2019 Japan tax reform outline

Transcription

1 4 February 2019 Japan tax newsletter Ernst & Young Tax Co Japan tax reform outline 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 Corporate taxation...2 International taxation...8 Individual income taxation and asset taxation...20 Tax administration/other...23 On 14 December 2018, the ruling party (a coalition comprised of the Liberal Democratic Party and Komeito) released the 2019 Tax Reform Outline (below the outline ). This newsletter provides an overview and explanation of the major amendments and revised provisions contained in the outline, which affect such matters as corporate taxation and international taxation. To accomplish the twin goals of the Abe Cabinet, i.e. converting the social security system into a reliable system for all ages which provides comfort to all generations from the young to the elderly and ensuring the nation s fiscal health, the consumption tax rate will be raised to 10% in October In order to smooth the fluctuations in demand that are expected to occur prior to and following the rate hike, sufficient support will be provided in terms of both national budget and tax rules. Tax measures to stimulate automobile and home purchases will be implemented. Furthermore, in order to secure a path for continuous growth amidst the aging of Japanese society, the productivity revolution and human resource development revolution continue to be issues of the highest priority. R&D tax rules will be revised from the perspective of encouraging innovative R&D. Various tax measures to assist small and mediumsized enterprises (SMEs) will be implemented and simultaneously, new tax payment deferment and exemption rules for inheritance tax and gift tax will be established to promote business succession of sole proprietors. Furthermore, transfer pricing taxation rules and earnings stripping rules will also be significantly revised to match the international standards concerning taxation agreed to in the OECD s BEPS project and other forums. Please note that the contents of this newsletter may be partially revised, deleted or added in response to future Diet deliberations on the reform bill.

2 Corporate taxation 1. Revision of R&D tax rules From the perspective of promoting active investment in R&D, R&D tax rules (special corporate tax credits available for conducting experimental research, etc.) will be revised as follows. (1) Gross-amount tax credits (tax credit rules pertaining to R&D expenses) (A) The maximum credit available to certain startups which conduct R&D (Note 1) will be increased to 40% (from the current 25%) of corporation tax of the applicable fiscal year. (B) High expense level tax credits will be abolished as a standalone measure but will be extended for 2 years after integrating it into the gross-amount tax credits as an additional measure which further increases the maximum credit enjoyed by entities with a high level of R&D expenses. The maximum credit will be 10% of corporation tax of the applicable fiscal year. (C) The credit rate curve (calculation formula for tax credit rates) for R&D expenses will be revised. (D) The applicable period of the special measure designating a maximum credit rate of 14% (c.f. the general rate of 10%) will be extended by 2 years. Current rules A maximum of 40% of corporation tax (C) High expense level tax credits (A ) Additional increase of the maximum credit R&D tax rules (maximum credit) Abolishment of high expense level tax credits Extension of A (Elective rules) (Temporary measure) 10% of corporation tax Post-reform A maximum credit of 45% (For startups, a maximum of 60%) (A ) Additional increase of the maximum credit in cases where the ratio of R&D expenses to sales exceeds 10% Temporary measure lasting 2 years (A) Gross-amount tax credits Increased to 40% for startups 25% of corporation tax (A) Gross-amount tax credits Increased to 10% (B) Open innovation tax credits 5% of corporation tax 10% of corporation tax (B) Open innovation tax credits (Prepared based on Key Points of the FY2019 Tax Reform on Economy and Industry, published by the Ministry of Economy, Trade and Industry in December 2018 (hereinafter, METI materials )) 2 Japan tax newsletter 4 February 2019

3 (2) Open innovation tax credits (tax credit rules pertaining to special R&D expenses) Certain research consigned to private-sector companies (including R&D startups (Note 2)) will be added to the list of eligible R&D expenses. The tax credit rate for research consigned to R&D startups and joint research conducted with R&D startups will be 25%, while the tax credit rate for research consigned to private-sector companies will be 20%. In addition, the maximum credit will be increased to 10% (from the current 5%) of corporation tax liability in the applicable fiscal year. Current rules Counterparty is a university or special research institution etc. Counterparty falls under the category Other (private-sector companies etc.) Research consigned to a large enterprise etc. Post-reform Credit rate 30% 20% Not eligible Credit rate (Current rules Post-revision) Joint research with R&D startups 20% 25% Research consigned to large enterprises etc. (Note 3) (Prepared based on METI materials) Not eligible 20% Even if an early stage startup has a cumulative deficit, if it posts a profit in any given fiscal year, it must pay taxes (e.g., in the case of companies with stated capital exceeding JPY100 million). This year s revision (i.e. the increase of the maximum tax credit from 25% of the applicable fiscal year s corporation tax to 40% of the same) will result in an increased amount of cash at hand remaining after such tax payments are made. This increase in cash at hand will act as a source of funds for further R&D investment. Furthermore, the consignment of research to large enterprises, which was formerly ineligible for open innovation tax credits before the revision, will henceforth be eligible for the open innovation tax credit. Use of the open innovation tax credits, whose scope was significantly expanded during the FY2015 tax reforms, stood at JPY300 million in FY2014, but increased to JPY3,900 million in FY2015 and to JPY 4,200 million in FY2016 (Source: Report of Results of the Survey Concerning Application of the Special Measures Concerning Taxation published by the Ministry of Finance (submitted to the Diet in February 2018)). As the application criteria were relaxed in the FY2017 reforms, and the FY2019 tax reforms will increase the maximum tax credit (5% to 10%), it is thought that the importance of open innovation tax credits to companies will continue to increase. (Note 1) Companies established within the previous 10 years and which have NOLs which will be carried over into the next fiscal year (excluding subsidiaries of large enterprises etc.). (Note 2) Eligible companies are startups that receive investments from venture funds that have been certified under the Industrial Competitiveness Enhancement Act or from national university corporations and national research and development agencies that meet certain requirements. (Note 3) Limited to basic research, applied research and R&D for the purpose of utilizing intellectual property, and excludes the mere consignment of R&D operations. Japan tax newsletter 4 February

4 2. Enterprise tax rate To correct the disparity in financial resources between regions, a portion of the corporate enterprise tax under the current rules will be revamped into a new measure named special corporate enterprise tax (name tentative), and this special corporate enterprise tax paid to prefectures will temporarily be deposited into the national treasury and then reallocated to each prefecture in accordance with population ratios and other factors. (1) For fiscal years beginning on or after 1 October 2019, the standard tax rates of the income levy and revenue levy of corporate enterprise tax will be reduced, and the special corporate enterprise tax will be introduced. The special corporate enterprise tax is a national tax levied on taxpayers obliged to pay corporate enterprise tax, and the tax returns therefor must be filed with and paid to relevant prefectures alongside corporate enterprise taxes. In terms of standard tax rates, the sum of the post-revision income levy rates of the corporate enterprise tax and special corporate enterprise tax rates will be identical to the income levy rate of the corporate enterprise tax under the current rules. (Standard tax rates of the corporate enterprise tax and special corporate enterprise tax) Ordinary companies with stated capital exceeding JPY100 million (income exceeding JPY8 million per annum) Ordinary companies with stated capital equal to or less than JPY100 million (income exceeding JPY8 million per annum) Companies subject to taxation based on revenue amount Corporate enterprise tax Prereform (a) Postreform (b) Special corporate enterprise tax Newly introduced (c) Post-reform corporate enterprise tax (b) + special corporate enterprise tax (c) 3.6% 1% 260% of (b) 3.6% 9.6% 7% 37% of (b) 9.59% 1.3% 1% 30% of (b) 1.3% (Prepared based on FY2019 Local Tax Reforms (Draft), published by the Ministry of Internal Affairs and Communications) (2) With regard to the tax rate limitations on the income levy for ordinary companies with stated capital exceeding JPY100 million (i.e. companies to which pro forma standard taxation based on companies size is applied), a measure will be established to raise said limits to 1.7 times the standard tax rate (currently 1.2 times the standard tax rate). 4 Japan tax newsletter 4 February 2019

5 3. Revision of qualification criteria for reorganization tax rules (1) Downstream merger conducted after a parent company has converted a subsidiary into a wholly-owned subsidiary In the event a company which has become a wholly-owned subsidiary of another company through share exchanges or other methods is projected to conduct a downstream merger in which the wholly-owning parent company is treated as the acquired company, the determination of tax-qualifying criteria, such as the control relationship continuity criteria, shall be made using the relationship at the time immediately prior to said merger. Step 1 Step 2 Details Implementation of share exchange whereby wholly-owning parent company P1 converts company S1 into a wholly-owned subsidiary Company P1 converts company S1 into a wholly-owned subsidiary Eligible for treatment as a tax-qualified reorganization even in cases where a merger (downstream merger) is conducted through which company S1 becomes the surviving company [100% controlling relationship] Company P1 Shareholders Company P1 Shareholders Diagram Company S1 Ceases to be a shareholder through the implementation of share exchanges Downstream merger Company S1 (Prepared based on METI materials) For the situations depicted in the above diagrams, in cases wherein company S1 holds the licenses and approvals, etc. necessary to operate business, there is a large demand for downstream mergers which enable company S1 to be the surviving company. In the future, reorganizations such as these will be able to be conducted with ease without concern as to whether they are qualified or non-qualified from a tax perspective. (2) Reorganizations using the shares of a wholly-owning parent company that indirectly owns shares With regard to tax-qualifying requirements relating to mergers, company splits and share exchanges, and the requirements regarding the deferral of capital gain recognition from the transfer of old shares, the shares (Note) of the company that indirectly owns all of the outstanding shares of the acquiring company will be added to the shares of the parent company of the acquiring company as qualified consideration in a triangular merger etc. Details Prior to the reorganization As consideration for the absorption-type merger whereby company S2 acquires company S3, shares of company P1, which indirectly owns 100% of the shares of company S2, are transferred to company P2 After to the reorganization Company S2, which acquired company S3, remains as the surviving company and company P2 becomes a new shareholder of company P1 alongside the general shareholders General shareholders General shareholders Company P2 Company P1 Company P2 Company P1 Diagram Company P1 shares Company S1 Company P1 shares Company S1 (Prepared based on METI materials) Company S2 [100% controlling relationship] Absorptiontype merger Company S3 New company S2 [100% controlling relationship] Japan tax newsletter 4 February

6 (Note) With regard to certain mergers conducted between companies within a corporate group, in the event that the shares of certain foreign companies indirectly owning all of the outstanding shares of the acquiring company (hereinafter, specially-related foreign company ) are provided as consideration, the merger will not be considered to have met the tax-qualification requirements. Furthermore, in the event that a merger in which shares of a specially-related foreign company are provided as consideration is not deemed as a qualified merger, then the capital gains on old shares owned by shareholders at the time of the merger will be taxed. In the event that company P1 in the above diagram is a listed company, there are cases where company P2, the shareholder of company S3 (the non-surviving entity), desires the acquisition of shares of company P1, which have higher liquidity (convertibility to cash). After the revision, even if consideration for this triangular merger is paid through the provision of company P1 shares to company P2, said merger will fulfill the qualification requirements. 4. Revision of the scope of enterprises categorized as large enterprises (1) With regard to SMEs issuing shares that are partnership property of investment limited partnerships (referred to as business succession funds ) in relation to certification of business restructuring investment plans under the Small and Medium-sized Enterprises Business Enhancement Act, determination of whether an SME is deemed to be a large enterprise (i.e. enterprises to which SME tax rules such as the following cannot be applied: The SME investment tax incentive, special depreciation in the event specified SMEs acquire management capability enhancement equipment, and SME business enhancement tax rules) will be conducted by excluding the shares owned by the Organization for Small & Medium Enterprises and Regional Innovation (categorized as a large enterprise) when it has invested in said business succession fund. (2) With respect to the determination of enterprises categorized as large enterprises, which are not considered as SMEs that are qualified for application of various special tax measures for SMEs provided for in the Act on Special Measures Concerning Taxation, the following companies will be added to the scope of large enterprises. (A) Wholly-owned subsidiaries of large enterprises (stated capital of JPY500 million or more) (B) Companies whose outstanding shares or investments are all owned by multiple large enterprises within a 100% capital relationship group Due to the measure in (2) above, companies such as company S2 which were qualified for application of various tax incentives since they were deemed as SMEs under the Act on Special Measures Concerning Taxation despite the fact that they did not qualify as SMEs under the Corporation Tax Act, are expected to lose eligibility for the application of various tax incentives. Company P (stated capital of JPY500 mil.) 100% Company S1 (stated capital of JPY100 mil.) 100% Company S2 (stated capital of JPY100 mil.) Company S1 Company S2 (Prepared based on METI materials) Corporation Tax Act Non-SME Non-SME Act on Special Measures Concerning Taxation Non-SME (Pre-revision) SME (Post-revision) Non-SME 5. Revision of requirements in relation to deductible performance-linked compensation Requirements in relation to procedures for deductible directors performance-linked compensation paid by companies will be revised as follows. (1) [Revised] Procedures concerning decisions made by the compensation committee and compensation advisory committee (hereinafter, compensation committee(s) etc. ) (A) The requirement that companies that have set up compensation committee(s) etc. not employ executive directors as members of the compensation committee(s) etc. will be removed, and a new requirement stipulating that executive directors cannot participate in resolutions concerning decisions concerning their own performance-linked compensation will be added. (B) New requirements will be added such that a majority of the members of compensation 6 Japan tax newsletter 4 February 2019

7 committee(s) etc. must be independent outside directors and that the approval of all independent outside directors who are members of said committee(s) etc. must be obtained concerning decisions on performance-linked compensation. (2) [Abolished] Procedures concerning decisions made by companies that have a board of corporate auditors The following two procedures will be removed from the scope of procedures which qualify as procedures to approve directors performance-linked compensation that are deemed as deductible expenses: (A) A decision made by the board of directors of a company that has a board of corporate auditors where appropriate documents have been submitted and approval has been obtained from the majority of the corporate auditors; and (B) A decision made by the board of directors of a company that has an audit committee where approval has been obtained from the majority of audit committee members. 6. Other (1) Introduction of special depreciation rules concerning disaster prevention and mitigation equipment for SMEs For SMEs that have received certification of their business continuity capability enhancement plans or collaborative business continuity capability enhancement plans (names tentative) under the Small and Medium-sized Enterprises Business Enhancement Act and that have acquired specified business continuity capability enhancement equipment (e.g. private electric generators, data backup systems and fire shutters) in relation to said business continuity capability enhancement plans or collaborative business continuity capability enhancement plans for said certification by 31 March 2021, and which have used said equipment for said business purposes, a tax measure will be introduced to allow a special depreciation of 20% of the equipment acquisition price. (2) Revision of requirements for special measures for taxation of investment companies investing in silent partnerships With regard to special measures pertaining to taxation of investment companies and special measures pertaining to taxation of trustee companies in relation to specified investment trusts, the requirement limiting ownership to less than 50% of the outstanding shares of or investments in other companies will be revised so that investments in other companies includes investments in silent partnerships (Tokumei Kumiai or TK in Japanese). (3) Extension of applicable periods (A) The applicable period of special measures for the reduction of the corporation tax rate of SMEs (15% of income equal to or less than JPY8 million per annum) will be extended by two years. (B) The applicable period of the SME investment tax incentive and SME business enhancement tax rules and other measures will be extended by two years upon the revision of certain application requirements etc. Japan tax newsletter 4 February

8 International taxation Revision of earnings stripping rules The earnings stripping rules under the current taxation system are based on the same concept as that of Action 4 of the Base Erosion and Profit Shifting (BEPS) Final Report. However, since there are discrepancies between the two rules in terms of qualified interest categories, the definition of adjusted income and the standard maximum deductible amount, revisions will be made to the current Japanese rules to match Action 4 of the BEPS Final Report while taking into consideration its impact on normal economic activities (e.g. loans from domestic (i.e. Japanese; same hereinafter) banks). 1. Overview of the rules An overview of the current earnings stripping rules is as follows. Maximum deductible Adjusted income (B) amount Related party net interest expenses only (A) *Interest included in the Japanese taxable income of the recipient is excluded Other (Depreciation/amortization and domestic and foreign dividend income) Taxable income in the applicable fiscal year (income before taxes) Adjusted income 50% C Deductible Non-deductible (*) * Non-deductible interest expenses from a given year can be carried over and deducted over the subsequent 7 year period. Enforcement: April 2013 An overview of the earnings stripping rules after the revision is as follows. Maximum deductible Adjusted income (B) amount Net interest expenses (A) *Interest included in the Japanese taxable income of the recipient is excluded Other (depreciation) Taxable income in the applicable fiscal year (income before taxes) Adjusted income 20% C Deductible Non-deductible (*) * Non-deductible interest expenses from a given year can be carried over and deducted over the subsequent 7 year period. Enforcement: April 2020 (A) Qualified interest (B) Adjusted income (C) Standard maximum deductible amount Requirements for exemption Current rules Related party net interest expenses only (interest included in the Japanese taxable income of the recipient is excluded) Income before deduction of interest, taxes and depreciation/ amortization expenses (EBITDA) (includes non-taxable domestic and foreign dividend income) (Prepared based on METI materials) Revision Net interest expenses (including that paid to or received from third parties; interest included in the Japanese taxable income of the recipient is excluded) Income before deduction of interest, taxes and depreciation/ amortization expenses (EBITDA) (does not include non-taxable domestic and foreign dividend income) 50% 20% The amount of related party net interest expenses is less than or equal to JPY10 million The amount of interest expenses paid to related parties is 50% or less of the total amount of interest expenses The amount of net interest expenses is less than or equal to JPY20 million The total amount of net interest expenses of all domestic group companies (share ownership ratio in excess of 50%) is 20% or less of total adjusted income 2. Qualified net interest expenses and non-qualified interest expenses Interest qualifying under the revised earnings stripping rules will equal the amount remaining (hereinafter, amount of qualified net interest expenses ) after deducting from the total amount of qualified net interest expenses for the applicable fiscal year (refers to the amount remaining after deducting the non-qualified interest expense amount from the interest expense amount; same hereinafter), the total amount of interest income calculated as corresponding to the aforementioned qualified net interest expenses (hereinafter, total amount of deductible interest income ). The aforementioned non-qualified interest expense amount refers to the following amounts prescribed for each category of interest expenses also described below. 8 Japan tax newsletter 4 February 2019

9 (1) The amount of interest expenses described below excluding interest expenses described under (2) (A) The amount of interest expenses included in the Japanese taxable income of the recipients of the interest expenses (B) The amount of interest expenses paid to certain public corporations (C) The amount of interest expenses pertaining to bond future agreements where there is a clear correspondence between the borrowing and the lending (excluding the amounts described under (A) and (B)) (2) Specified bond interest (refers to interest expenses paid to unrelated parties pertaining to bonds (excluding bonds whose acquirer(s) does/do not constitute the substantial majority) issued by said company; hereinafter the same.) Any of the following amounts per bond (A) The amount of specified bond interest that is withheld at source during payment or included in the domestic taxable income of the recipient of that specified bond interest, and the amount of specified bond interest paid to certain public corporations. (B) The amount prescribed below, depending on the category of the bond as defined below i. Bonds issued in Japan: Amount equivalent to 95% of the amount of specified bond interest ii. Bonds issued overseas: Amount equivalent to 25% of the amount of specified bond interest Under the current rules, interest expenses paid to foreign related parties are deemed as qualified net interest expenses, but in Action 4 of the BEPS Final Report, both domestic and foreign interest expenses, regardless of whether they are paid to related parties or to unrelated parties, are deemed qualified interest expenses. After the revision, qualified interest expenses will, in practice, be the amount of interest expenses paid to foreign related parties and foreign unrelated parties as a result of consideration given towards the impact on normal economic activities (e.g. loans from domestic banks). In other words, in comparison to conditions before the revision, there will be the addition of interest expenses paid to foreign unrelated parties. 3. Adjusted income In the calculation of adjusted income, both the amount of non-qualified dividend income excluded from taxable income and the amount of non-qualified dividends received from foreign subsidiaries excluded from taxable income will be excluded from the amounts added to the income of the applicable fiscal year, and non-deductible income tax amounts that are deducted from corporation tax amounts will be excluded from the amounts deducted from the income of the applicable fiscal year. Furthermore, necessary measures will be established for the calculation of adjusted income of operators of silent partnership (Tokumei Kumiai or TK in Japanese) agreements. Under the current rules, the amount of non-qualified dividend income excluded from taxable income and the amount of non-qualified dividends received from foreign subsidiaries excluded from taxable income are added to the income of the applicable fiscal year. However, these rules will be revised in order to realign them with recommendations provided in Action 4 of the BEPS Final Report, which is not to make adjustments for tax-exempt income. Japan tax newsletter 4 February

10 4. Standard maximum deductible amount In the event that qualified net interest expenses exceed 20% of adjusted income in the applicable fiscal year (from the current 50%), the amount equivalent to the amount in excess of said limit will not be included in deductible expenses. The standard fixed ratio under current Japanese tax rules is 50% which exceeds the best practice range for standard fixed ratios recommended in Action 4 of the BEPS Final Report set between 10% to 30%. Therefore, tax rules will be revised to lower said ratio to 20%. 5. Application exemption criteria The earning stripping rules will not be applied when any of the following criteria are met. (1) The amount of qualified net interest expenses in the applicable fiscal year is JPY20 million or less (from the current JPY10 million or less) (2) The ratio of the amount under (A) in the applicable fiscal year to the amount under (B) is 20% or less (A) The amount remaining after deducting the total amount of qualified net interest income (refers to the amount remaining after deducting the total amount of qualified interest expenses from the total amount of deductible interest income) of a domestic company* from the total amount of qualified net interest expenses (B) The amount remaining after deducting the total amount of adjusted losses (refers to the amount less than zero in the event that an amount less than zero is derived from the calculation of adjusted income) of a domestic company* from the total amount of adjusted income * Domestic companies refers to any company located in Japan and other companies located in Japan that are related to said company through ownership of more than 50% of outstanding shares (limited to companies whose start date and last date of a fiscal year both respectively equal the start date and last date of the fiscal year of said domestic company). Under the current rules, a de minimis standard exempting companies from application of the earning stripping rules has been established for companies whose qualified net interest expenses equal JPY10 million or less. In addition, a standard has been established for companies whose qualified interest is equal to or less than 50% of interest expenses, exempting such companies from application of the earning stripping rules. These revisions will increase the de minimis standard from JPY10 million to JPY20 million. Furthermore, the standard for companies whose qualified interest is equal to or less than 50% of interest expenses will be abolished and a new standard for holding companies will be established as described in (2) above. 6. Amount of deductible excess interest (1) In the event that qualified net interest expense is less than 20% of adjusted income of the applicable fiscal year (from the current 50%, as mentioned in 4. above), and if there were any amounts which were treated as non-deductible interest in any fiscal years beginning within the previous 7 years due to application of earnings stripping rules (hereinafter, excess interest ), then an amount equivalent to said excess interest can be included in deductible expenses not to exceed a limit which equals the difference between the qualified net interest expenses and 20% (from the current 50%) of adjusted income. (2) A revision will be made to allow application of (1) above, even if the applicable amounts are indicated in documents attached to amended tax returns or requests for correction. There is no change to the rule that excess interest can be carried over for 7 years. 10 Japan tax newsletter 4 February 2019

11 7. Application period The above revisions (excluding 6. (2)) are applicable to corporation tax for fiscal years beginning on or after 1 April The above revision described in 6. (2) is applicable to corporation tax whose submission deadlines for final tax returns, etc. is on or after 1 April Furthermore, although the aforementioned revisions are related to national taxation, the necessary local tax (corporate inhabitant tax and corporate enterprise tax) measures will also be established in accordance with the treatment in national taxation concerning the revision of the earning stripping rules. Although earning stripping rules will be revised to not include non-qualified domestic and foreign dividend income (excluded from taxable income) in adjusted income, and the standard maximum deductible amount will be lowered from 50% to 20%, through revisions to limit qualified interest, in practice, to interest expenses paid to foreign parties and the introduction of the rule described in 5. (2) above, the new rules give due consideration to the economic activities of Japanese companies. On the other hand, this will require foreign companies in Japan which have large amounts of loans from overseas, companies employing structured finance products, and companies issuing bonds overseas to exercise caution. Revision of transfer pricing tax rules In view of the amendments made to the BEPS Report and the OECD Transfer Pricing Guidelines (hereinafter, TPG ), revisions will be made to the transfer pricing tax rules in Japanese laws concerning methods for calculating arm s length prices and transactions of certain hard-to-value intangible assets. 1. Clarification of the definition of intangible assets subject to transfer pricing tax rules Intangible assets subject to transfer pricing tax rules are said to be assets other than tangible assets and financial assets (cash, deposits and securities) that are owned by companies, and for which consideration should be paid in the event they are transferred or lent out in accordance with the terms of ordinary transactions conducted between independent business operators. The TPG provides that the word intangible is meant to address something which is not a physical or a financial asset, which is capable of being owned or controlled for use in commercial activities and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances. In response, the reforms will clarify the scope of intangible assets for tax purposes. These provisions are thought to define intangible assets under the transfer pricing tax rules. 2. Revision of methods for calculating arm s length prices (TPMs) The discounted cash flow method (DCF method) will be added to the methods allowed for the calculation of arm s length prices (hereinafter, transfer pricing methods or TPM ). The DCF method is recognized as an effective TPM for intangible asset transactions when comparable transactions allowable under the TPG cannot be identified. Along with this revision, in the event companies do not submit documents deemed necessary for calculating arm s length prices, the DCF method will be added to TPMs that can be employed in the calculation of estimated taxation by National Tax Agency employees to calculate an amount deemed as the arm s length price (based on information that would have been available to them at the time the foreign related transactions were conducted). TPMs proposed by the TPG and the necessity of referencing comparable transactions. TPM 1. Comparable uncontrolled price method (CUP method) 2. Resale price method (RP method) 3. Cost plus method (CP method) 4. Transactional net margin method (TNMM) 5. Transactional profit split method 6 Other methods TPMs that reference comparable transactions Cannot be used when there are no comparable transactions Expansion of TPG concerning the DCF method during the BEPS Project Prepared based on Ministry of Finance Explanatory Materials (Concerning International Taxation) (2 of 2), a document prepared for the 20th Tax Commission Meeting (7 November 2018) Japan tax newsletter 4 February

12 The TPG recommends use of the DCF method as the TPM for intangible asset transactions and other transactions. In practice, although there are cases wherein the DCF method is used to calculate transfer prices of intangible assets, in Japan, legal treatment of the DCF method is unclear. Revisions will be made for this reason, but in the future, public announcements providing clear guidance concerning the application of the DCF method are desired. 3. Introduction of price adjustment measures pertaining to transactions involving hard-to-value intangibles (specified intangible asset transactions) With regard to transactions involving specified intangible assets (hereinafter, specified intangible asset transactions ), in the event that there is a difference between the forecasts used as a base for the calculation of arm s length prices and the results, the District Director of the Tax Office will be given the authority to make corrections by deeming as the arm s length price the amount calculated using the most appropriate TPM for the specified intangible asset transaction under review, after taking into consideration the results of the specified intangible asset transaction under review and the probability of the occurrence of the events that caused the difference. However, notwithstanding the foregoing are cases where the difference between the foregoing calculated amount and initial transaction price does not exceed 20%. (1) Specified intangible assets Specified intangible asset refers to an intangible asset that meets all of the following requirements. (A) Is unique and has significant value (B) Revenue forecasts are used as a base for the calculation of its arm s length price (C) Projections used as a base for the calculation of its arm s length price are deemed to be uncertain The definition of specified intangible assets is thought to be largely identical to the definition of hard-to-value intangibles (HTVI) described in the TPG. Although many countries (e.g. the UK, the Netherlands, Australia and New Zealand) are thought to be in line with the TPG, caution is necessary when conducting transactions with countries that have established their own rules concerning intangible asset transactions (e.g. the US and Germany). Public announcements providing clear guidance concerning specified intangible assets are desired. (2) Application exemption criteria (Note) This price adjustment measure will not be applied in cases wherein National Tax Agency employees request submission of documents described in (A) or (B) below from a company and the company submits said documents within a fixed period following the request date. (A) Documents described below i. Documents that include details of forecasts used as a base for the calculation of arm s length prices of specified intangible asset transactions ii. Documents that provide evidence that the events that caused the difference between said forecasts and results were natural disasters or other similar events and that it was extremely difficult to forecast its occurrence at the time of transaction, or that the arm s length price was calculated after appropriately taking into consideration the probability of the occurrence of said events at the time of transaction (B) Documents that provide evidence that the difference between the forecast revenue amount between the period lasting from the first day of the fiscal year that includes the first day when unrelated party revenue was generated through the use of a specified intangible asset until 5 years have passed from the first day of the first fiscal year and the actual revenue amount does not exceed 20% If a company submits the documents described in (B) above, the price adjustment measure will not be applied to days subsequent to the submission date. 12 Japan tax newsletter 4 February 2019

13 Companies are required to prepare documents that include details of forecasts used in the calculation of the arm s length price at the time of transaction when conducting a specified intangible asset transaction. Furthermore, in the event an unforeseeable event occurs in fiscal years after the transaction and the actual revenue greatly deviates from the forecast revenue, the company is required to prepare documents that include analyses of the causes. 4. Extension of the period for a correction decision relating to transfer pricing tax rules The periods for correction decisions and requests for the correction of corporation tax relating to transfer pricing tax rules will be extended to seven years (from the current six years). Caution is necessary not only for specified intangible asset transactions or when selecting the DCF method as a TPM, but also regarding the fact that the general period for correction decisions etc. under transfer pricing tax rules will be extended by one year. 5. Establishment of the difference adjustment method With regard to adjustments of differences made in relation to a TPM for referencing the profit margin of comparable transactions, when necessary adjustments cannot be made due to the fact that assessing quantitative differences is extremely difficult, use of a method based on the interquartile method will be allowed for adjusting such differences. Public announcements providing clear guidance concerning specific operation methods are desired, such as explanations of the type of situations deemed as cases when necessary adjustments cannot be made due to the fact that assessing quantitative differences is extremely difficult. 6. Application period The above revisions are applicable to corporation tax for fiscal years beginning on or after 1 April 2020 and income tax for 2021 or after. Furthermore, although the aforementioned revisions are related to national taxation, the necessary local tax (individual inhabitant tax, corporate inhabitant tax and corporate enterprise tax) measures will also be established in accordance with the treatment in national taxation concerning the revisions of the transfer pricing tax rules. Revision of foreign subsidiary income inclusion taxation rules (CFC rules) 1. Shelf companies The following foreign related companies will be excluded from the scope of shelf companies (or paper companies in Japanese). Even if companies are excluded from the scope of shelf companies as a result of qualifying as foreign related companies under (1) to (3), there may be cases when they are classified as cash boxes. Furthermore, foreign related companies with an effective tax rate of less than 20% will be excluded from application of this revision. In addition, it is necessary to heed future developments concerning whether there will be requirements to attach documents to final tax returns to fulfill the exemption requirements described below, as was required for exemption under the former tax rules, or whether submission of documents will be required each time the tax authorities request documents that show that requirements are being met as is the case with the presumptive provisions under the current tax rules. Japan tax newsletter 4 February

14 (1) Certain foreign related companies which are holding companies (A) A foreign related company whose main business is to own shares of subsidiaries and where more than 95% of its assets are comprised of shares of subsidiaries and certain cash and deposits and where more than 95% of its income is comprised of dividends from subsidiaries and certain interest on deposits (Note) Subsidiary above refers to a foreign company located in the same country as the head office of the foreign related company under review and of which 25% or more shares are owned by said foreign related company. The types of shelf companies thought to be excluded from controlled foreign corporation (CFC) rules (i.e. will no longer be deemed as shelf companies) are as portrayed in figure 1. Figure 1 Domestic company (Note 1) The foregoing specified subsidiary refers to a foreign company partially subject to CFC rules located in the same country as the head office of the foreign related company under review or other non-business operating companies related to the business operating company under review. (Note 2) The foregoing business operating company refers to a foreign related company that fulfills the economic activity criteria and the directors and employees of its head office are engaged in carrying out all operations ordinarily deemed as necessary to appropriately execute its main business. The same applies in (2). The types of shelf companies thought to be excluded from CFC rules (i.e. no longer deemed as shelf companies) are as portrayed in figure 2. Figure 2 Japan Country X Domestic company Foreign related company Japan Country X Shelf company Subsidiary 25% or higher Foreign related company (Business operating company) Shelf company (Non-business operating company) Foreign related company partially subject to CFC rules (Specified subsidiary) (B) A foreign related company whose main business is the ownership of shares of specified subsidiaries and which meets all required criteria including that its businesses are managed, controlled and operated by a business operating company that is located in the same country as the head office of said foreign related company, and said foreign related company fulfills functions indispensable for said business operating company to execute business in said country; furthermore, more than 95% of said foreign related company s assets are comprised of shares of specified subsidiaries and certain cash and deposits and more than 95% of its income is comprised of dividends from specified subsidiaries, certain consideration received from share transfers of specified subsidiaries and certain interest on deposits (referred to as a non-business operating company in (B)) 14 Japan tax newsletter 4 February 2019

15 While a foreign related company that falls under (A) is subject to application of the foreign subsidiary income inclusion taxation rules (CFC rules) under the current tax system, dividends received from companies that fulfill requirements such as share ownership ratios of 25% or more will not be included in the calculation of the applicable amount pertaining to said foreign related company and as a result, income inclusion taxation (or unitary taxation) will not occur for said amount. It is thought that this measure was established after taking into account the fact that income inclusion taxation does not occur even under the current rules. Moreover, in the event a foreign related company that falls under (A) transfers its subsidiary shares, it will become difficult to fulfill the income requirements therein. On the other hand, since income requirements under (B) include certain consideration received from share transfers of specified subsidiaries, it will become easier for a foreign related company to fulfill said requirements. However, this category is subject to the following additional requirements in comparison to (A). (i) Main business is the ownership of shares of specified subsidiaries (refer to Note 1 for requirements of a specified subsidiary) (ii) Its businesses are managed and controlled by a business operating company located in the same country as its head office (refer to (Note 2) for requirements of a business operating company) (iii) Fulfills functions indispensable for said business operating company to execute business With regard to (iii), it is necessary to heed future developments since it is currently unclear what functions specifically are recognized by these rules (the same applies for (2) and (3)). (2) Certain foreign related companies relating to the ownership of real estate (A) A foreign related company whose main business is to own certain real estate located in the same country as that of its head office or shares of specified subsidiaries and which meets all required criteria including that its businesses are managed, controlled and operated by a business operating company located in the same country, and said foreign related company fulfills functions indispensable for said business operating company to execute business (limited to the real estate business) in said country; furthermore, more than 95% of said foreign related company s assets are comprised of said real estate, shares of specified subsidiaries and certain cash and deposits and more than 95% of its income is comprised of income earned from said real estate and from shares of specified subsidiaries, and certain interest on deposits (referred to as a non-business operating company in (A)) (Note) The foregoing specified subsidiaries refers to other non-business operating companies related to the business operating company under review. The types of shelf companies thought to be excluded from controlled foreign corporation (CFC) rules (i.e. will no longer be deemed as shelf companies) are as portrayed in figure 3. Figure 3 Japan Country X Domestic company Shelf company (Non-business operating company) Shelf company (Non-business operating company/ specified subsidiary) Foreign related company (Business operating company) Real estate Japan tax newsletter 4 February

16 (B) A foreign related company whose main business is to own real estate located in the same country as that of its head office and actually used by a business operating company located in the same country as the head office of said foreign related company and which meets all required criteria including that its businesses are managed, controlled and operated by said business operating company; furthermore, said foreign related company fulfills functions indispensable for said business operating company to execute business in said country and more than 95% of said foreign related company s assets are comprised of said real estate and certain cash and deposits and more than 95% of its income is comprised of income earned from said real estate and certain interest on deposits. It is thought that type (A) was established to cover foreign related companies engaged in the real estate business owning real estate for the purpose of selling or lending them to third parties, and type (B) to cover foreign related companies that own real estate for its own use such as an office building. Moreover, if certain requirements are fulfilled, foreign related companies whose main business is to own shares of specified subsidiaries (intermediary holding companies; refer to the note for criteria concerning specified subsidiaries) are also allowed under type (A), while such ownership is not allowed under type (B), since it is limited to foreign related companies whose main business is to own real estate. Concerning type (B), it is thought that the requirements for matters other than real estate are roughly the same as those described in 1. (1) (B) above. (3) Certain foreign related companies relating to resource development and other projects A foreign related company whose main business is the ownership of shares of specified subsidiaries, provision of funds procured from unrelated parties to specified subsidiaries or ownership of real estate located in the same country as that of its head office, and which meets all required criteria including that its businesses are managed, controlled and operated by a business operating company located in the same country 16 Japan tax newsletter 4 February 2019 and said foreign related company fulfills functions indispensable for said business operating company to execute businesses to develop or establish resources, such as petroleum or natural gas, or social capital in said country (referred to as resource development projects in (3)); furthermore, more than 95% of said foreign related company s assets are comprised of shares of specified subsidiaries, certain loans provided to specified subsidiaries, said real estate and certain cash and deposits and more than 95% of its income is comprised of income earned from shares of specified subsidiaries, said loans and said real estate, and certain interest on deposits (Note 1) The foregoing specified subsidiaries refers to foreign companies located in the same country as the head office of the foreign related company under review and of which 10% or more of shares are owned by said foreign related company, and they fulfill functions indispensable for the business operating company under review to carry out resource development projects in said country. (Note 2) The foregoing business operating company refers to a foreign related company that fulfills the economic activity criteria and whose directors and employees of its head office are engaged in carrying out all operations ordinarily deemed as necessary to appropriately execute resource development projects. In addition, it also includes other foreign companies located in the same country as the head office of said foreign related party and where the directors and employees of said other foreign companies jointly engage in carrying out all of the foregoing operations. The types of shelf companies thought to be excluded from controlled foreign corporation (CFC) rules (i.e. will no longer be deemed as shelf companies) are as portrayed in figure 4. Figure 4 Domestic company Japan Country X Shelf company (Non-business operating company) Functions indispensable for executing resource development projects (specified subsidiary) Resources 10% or higher Shelf company (Non-business operating company) Provision of funds Foreign related company (Business operating company)