Japan will continue to domestically implement the remainder of the BEPS Action Plans from these viewpoints.
Does the tax system broadly follow the recognised OECD Model?
Does it have taxation of; a) business profits, b) employment income and pensions, c) VAT (or other indirect tax), d) savings income and royalties, e) income from land, f) capital gains, g) stamp and/or capital duties.
If so, what are the current rates and are they flat or graduated?
The tax system in Japan broadly follows the recognised OECD Model, and is largely similar to the tax system commonly employed by advanced Western countries.
a. Taxation of business profits
Japanese corporations are subject to corporate taxation comprised of (i) national corporate tax as well as (ii) local inhabitants tax and (iii) local enterprise tax. The effective marginal corporate tax rate, taking into consideration the foregoing taxes, applicable to Japanese corporations is, in general, around (a) 29.97% for the fiscal year beginning on or after April 1, 2016 and (b) 29.34% for the fiscal years beginning on or after April 1, 2018 (each assuming Japanese corporations headquartered in the central Tokyo metropolitan area and having stated capital of more than 100 million yen).
Japanese resident individuals are taxed at regular progressive rates. The marginal tax rate of individual income taxation is 55.945% (comprised of 45% national individual income tax, 0.945% special reconstruction income surtax and 10% local inhabitants tax) for calendar years from 2015 through 2037. The marginal rate generally applies to the bracket of the taxable income of an individual exceeding 40 million yen.
Foreign corporations and non-resident individuals are taxed in substantially the same manner as above, to the extent that they have a permanent establishment in Japan and the relevant business profits are attributable to that permanent establishment in Japan. Otherwise, business profits sourced from Japan are not taxable in Japan for foreign corporations and non-resident individuals.
b. Taxation of employment income and pensions
These are taxed on Japanese resident individuals at the regular progressive rates, where the marginal tax rate is 55.945% as mentioned above. Retirement income generally receives preferential tax treatments and is effectively taxed at a very low rate. For non-resident individuals, employment income derived from a Japanese source is subject to 20.42% withholding tax, unless exempted by an applicable tax treaty.
c. VAT (or other indirect tax)
VAT applies in Japan as consumption taxes. Consumption taxes (national and local) are payable by individual or corporate taxpayers engaged in sale of goods or provision of services that are taxable for consumption tax purposes, i.e., sale of goods or provision of services conducted in Japan (unless specifically designated as nontaxable). The tax rate is currently 8%, and will be raised to 10% from October 2019.
Consumption taxes are charged to the recipient or purchaser of the goods or services (i.e., the recipient or purchaser will pay to the provider or seller the applicable consumption tax amount (8% or 10%) in addition to the purchaser price), and (i) the seller or the provider will report and pay the consumption taxes to the Japanese government by filing a tax return and (ii) the recipient or purchaser may be eligible to take input tax credit as to the consumption tax amount so paid to offset against its own consumption tax liability.
Foreign individual or corporate taxpayers are also subject to the consumption taxes, regardless of whether or not they have a permanent establishment in Japan for income or corporate tax purposes, so long as they engage in sale of goods or provision of services conducted in Japan that is taxable for consumption tax purposes. However, foreign taxpayers may be exempt from the consumption tax liability because of a small business exemption, if, in general, the total taxable sale from the sale of goods or provision of services conducted in Japan (i) during a fiscal year two years preceding the relevant fiscal year (e.g., 2016 for the consumption tax liability in 2018) and (ii) during the first six months’ period of the fiscal year immediately preceding the relevant fiscal year (e.g., January through June of 2017 for the consumption tax liability in 2018) did not exceed 10 million yen.
d. Taxation of savings income and royalties
Japanese corporations are taxed on interest arising from deposits and royalties arising from intellectual property in the same manner as business profits mentioned above. Japanese resident individuals are taxed on interest arising from deposits at a flat rate of 20.315% by way of withholding separately from other income, but are taxed on royalties arising from intellectual property substantially in the same manner as business profits mentioned above.
Foreign corporations and non-resident individuals having no permanent establishment in Japan are subject to Japanese taxation by way of withholding only, where the withholding tax rate is 15.315% for interest arising from deposits made in Japan and 20.42% for royalties arising from certain prescribed types of intellectual property (patents, design rights, copyrights, etc.) registered or otherwise sourced in Japan. These withholding taxes may be exempted or reduced by an applicable tax treaty.
e. Taxation of income from land
Japanese corporations are taxed on rents and capital gains arising from land and buildings in the same manner as business profits mentioned above. Japanese resident individuals are taxed on rents arising from land and buildings substantially in the same manner as business profits mentioned above, but are taxed on capital gains generally at the flat rate of 20.315% (if the holding period is more than 5 years) or39.63% (if the holding period is 5 years or less).
Foreign corporations and non-resident individuals having no permanent establishment in Japan are subject to Japanese taxation on rents and capital gains arising from land and buildings located in Japan, by way of both withholding and reporting by filing a tax return, as a general matter. The withholding tax rate is 10.21% for capital gains and 20.42% for rents. Then, by filing a tax return, foreign corporations are subject to the national corporation tax (but not local taxes) at the rate of (a) 23.4% for the fiscal year beginning on or after April 1, 2016 and (b) 23.2% for the fiscal years beginning on or after April 1, 2018, and non-resident individuals are subject to income tax on the capital gains generally at the flat rate of 15.315% (if the holding period is more than 5 years) or 30.63% (if the holding period is 5 years or less). The withholding tax properly withheld will be credited against the tax payable by the tax return.
Note there are some transactional, rather than income, taxes applicable to land and/or buildings.
f. Taxation of capital gains
Japanese corporations are taxed on capital gains arising from sale of securities (bonds, shares, etc.) in the same manner as business profits mentioned above. Japanese resident individuals are taxed on capital gains arising from sale of securities (certain specified bonds, shares, etc.) at the flat rate of 20.315%, unless exempted by the individual savings accounts regime (commonly referred to as NISA).
Foreign corporations and non-resident individuals having no permanent establishment in Japan are subject to Japanese taxation on capital gains arising from sale of shares of a Japanese corporation, only if such foreign corporation or non-resident individual, together with certain related persons (its affiliates and related parties, etc.) as defined in Japanese tax laws and partnerships in which it is directly or indirectly a partner: (i) owns or owned 25 % or more of the total shares of the Japanese corporation at any time during a period of three years on or before the end of the fiscal year of the foreign corporation (or the calendar year for non-resident individuals) 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 or calendar year. This exceptional rule is commonly referred to as the ‘25/5 rule’ in practice. If this applies, foreign corporations are subject to the national corporation tax (but not local taxes) at the rate of (a) 23.4% for the fiscal year beginning on or after April 1, 2016 and (b) 23.2% for the fiscal years beginning on or after April 1, 2018, and non-resident individuals are subject to income tax at the flat rate of 15.315%. No Japanese taxation will apply to foreign corporations and non-resident individuals having no permanent establishment in Japan except for the ‘25/5 rule’ mentioned above and except where the subject Japanese corporation is a certain “real estate holding corporation”.
g. Stamp and/or Capital duties
Stamp duty is imposed on certain limited category of documents, such as sale and purchase agreement of real property and loan agreements, per one executed original copy. The rate differs depending upon the amount at stake as recorded on the document. The maximum rate of stamp duty applicable to loan agreements, for example, is 600,000 yen (where the principal of the loan exceeds 5 billion yen). Stamp duty is imposed only on an executed original; so facsimile or pdf copies are not dutiable.
Japan does not have capital duties; however, as a similar charge, registration and license tax is imposed on various kinds of commercial registration concerning companies. For example, if a Japanese corporation files for a commercial registration of increase of its stated capital, registration and license tax is imposed at the rate of 0.7% of the increased amount of the stated capital. In addition, as part of local enterprise tax mentioned above (which is essentially income taxation), corporations having stated capital of more than 100 million yen are subject to business scale-based taxation regime, where the amount of stated capital and capital reserves for tax purposes is one of the tax bases (in Tokyo, 0.525% of that amount will be taxed as local enterprise tax).
Is the charge to business tax levied on, broadly, the revenue profits of a business as computed according to the principles of commercial accountancy?
Yes. Taxable income for corporate tax purposes will basically be calculated based upon the income for accounting purposes, in accordance with the generally accepted accounting principles of Japan. For this purpose, it is considered generally accepted accounting principles that income shall be taxed on an accrual basis rather than receipts basis.
Then, solely for tax purposes, substantial adjustments will be made. Major adjustments include: (i) exclusion from taxable income of all or part of dividend income received from Japanese corporations (an equivalent of dividend received deduction), (ii) exclusion from taxable income of dividend income received from foreign subsidiaries (a territorial approach to mitigate international double taxation as to income derived through foreign subsidiaries, in lieu of indirect foreign tax credit), (iii) limitation on deductibility of remunerations paid to directors and officers of the corporation, (iv) limitation on deductibility of donations or gifts made by the corporation as well as entertainment expenses, (v) denial of deductibility of allowances or reserves established internally by the corporation, (vi) denial of deductibility of criminal or administrative fines or damages due to will misconduct or gross negligence, (vii) deduction of net operating loss carryforwards from prior fiscal years, (viii) mark-to-market rules for trading securities and derivatives in respect of unrealized built-in gains and losses, (ix) Japanese consolidated tax regime (available for 100% owned corporate group consisting of Japanese corporations upon election), and (x) group-based taxation regime (special rules for transactions among 100% owned corporate group consisting of Japanese corporations). In addition, there are special rules for acquisitive and divisive reorganizations (e.g., merger, divestiture, etc.) like section 368(a)(1) et al of the U.S. Internal Revenue Code, e.g., deferral of recognition of gains and losses arising from reorganization transactions.
Each of these regimes has complicated and detailed rules consisting of general principles and various exceptions and further exceptions.
Are different vehicles for carrying on business, such as companies, partnerships, trusts, etc, recognised as taxable entities? What entities are transparent for tax purposes and why are they used?
Yes. Japanese corporate law makes available several options of corporate forms; among these, the most commonly used one is a kabushiki kaisha (stock corporation; commonly referred to as a “KK”). A godo kaisha, which is modeled after a U.S. limited liability company (LLC), is also common for small businesses or as subsidiaries of foreign companies (commonly referred to as a “GK”). As Japanese corporations, a KK or a GK is taxed as a corporation, and cannot be taxed as a transparent or passthrough entity.
Only non-corporate business forms are eligible for transparent or passthrough taxation for Japanese tax purposes. These business forms take the form of a partnership (kumiai), which is an aggregate of partners based upon a contractual relationship, but not being an entity separate and distinct from the partners. A partnership (kumiai) is taxed as transparent or passthrough; that is, they will not be treated as an independent taxpayer, but rather their partners are taxed as taxpayers with respect to the income derived from the business of the partnership. In general, the profits and losses derived from the business of the partnership are allocated to each of the partners based upon the percentage agreed upon in the relevant partnership agreement (most commonly, the ratio of capital contributions). There are rules for limitation of allocation of losses to certain passive partners (e.g., limited partners) to prevent tax avoidance using these partnership structures.
Trusts are also recognized. Generally, plain-vanilla common-law type of trusts are disregarded and treated as a conduit, i.e., it is treated for tax purposes as if the beneficiary of the trust owned the entrusted assets directly and derived the income and gains from the entrusted property directly. However, some special types of trusts are treated as a corporation by itself (i.e., as a standalone taxpayer apart from beneficiaries), and some investment trusts used as a collective investment vehicle are treated as somewhat an opaque entity, i.e., the trust itself is not a taxable entity and the beneficiaries or the investors are taxed only when they received actual distributions.
Is liability to business taxation based upon a concepts of fiscal residence or registration? Is so what are the tests?
In taxing business profits of a corporation, whether or not a corporation is a Japanese corporation or a foreign corporation for tax purposes is determined by reference to the jurisdiction of incorporation or registration. That is, so long as the taxpayer is a Japanese corporation for Japanese corporate law purposes such as a KK or a GK, even if the place of effective management of that corporation is outside Japan, it is treated as a Japanese corporation for Japanese tax purposes.
Similarly, so long as a corporation is incorporated and registered in jurisdictions other than Japan for corporate law purposes, the corporation is a foreign corporation for tax purposes even if the place of effective management is within Japan. However, in that case, the foreign corporation is very likely deemed to have a permanent establishment in Japan, and the business profits are taxed in Japan so long as the profits are attributable to the permanent establishment in Japan.
Are there any special taxation regimes, such as enterprise zones or favourable tax regimes for financial services or co-ordination centres, etc?
A few special tax and other incentives have been established in order to attract R&D activities and/or investments into Japan by foreign multinational enterprises. For example, the Tokyo metropolitan government, in cooperation with the Japanese national government, provides a regime called the Asian headquarters special region. There, if a qualifying foreign multinational enterprise establishes a Japanese corporation as a subsidiary based upon an approval of the Tokyo metropolitan government for the purpose of conducting R&D activities in Japan or establishing an Asian regional headquarters in Japan (i.e., as an intermediate holding company), that Japanese subsidiary can enjoy, among other benefits, special tax credit or special accelerated depreciation deduction for the investments made in machinery and buildings, along with total exemption of local transactional taxes such as real property acquisition tax, fixed property tax and city planning tax.
In addition, as special taxation regimes that are equally applicable to Japanese businesses. One example is the special taxation regime for promoting increase of salary payments to employees, where taxpayers can enjoy tax credit of 10% of the increased amount of the total deductible salary payments to their employees as compared to past (applicable for fiscal years beginning by the end of March 2018). These measures reflect the economic policy referred to as “Abenomics” of the incumbent Prime Minister and his ruling party.
Are there any particular tax regimes applicable to intellectual property, such as patent box?
No, we do not have a patent box regime or other regimes providing a preferential tax treatment for income and gains generated from intellectual property. That is, royalties and capital gains generated from intellectual property derived by a Japanese corporation are taxed in the same manner as ordinary business profits.
Is fiscal consolidation employed or a recognition of groups of corporates for tax purposes and are there any jurisdictional limitations on what can constitute a group for tax purposes? Is a group contribution system employed or how can losses be relieved across group companies otherwise?
Yes. Japanese corporation tax law has consolidated taxation regime. A Japanese corporation (a consolidated parent company) and its wholly-owned direct and indirect Japanese subsidiaries form the consolidated group. Foreign corporations, whether as a consolidated parent company or a consolidated subsidiary, cannot be included in the consolidated group. To qualify as a consolidated subsidiary, all of its issued shares must (save very limited exceptions) be wholly-owned, either directly or indirectly, by the Japanese corporation as the consolidated parent company. It is not allowed to “cherry-pick” subsidiaries to be subject to the consolidated taxation regime; so long as a subsidiary has a relationship of direct or indirect 100% shareholding with the consolidated parent company, it must be included. The consolidated taxation regime is elective, i.e., it shall apply only if the Japanese tax authority has approved the consolidated return filing based upon an application by the consolidated group.
Under the consolidated taxation regime, taxable income of a member of the consolidated group will be offset against losses of another member. It must be noted, however, that, upon entering into the consolidated taxation regime, certain principal assets of all the consolidated subsidiaries shall in principle be marked to market to crystalize all unrealized built-in gains and losses pertaining to those assets, and such consolidated subsidiaries will report taxable income (or losses) accordingly. The 2017 tax reform has made clear that self-created goodwill or enterprise value of the to-be-consolidated subsidiaries does not need to be marked to market (thus giving rise to no mark-to-market gains). Also, net operating loss carryforwards of all the consolidated subsidiaries shall in principle be disregarded in their entirety upon entering into the consolidated taxation regime. While there are several exceptions to these rules, they often become an obstacle for election of the consolidated taxation regime if no such exception is available. On the other hand, there is no mark-to-market requirement for the consolidated parent company and the net operating loss carryforwards of the consolidated parent company will survive the consolidation election.
The consolidated taxation regime is currently for national corporation tax only. There is no consolidated taxation regime for local taxes (inhabitants tax and enterprise tax).
Along with the consolidated taxation regime, under Japanese corporation tax law, there is another different but similar taxation regime, referred to as a “group-based taxation regime.” The group-based taxation regime applies to transactions among Japanese corporations (not including foreign corporations) having the relationship of direct or indirect 100% share ownership, or substantially the same as the relationship for the consolidated taxation regime. If a member of the group sells certain assets owned by it to another member of the group, gains and losses arising from the sale will be deferred at the seller, until the purchaser further disposes of such assets out of the group or other realization event occurs. If a member of the group makes donation to another member of the group, the donation is not deductible at the donor, and is not taxed as gift (or receipt of economic benefit with no consideration) at the donee. However, no set-off of profits and losses among the group is available under this regime. It is important to note that the group-based taxation regime applies mandatorily, regardless of elections by the taxpayers, unlike the consolidated taxation regime.
Are there any withholding taxes?
Yes. Interest on loans (where the loan proceeds are used in Japan), dividends on shares of a Japanese corporation (which are not publicly traded), and royalties for use in Japan of intellectual property are subject to withholding tax at the rate of 20.42% (20% national tax and 0.42% special reconstruction income surtax) when paid to nonresident individuals and foreign corporations.
Interest on debt securities issued by a Japanese corporation is subject to withholding tax at the rate of 15.315% (15% national income tax and 0.315% special reconstruction income surtax) when paid to nonresident individuals and foreign corporations. However, there are special taxation measures whereby interest on (i) Japanese government bonds, Japanese municipal bonds and Japanese corporate bonds each issued in Japan and traded and owned through the Japanese book-entry system and (ii) Japanese “eurobonds” (meaning bonds issued by Japanese corporations outside Japan and interest is paid outside Japan), which is paid to nonresident individuals and foreign corporations, is in principle exempt from Japanese withholding tax, subject to certain documentation and identification requirements being met.
Dividends paid on publicly traded shares of a Japanese corporation are subject to withholding tax at the rate of 15.315% through December 31, 2037 when paid to nonresident individuals and foreign corporations; provided that 20.42% withholding tax applies to an individual shareholder who holds 3% or more of the total issued shares. No exemption from or reduction will apply under Japanese domestic tax law to withholding tax on dividends.
If the nonresident individuals and foreign corporations have no permanent establishment in Japan, the Japanese taxation is finalized only by the withholding tax. The domestic law withholding tax rates as well as the source rules of income mentioned above may be modified by an applicable tax treaty. In particular, some tax treaties, e.g., that with the United States, totally exempt Japanese withholding tax on certain intercompany dividends and royalties paid to certain U.S. qualified residents, subject to limitation on benefits and other conditions being met. The tax treaty with the United Kingdom totally exempt Japanese withholding tax on interest, certain intercompany dividends and royalties paid to certain U.K. qualified residents, subject to limitation on benefits and other conditions being met.
Are there any recognised environmental taxes payable by businesses?
Japan has no specific type of tax called as environmental tax; however, effectively the same taxation has been achieved by increasing the rate of petroleum and coal tax according to the expected CO2 emissions. The petroleum and coal tax is one of the indirect taxes of Japan and applies to petroleum, gases and coal as well as some related products. This has been introduced as an anti-global warming measure.
Is dividend income received from resident and/or non-resident companies exempt from tax? If not how is it taxed?
Dividend income derived by a Japanese corporation from another Japanese corporation is, in whole or in part, excluded from the taxable income (i.e., effectively dividend received deduction) of the receiving Japanese corporation, as outlined below:
(i) if the receiving Japanese corporation owns 100% of the shares of the paying Japanese corporation throughout the calculation period for the relevant dividend (generally meaning the fiscal year to which such dividend pertains to), 100% of the dividend is excluded from the taxable income.
(ii) if the receiving Japanese corporation owns more than one-third (1/3) but less than 100% of the shares of the paying Japanese corporation throughout the calculation period for the relevant dividend, 100% of the dividend is excluded from the taxable income but interest expenses pertaining to the acquisition of the underlying shares is added back to the taxable income.
(iii) if the receiving Japanese corporation owns more than 5% but less than one-third (1/3) of the shares of the paying Japanese corporation, 50% of the dividend is excluded from the taxable income.
(iv) if the receiving Japanese corporation owns 5% or less of the shares of the paying Japanese corporation, 20% of the dividend is excluded from the taxable income.
As to dividend income derived by a Japanese corporation from its foreign subsidiary, dividend to be received from such foreign subsidiary will be exempt from Japanese corporate taxation with respect to 95% of the amount of such dividends. Such qualifying foreign subsidiary in general means a foreign corporation 25% or more of whose total issued shares or voting rights are owned by the Japanese corporation for the period of at least six months up to when the dividends become payable. The shareholding percentage can be modified (in most cases reduced, say to 10%) by the indirect foreign tax provision of the applicable tax treaty. This means that Japan has effectively adopted a territorial-based taxation regime so long as foreign income is derived in the form of dividends from foreign subsidiaries.
From the perspective of an international group seeking to re-locate activities from the UK in anticipation of Brexit, what are the advantages and disadvantages offered by the jurisdiction?
Not applicable to Japan. However, Japanese multinational financial institutions are definitely looking for an alternative location to the UK after the Brexit, for example, the Netherlands, Germany and Ireland, taking into consideration various factors.