2018 Japan tax reform: Taxation related to financial businesses

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1 22 January 2018 Financial services tax alert Ernst & Young Tax Co Japan tax reform: Taxation related to financial businesses EY Global tax alert library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: International-Tax/Tax-alert-library%23date Contents 1. Measures related to the enhancement of the convenience of NISA 2. Revisions related to Specified Accounts 3. Revision of foreign tax credits relating to securities investment trusts 4. Tax incentives for wage increases and productivity enhancements 5. Revision of CFC rules 6. Domestic/foreign judgment of consumption tax relating to the transfer of paperless securities 7. Revision of the definition of permanent establishments (PE) 8. Revision of gift tax and inheritance tax related to general incorporated associations 9. Other 10. Concluding remarks On 14 December 2017, the Liberal Democratic Party and Komeito released the 2018 Tax Reform Outline. As symbolized by such keywords as productivity revolution and human resources development revolution, reflected in this tax reform outline are the establishment of tax rules in accordance with a deep resolve to carry out government-led large-scale reforms for continuous economic growth and revisions of tax rules in consideration of the formulation of international taxation rules in accordance with items agreed to in the BEPS (Base Erosion and Profit Shifting) project. Specifically, reforms with large impacts on the taxable income and tax burden of entities are expected, such as revisions of taxation rules including measures for the reduction of corporation tax to incentivize wage increases and productivity enhancements, regulations related to permanent establishments and CFC (Controlled Foreign Company) rules. Furthermore, because reforms directly impacting financial businesses (e.g. revision of foreign tax credits relating to securities investment trusts and the treatment of consumption tax relating to the transfer of paperless securities) are included in the financial and securities tax rules, attention should be given to the details of such treatments, which will be clarified at a later date. This alert provides commentary regarding finance-related tax rules and major reforms specific to financial institutions contained in the 2018 Tax Reform Outline.

2 1. Measures related to the enhancement of the convenience of NISA (Nippon Individual Savings Accounts) a. Revision of NISA account opening procedures Although the number of NISA accounts being opened has been on the rise since NISA was established in 2014, there are also a considerable number of accounts in which no purchases have been made after opening, and, because it takes time for the tax authorities to perform confirmation of duplicate accounts, there are obstacles to making purchases immediately after opening an account. This reform addresses the aforementioned issues by establishing the following measures. i. Submission of forms for the simplified opening of tax exempt accounts which do not require the attachment of a tax exemption confirmation letter. This will allow residents opening a tax exempt account to submit forms for the simplified opening of tax exempt accounts which do not require the attachment of a tax exemption confirmation letter (current tax rules require the attachment of prescribed documents such as tax exemption confirmation letters) to financial institutions. Financial institutions having received the submission of the aforementioned forms will be required to, in addition to opening the tax exempt account, quickly provide the tax authorities site with the information listed in the aforementioned forms (filing information). ii. Confirmation by the tax authorities The tax authorities, having receiving the provision of the form information described above in i., will provide the financial institutions with a judgment regarding the appropriateness of the opening of the tax exempt account at that financial institutions after the opening of that account. Furthermore, the aforementioned reforms will apply to forms for the simplified opening of tax exempt accounts submitted on or after 1 January b. Handling at the conclusion of the NISA tax exempt period Under current rules, after five years have passed from investment in a NISA account, marking the conclusion of the tax exempt period, it is possible to continue using the tax exempt space to invest; in the event that, however, this option is not chosen, the shares that were owned in the NISA account will be transferred to a taxable account. Furthermore, while there are both Specified and General Taxable Accounts, to the extent that there is no particular indication of intent, the transition will be to a General Account. In the case of Specified Accounts, financial institutions are required to withhold and prepare annual transaction reports. (Individual investors are permitted to file tax returns separately.) However, in the case of General Accounts, individual investors must file returns on their own, and, because shares in General Accounts are not allowed to be transferred to Specified Accounts, the enhancement of investor convenience had been an issue. With these reforms, the shares in a tax exempt account will, at the conclusion of the tax exempt period (after five years for NISA and Junior NISA, and after 20 years for Monthly Investment-type NISA) in general be transferred to Specified Accounts, and allowances will be provided to prevent missing filings from individuals who do not notice the transition to a taxable account. From the perspective of further popularizing and promoting NISA, it is thought that it will be necessary to, in consideration of the timing of the reforms, prepare administrative procedures for transitioning to the new rules and to provide support for financial institutions in establishing and preparing operational systems. 2 Financial services tax alert 22 January 2018

3 2. Revisions related to Specified Accounts a Expansion of the scope of listed shares eligible for obtainment in Specified Accounts Certain listed shares that have transfer restrictions will be added to the scope of listed shares eligible for obtainment in Specified Accounts An expected example of such shares are so-called restricted stocks and transfer will be permitted to Specified Accounts after releasing from such restrictions. b. Obligation of notifications from listed entities to financial institutions In the event that an entity which issued listed shares managed in Specified Accounts performs a corporate demerger, that entity will be required to notify the financial institutions that such Specified Accounts have been opened with the necessary information for the acquisition value of those listed shares. This obligation is that financial institutions will, in an appropriate manner, manage and grasp listed share acquisition prices and fulfill obligations for withholding. 3. Revision of foreign tax credits relating to securities investment trusts a. Exception from obligation for withholding relating to listed share dividends Rules regarding the elimination of double taxation in respect of dividends from securities investment trusts and foreign shares owned by Investment Corporations will be revised. Specifically, in accordance with the following categories, amounts of foreign income tax (limited to an amount equaling the amount of income tax multiplied by the ratio of funds allocated to assets denominated in foreign currencies) will be deducted from the amount of income tax withheld by securities firms (the payment handling agents). Furthermore, an amount equivalent to the deducted amount of foreign income tax will, upon filing of a tax return, be credited from the tax amount on dividend income. i. Distribution of profits of Collective Investment Trusts Of the amount of foreign income tax paid with respect to the entrusted assets by that Collective Investment Trust, the amount of the portion corresponding to the distribution of the respective profits ii. Profit dividends of Specific Purpose Companies Of the amount of foreign corporation tax paid by a Specific Purpose Company, the amount corresponding to the respective profit dividends iii. Investment equity dividends of Investment Corporations Of the amount of foreign corporation tax paid by an Investment Corporation, the amount corresponding to the respective dividends iv. Dividends of surplus of Specific Purpose Trust beneficiary rights Of the amount of foreign corporation tax paid with respect to the entrusted assets by a Specific Purpose Trust, the amount corresponding to the respective dividends of surplus b. Exception from taxation of profits relating to trust assets Even under current tax rules, there are rules for the deduction of amounts of foreign income tax from income tax withheld from distributions when a trust bank pays distributions of collective investment trust (e.g. securities investment trust, etc.) profits; however, in response to the aforementioned a., measures establishing a maximum amount of deductible foreign income tax will be established. Furthermore, the amount of income tax (including foreign income tax) paid with respect to trust assets of a securities investment trust having the purpose of investment into trust certificate of another securities investment trust (mother fund) will be deducted from the amount of withholding tax relating to the distribution of baby fund profits; however because these baby funds are limited to public offerings under current tax rules, private offerings will also become eligible for deduction. Financial services tax alert 22 January

4 c. Amendment relating to the profit dividends of Investment Corporations and Specific Purpose Companies With regards to the profit dividends of Investment Corporations and Specific Purpose Companies, the amount of withholding tax relating to the amount of dividends paid to dividend payees will be the amount resulting from deducting the amount equivalent to the foreign corporation tax creditable per the aforementioned a. ii and a. iii. The aforementioned reforms a. to c., out of consideration for the administrative compliance burden placed on financial institutions, will be applied to dividends paid on or after 1 January Furthermore, the aforementioned matters are revisions relating to national taxation (income tax and special income tax for reconstruction), and do not affect regional taxation. In the event that foreign shares were included in the trust assets of a securities investment trust, foreign income tax imposed on those dividends had been subject to adjustment for double taxation through deduction from the amount of income tax relating to distributions of profit from securities investment trusts; however, with the change of the tax withholding agent relating to distributions of profit from securities investment trusts from trust banks to the payment handling agents, such as securities firms, beginning in January 2010, that adjustment became administratively difficult. With these reforms, adjustment will become possible by the payment handling agents, ameliorating negative effects arising due to double taxation. Furthermore, details have not been made available regarding administrative procedures relating to the aforementioned measures. In general, a tax return is not filed for financial income managed in Specified Accounts; for others, however, it will be necessary to confirm detailed handling (which will be formulated at a future date), including new structures for foreign income tax credit in the case of income tax returns. 4. Tax incentives for wage increases and productivity enhancements As one measure towards the realization of the productivity revolution advocated by the Japanese government, the three-year period until fiscal 2020 will be deemed a period of intensive investment, and entities having made domestic capital investments and investments in human resources for the enhancement of productivity during that period will be given the benefit of reduced corporation tax. For details relating to the tax rules and measures, please reference the EY Japan tax newsletter 2018 tax reform outline. The following is an outline of the reforms. a. Reformulation of tax credits for salary growth The current tax credits for salary growth will be reformulated such that for each fiscal year beginning during the period from 1 April 2018 through 31 March 2021, criteria relating to capital investment will be added to the current eligibility criteria related to salary, making possible a maximum 20% credit of corporation tax. b. Creation of tax rules related to the promotion of information-sharing For the realization of productivity enhancements, an entity with blue tax form filing status having received certification of an innovative data use plan (tentative title) under the Act for Temporary Measures (tentative title), and which, during the period lasting from the date of enforcement of the aforementioned Act through 31 March 2021, acquires equipment making use of information-sharing (minimum total acquisition cost: JPY50 million), will enjoy the selective application of 30% special depreciation of the acquisition cost or a tax credit of 5% of the acquisition cost. c. Revision of conditions for the application of tax incentives contained in the Act on Special Measures Concerning Taxation Benefits such as R&D tax incentives will be restricted for large enterprises and caution is necessary in cases where the income and investment towards capital or human resources thereof decrease compared to the previous fiscal year. 4 Financial services tax alert 22 January 2018

5 5. Revision of CFC rules Although the 2017 tax reform included a revision of anti-tax haven rules, because further consideration is necessary in light of the actual conditions of various overseas financial businesses, the following measures will be established. a. Application of economic activity criteria related to financial holding entities In consideration of the actual business conditions of foreign financial subsidiaries, financial holding entities equivalent to foreign financial subsidiaries whose primary business is the possession of shares will be deemed to fulfill the business criteria. (Under current rules, in the event that entities perform control activities contributing to the enhancement of profitability, those entities are deemed to fulfill the business criteria.) b. Criteria for insurance subsidiaries qualifying as foreign financial subsidiaries In the event that, in accordance with local laws and regulations, insurance subsidiaries are established with separate functions and act as units for the operation of an insurance business, e.g. in case of Lloyd s (UK) market, these subsidiaries will undergo judgment regarding the criteria for qualifying as a foreign financial subsidiary as a unit. (Insurance underwriting subsidiaries and managing agency subsidiaries in the Lloyd s (UK) market, or insurance contractors and underwriters in other markets.) c. Criteria for foreign financial holding entities qualifying as foreign financial subsidiaries Entities other than pure financial institutions, such as acquired holding entities of financial groups, are sometimes included under the umbrella of holding companies, and to avoid the loss of qualification as a foreign financial subsidiary under such circumstances, the following two criteria, concerning criteria regarding cases in which the book value of foreign financial institution shares exceeding 75% of the book value of total assets, will be revised. (i) (ii) > 75% (i): The total book value of owned shares of foreign financial institutions, other foreign financial holding entities, certain intermediary holding entities and certain dependent related (a) subsidiaries (ii): The amount remaining after deduction, from the amount of total assets, of the amount of loans made to foreign financial institutions, other foreign financial holding entities, certain intermediary holding entities and certain dependent related subsidiaries (iii) (iv) > 50% (iii): The total book value of owned shares of foreign financial institutions, other foreign financial holding entities and certain (b) intermediary holding entities (iv): The amount remaining after deduction, from the amount of total assets, of the amount of loans made to foreign financial institutions, other foreign financial holding entities and certain intermediary holding entities d. Judgment concerning foreign financial holding entities in the event that there are restrictions on the investment of equity by foreign financial institutions There are cases in which, upon the entrance of a financial institution into an overseas market, depending on local restrictions on the investment of equity, possession of greater than 50% of shares is not possible. This reform, in light of such conditions, will implement measures such that foreign financial holding entity criteria are fulfilled in the event that certain criteria are fulfilled, even in cases in which more than 50% cannot be owned due to restrictions on the investment of equity. In the 2017 tax reform, treatment such that, in the event that qualification as a certain financial subsidiary occurred, passive income was excluded from inclusion were established; however, in consideration of the actual business circumstances of financial institutions, revision of the scope of financial subsidiaries to which passive income is not subject to inclusion occurred during this reform. In preparation for the introduction of the new rules in April 2018, it is necessary to prepare early for compliance in tax filing work. Financial services tax alert 22 January

6 6. Domestic/foreign judgment of consumption tax relating to the transfer of paperless securities Under the Consumption Tax Act, consumption tax is imposed on domestic transfers of assets. Furthermore, with regards to the judgment of whether or not a transfer of securities occurred domestically (the domestic/ foreign judgment), the judgment is made according to the location of the respective securities for securities in accordance with the Financial Instruments and Exchange Act, and the location of the institution to which registered national government bonds are located for registered national government bonds. 1 Conversely, because the treatment regarding transfers of paperless securities is not necessarily clear under current laws and regulations, the implications for taxpayers were uncertain. With this reform, the following judgment criteria will be established. i. Securities registered by book-entry transfer institutions (book-entry transfer institutions or similar foreign institutions): the location of the book-entry transfer institution ii. Other: headquarters of the issuer of the respective securities In consideration of the digitization of securities and the continuing advancement of settlement rules, this reform will clarify the treatment relating to the transfer of securities (shares, bonds, investment trust certificates, etc.) under the Consumption Tax Act. It will be necessary to pay attention to the details of treatment with regards to the definition of book-entry transfer institutions, the scope of securities, and the judgement of locations in the event that there is no book-entry transfer institution, as they are clarified at later dates. 7. Revision of the definition of permanent establishments (PE) With regards to international trends concerning PE, PE-related guidelines in the OECD model treaty were revised in November 2017, in light of the BEPS Action 7 Final Report published in October Furthermore, 68 countries agreed to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI), which includes measures to prevent the artificial avoidance of PE status, in June 2017; Japan signed in June 2017 as well. Revisions in light of such international trends will be implemented as a part of this reform. For details relating to the revision of PE rules, please reference the EY Japan tax newsletter 2018 tax reform outline. The following is primarily a comparison of current tax rules and the proposal, and also includes projections regarding the effects on financial institutions. a. Revision of guidelines related to agency PE Current agent PE regulations The following non-residents or foreign entities (non-residents, etc.) listed below in i. to iii. However, independent agents are excluded. i. On behalf of non-residents, etc., persons possessing authority to conclude certain agreements relating to the business and habitually exercising such authority. (However, agents of the same business operator are excluded.) ii. Inventory storage agents iii Order acquisition agents (Independent agents) Persons who themselves independently engage in tasks related to the business for a nonresident, etc. listed above, and who engage in such tasks using ordinary methods Japan tax reform outline Persons habitually concluding contracts relating to the business or habitually playing the principle role leading to the conclusion of contracts and these contracts are for the transfer of the ownership of assets owned by the nonresident etc. will be added to the clause on the left. Furthermore, measures related to agents of the same business operator will be eliminated. Deletion Deletion From the scope of independent agents, persons exclusively or principally acting on behalf of one or two or more persons to which they are closely related (persons in a capital relationship exceeding 50%), will be excluded. For example, with respect to funds, the FSA published the "Q&A for the Legal Independence in determination of whether a Domestic Investment Manager is treated as an Independent Agent and other materials in light of the regulations regarding independent agents introduced in the 2008 tax reform 3, however, it is necessary to heed future trends in how the contents of the Q&A and other materials are effected. 1 Order for the Enforcement of Consumption Tax, Article 6-1(9)(i) and (ii) 2 In general, refers to persons meeting three criteria: legal independence, economic independence, and business normalcy Financial services tax alert 22 January 2018

7 b. Reformulation of exemptions from taxation for foreign partners Because the application of tax treaties gives rise to the possibility of treatment of financial businesses as possessing a PE, measures exempting income attributed to a PE (limited to certain income derived under investment partnership agreement, which is attributed to investors PE) from income tax and corporation tax, to ensure that such treatment does not affect existing tax treatment, will be established. Furthermore, The aforementioned revisions are applicable to income tax for 2019 and thereafter, and to corporation tax (and local tax) for fiscal years beginning on or after 1 January Revision of gift and inheritance taxation relating to general incorporated associations a. Revision of the imposition of gift tax, etc., in the event that a gift, etc. is made to a general incorporated association, etc. Under current tax rules, in the event that an individual gifts, etc., financial assets to a general incorporated association, etc., in those cases in which the application of tax exemption rule does not result in an unreasonable decrease in tax burden, such gifts, etc., will be tax exempt. This reform treats cases meeting none of the criteria for this tax exemption (e.g., a statement limiting the ratio of relatives, etc. in the pool of executives, etc., to equal to or less than 1/3 listed in the articles of incorporation) as taxable gifts, thereby clarifying the regulations. b. Taxation of specified general incorporated associations in the form of inheritance tax Upon the death of an executive of a general incorporated association, etc. (specified general incorporated association, etc.) meeting any of the following criteria, the specified general incorporated association, etc. will be deemed to have acquired from the decedent, via bequeathal, an amount equivalent to an amount calculated by dividing the net assets of the specified general incorporated association by the number of related executives (including the decedent) at the time of death and inheritance tax will be imposed on the specified general incorporation. i. The ratio of number of related executives to the total number of executives exceeded 50% immediately prior to the inheritance. ii. Within five years from the inheritance, the total of periods in which the number of related executives to the total number of executives exceeds 50% is 3 years or greater. The reform of a. and b. listed above will apply to inheritance tax relating to the death of executives of general incorporated associations, etc., on or after 1 April (Certain transitional measures exist.) There is no concept of equity with regards to general incorporated associations, etc. If an individual has a general incorporated association, etc., take possession of the assets that individual possesses, those assets then belong to no one; therefore, even in the event that an inheritance arises due to the death of that individual at a later date, that inheritance will not be subject to taxation in the form of inheritance tax. Excessive inheritance tax countermeasures utilizing such tax treatments are subject to scrutiny; this reform is expected to put a stop to the utilization of general incorporated associations, etc., in manners that deviate from the intention of the rules. 9. Other a. Revision of the judgment period of real estate related entities With regards to the taxation of capital gains of real estate related entities relating to non-resident or foreign entities, in light of the revisions to the OECD model treaty in November 2017, the timing of the judgement on real estate related entities will be revised from the Date immediately before the beginning of the fiscal year of the transfer under current rules to any time within the 365 days preceding the date of the transfer of shares. This revision is applicable to income tax for 2019 and thereafter, and to corporation tax for fiscal years beginning on or after 1 April Financial services tax alert 22 January

8 b. Extension of the application period of tax exemption rules for interest on margins relating to over-the-counter derivative transactions Tax exemption rules for interest on margins relating to over-the-counter derivative transactions were time limited measures scheduled until 31 March 2018; however, this reform, from the perspective of maintaining a stable transaction environment, will extend the application period by three years. c. Interest on payments of substitute money for dormant deposits paid by financial institutions contracted by the Deposit Insurance Corporation of Japan In concert with the enforcement of the Act on Utilization of Funds Related to Dormant Deposits 4 beginning in January 2019, the necessary measures to designate financial institutions as special withholding agents for prefectural inhabitants tax on interest with respect to the amount equivalent to interest on substitute funds such as dormant deposits paid by financial institutions will be established. d. Relaxation of the paid dividend criteria in the conduit criteria for Investment Corporations Under current rules, the deduction of dividends by Investment Corporations is recognized under the condition that in excess of 90% of earnings available for dividends (net profit before tax - deducted items from certain categories) are paid as dividends. From the perspective of revitalizing real estate securities, including investment into foreign real estate, this reform will define the amount of earnings available for dividends utilized for this condition, under the assumption of the amendment of related laws and regulations relating to accounting treatment, as the amount after deduction of the amount of foreign corporation tax paid by the Investment Corporation. e. Revision of the period in which application of special effectiveness testing methods for hedge accounting begins With regards to application of special effectiveness testing methods for hedge accounting, a taxpayer will be allowed to apply the special effectiveness testing method from the fiscal year when the application form is submitted and approved by the tax authorities. It is expected that not only will this enable treatment matching the actual state of risk management as seen by financial institutions, but also to have the effect of lessening administrative burdens related to tax return filings. f. Change of income recognition relating to long-term installment sales In concert with expectations regarding the revision of accounting standards related to recognition of revenue, for both corporation tax and consumption tax, and with respect to sales of assets, etc. corresponding to longterm installment sales, the elective system under which revenue and expenses are calculated on a deferred payment basis will be eliminated. Furthermore, finance lease transactions will be excluded. g. Simplification of procedures for the exemption from filing and payment of stamp duties relating to deposit passbooks With regards to deposit passbooks, a simple payment method at the time of annual approval applications, involving filing and payment of tax based upon the number of accounts opened as of 1 April, is currently recognized; administrative procedures will be simplified by eliminating the need for resubmission of approval applications. 4 Act on Utilization of Funds Related to Dormant Deposits to Promote Public Interest Activities by the Private Sector (Act No. 101 of December 9, 2016) 8 Financial services tax alert 22 January 2018

9 10. Concluding remarks This alert provided an introduction to finance-related tax rules and major reforms specific to financial institutions contained in the FY2018 Tax Reform Outline. Furthermore, although such matters were ultimately not part of these reforms, future items for consideration include the further unification of financial income taxation for individual investors (including derivatives) and the ideal form of imposition of consumption tax on the provision of crossborder services, and will continue to be debated. In addition to confirming the laws and regulations once published and appropriately managing and complying with the details of the reform, it is important to continue to pay close attention to future items for consideration. For additional information with respect to this alert, please contact the following: Contacts Ernst & Young Tax Co. Business Tax Services, Financial Services Group Shinichi Tanimoto Partner Kazuhiro Ebina Partner Ichiro Suto Partner Hiroyuki Nishida Follow us for the latest tax news. Comments or general inquiries regarding this tax newsletter may be directed to our Brand, Marketing and Communications team at EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization and/or one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY s Tax services EY s tax professionals in Japan provide you with deep technical knowledge, both global and local, combined with practical, commercial and industry experience. Our highly regarded tax professionals operate in four major cities in Japan. Our talented people, consistent methodologies and unwavering commitment to quality service help you to build the strong compliance and reporting foundations and sustainable tax strategies that help your business succeed Ernst & Young Tax Co. All Rights Reserved. Japan Tax SCORE This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, law or other professional advice. Please refer to your advisors for specific advice. Financial services tax alert 22 January