This chapter is based on information available up to 1 January 2010. Introduction Taxes in Japan are imposed by both the national government and local authorities. Companies are subject to corporation tax (national income tax), business tax (local tax) and prefectural and municipal inhabitant taxes (local tax). A size-based business tax is also payable by a company with capital exceeding. In addition, a special family company tax applies to certain closely held companies. Capital gains are treated as ordinary income and subject to income tax, and as such there is no separate capital gains tax. A VAT-style consumption tax applies. Employers are also required to make social security contributions. Corporation tax is imposed under the Corporation Tax Law (Hojinzei Ho, Law 34 of 1965), while withholding tax is levied under the Income Tax Law (Shotokuzei Ho, Law 33 of 1965) and consumption tax is levied under the Consumption Tax Law (Shohizei Ho, Law 108 of 1987). Local tax is assessed by each local authority in accordance with the Local Tax Law (Chihozei Ho, Law 226 of 1950), which provides the framework for the basic outlines and limits of local taxes. These laws are usually amended every year. The primary legislation is supplemented by numerous cabinet orders and administrative regulations and guidance. National taxes are administered, levied and collected by the National Tax Agency (NTA). The currency is the Japanese yen ( ). 1. Corporate Income Tax 1.1. Type of tax system Japan has a classical system of corporate taxation. Profits are taxed at corporate tax rates at the corporate level and may be taxed again in the hands of its shareholders when they are distributed. However, dividends from domestic corporations may be fully or partly exempt under the Dividend Received Deduction rule (see 2.2.), and dividends from certain foreign corporations may be 95% or fully exempt under the Foreign Dividend Exclusion rule (see 6.1.1.) and the anti-tax haven rule (see 7.4.). Individual shareholders may be entitled to a credit for dividends received. 1.2. Taxable persons Corporate tax is levied on both domestic and foreign companies as well as certain types of trusts. Public corporations (koukyo hojin) are fully exempt from corporate tax, while public interest corporations (koeki hojin) are exempt from corporate tax if the income is not derived from profit-making activities. This chapter is restricted to Japanese-incorporated joint-stock companies (kabushiki kaisha) and limited liability companies (godo kaisha), other than tax-exempt companies such as public corporations and public interest corporations. These entities are referred to in this chapter as companies. The various forms of partnerships which do not have legal personalities (general and silent partnerships, investment limited partnerships and limited liability partnerships) are transparent for tax purposes in general. 1.2.1. Residence A company is resident in Japan if its head office or main office is in Japan. The effective place of management is not relevant. A resident company is referred to as a domestic company. 1.3. Taxable income 1.3.1. General Domestic companies are subject to corporation tax on their worldwide income. Foreign companies operating through a branch or any other permanent establishment are, in principal, subject to corporation tax on Japanesesource income only (see 6.2.). All types of income and capital gains are not separately categorized for tax computation purposes. In general, tax is levied on total corporate net income, after adjusting annual profits and losses in accordance with tax rules. Annual profits and losses are calculated based on Japanese generally accepted accounting principles on an accruals basis. 1.3.2. Exempt income See 2.2. for exemptions on dividends from domestic companies, and 6.1.1. and 7.4. for exemptions on dividends from foreign companies. 1.3.3. Deductions General business expenses are tax deductible if the expenses are wholly and exclusively incurred for business purposes. In general, accrued/prepaid expenses are deductible if the services for such expenses have been provided and the amount can be reasonably estimated. 539
Corporate Taxation Dividends are not deductible except in certain limited cases such as dividends from a tokutei mokuteki kaisha (TMK, a special purpose company established under the Japanese Asset Liquidation Law) or a toshi hojin (TH, a special purpose company established under the Investment Trust and Investment Corporation Act) under certain conditions. Interest and royalties are generally deductible. Periodic directors remuneration in a flat amount, previously reported fixed-amount remuneration for directors which is not periodical remuneration, and profit-related compensation for directors satisfying certain conditions are generally deductible. However, remuneration other than these, or directors remuneration exceeding a reasonable level, is not deductible. Companies with paid-in capital of not more than 100 million are allowed to deduct 90% of entertainment expenses, up to a maximum deduction of 5.4 million for fiscal years ending on or after 1 April 2009 (previously, 3.6 million). Companies with paid-in capital of more than are not allowed any deduction for entertainment expenses. All donations and charitable contributions made to national or local governments are fully deductible while such contributions to other organizations are subject to a limit on deduction, calculated based on the amount of paid-in capital and taxable income for the fiscal year. No deductions are allowed in respect of donations made to overseas related parties. 1.3.4. Valuation of inventory Inventory must be recorded at its actual cost of acquisition or manufacturing at the time of acquisition. The valuation methods allowable for tax purposes are: the cost method (specific identification, FIFO, weighted average, moving average, recent purchase, or retail method); or the lower of cost or market value method. A company must apply the same valuation method consistently every year, and a change to the valuation method must be approved by the tax office before it becomes effective. 1.3.5. Depreciation and amortization In general, a company may select either the straight-line method or the declining-balance method to compute the depreciation of each class of tangible assets. The default depreciation method for most assets is the declining-balance method. However, for buildings and certain leased assets, the straight-line method must be used. Intangible assets must also be amortized using the straight-line method. Once the depreciation methods are selected, the same methods must be applied consistently every year. A company may change its depreciation methods but an application must generally be sent to the tax office for approval before the changes are made. The depreciation and amortization allowable for tax purposes must be computed in accordance with the statutory useful lives of the assets provided in the Ministry of Finance Ordinance. Intangible assets can be fully amortized over the statutory useful lives. As for tangible assets, the total depreciable amount is the acquisition cost less 1. The acquisition cost should include any incidental expenses incurred in making the assets available for use. Under prior rules for assets put into use before 1 April 2007, the total depreciation amount was 95% of the acquisition cost. The remaining value (i.e. the remaining 5% of the acquisition cost) of these assets can be depreciated over 5 years from the year following that in which 95% of the asset has been depreciated under the old depreciation method. The depreciation must be recorded in the books of account. The amount of depreciation in excess of the allowable limit for tax purposes must be added back to the profits in calculating taxable income. If the book depreciation amount is less than the allowable amount for tax purposes, no adjustment is required, and effectively the asset has an extension of its useful life for tax purposes. If, for some reason, no depreciation is recorded in the accounts, no tax deduction would be available. This could effectively result in a postponement of depreciation, but audit issues may arise. Assets that cost less than 100,000 or with an economic useful life of not more than 1 year can be fully written off in the year of acquisition. Assets that cost less than 200,000 can be depreciated over 3 years. Special depreciation may be claimed by companies filing blue tax returns (see 1.8.2., i.e. increased first year depreciation or accelerated depreciation. Only certain assets qualify for special depreciation. 1.3.6. Reserves and provisions Reserves and provisions for estimated or potential liabilities are generally not tax deductible, except for some specific reserves and provisions. A specific provision for doubtful debts based on specific events (such as bankruptcy) is deductible with a certain limitation dependent upon specific events. A general provision for doubtful debts is also deductible up to a certain limit calculated based on the ratio of actual bad debt losses incurred in the prior 3 years. For companies with capital not exceeding, a statutory percentage based on the type of industry may be used as an alternative method to calculate its allowable general bad debt provision. Provisions for returned sales and reserves for special repairs are allowable subject to a limit. The reserve for retirement allowances is being phased out and transitional measures are in force. 1.4. Capital gains There is no separate tax on capital gains. Companies are liable for corporation tax on capital gains at the same tax rates as those for ordinary income. When a company realizes a capital gain from the sale of land, a special surtax is ordinarily imposed, but the surtax has been suspended until 31 December 2013. 540
Corporate Taxation Japan Generally, capital gains are calculated by deducting the tax base of the transferred assets and related costs from the sale proceeds. Rollover relief is provided for in the following transactions: transfer of assets and liabilities from a merged company to the surviving company under a tax qualified merger (this is also applicable to other types of reorganizations, such as corporate divisions and contributions in kind); surrender of the shares in a merged company by its shareholders, provided that the shareholders receive only shares in the surviving company under a merger (this is also applicable to other types of reorganizations, such as corporate divisions, contributions in kind and share-for-share exchanges); surrender of the shares in a merged company by its shareholders, provided that the shareholders receive only shares in the parent company owning 100% of the surviving company under certain conditions in a triangular merger (this is also applicable to other types of reorganizations, such as corporate divisions and share-for-share exchanges); transfer of assets (excluding inventory and small assets) within a tax consolidated group (see 2.1.); sale of a piece of land within 10 years after another piece of land is acquired in 2009 and/or 2010. The maximum amount of deferred capital gains is 80% of the capital gains (60% if the land is acquired in 2010); transfer of assets when replacement property is acquired using government subsidies, etc. 1.5. Losses 1.5.1. Ordinary losses Tax losses may be carried forward for 7 years (5 years for losses that relate to tax years commencing prior to 1 April 2001). A company can generally carry forward its tax losses only if the company has a blue tax return filing status (see 1.8.2.). Restrictions apply on the carry-forward of losses where there has been a change of ownership of the company, i.e. when there is a change of more than 50% of the ultimate shareholders. These restrictions only apply where within 5 years following the change of ownership, one of several specified events occurs, such as the commencement of business by a company that was a dormant company at the time of the ownership change. The tax law allows for losses to be carried back for 1 year. However, this provision has been suspended since 1 April 1992 except in certain limited cases, e.g. in the dissolution of a company, and for companies with paidin capital of not more than for years ending on or after 1 February 2009. 1.5.2. Capital losses There is no distinction between ordinary losses and losses of a capital nature. 1.6. Rates 1.6.1. Income and capital gains Taking all the national and local taxes (see 3.) into account, generally an effective statutory tax rate of 42% applies for companies with paid-in capital of up to 100 million, and 41% for companies with paid-in capital of more than. Note that companies with paid-in capital of more than are also liable to a size-based business tax (see 3.1.). Corporation tax (national tax) is levied at the following rates: Taxable income ( ) Marginal up to exceeding first 8 million 22* 30 over 8 million 30 30 * As a temporary measure to stimulate the economy, 18% applies from 1 April 2009 to 31 March 2011. Capital gains are also subject to corporation tax at the same rates as for ordinary income. When a company realizes a capital gain from the sale of land, a special surtax is imposed on the gain at 5% or 10% depending on the length of the holding period. However, the surtax has been suspended until 31 December 2013. 1.6.2. Withholding taxes Dividends received by a Japanese corporate shareholder from an unlisted Japanese company are subject to withholding tax at 20%. If the dividend paying company is a listed company, the withholding tax rate can be reduced to 15%, which is further reduced to 7% until 31 December 2011 as a temporary measure. Interest on bank deposits and company/government bonds is generally subject to withholding tax at 20% (15% for national tax and 5% for inhabitant tax (see 3.2.)). Interest on loans paid to another Japanese company is not subject to withholding tax. The withholding tax is not a final tax, and is generally creditable against the corporation tax liability. Excess payments are refundable. See 6.3. for withholding tax on payments to non-resident companies. 1.7. Incentives 1.7.1. Tax credits for research and development A company filing a blue tax return (see 1.8.2.) is eligible for research and development (R&D) tax credits. The amount of tax credit depends on the size of the companies and the R&D ratio, i.e. the ratio of total R&D expenditure to the average sales proceeds for the preceding 3 years and the current fiscal year ( average sales proceeds ), etc. 541
Corporate Taxation For large-scale companies (generally, paid-in capital of more than ): where the R&D ratio is 10% or more, the tax credit is 10% of total R&D expenditure; and where the R&D ratio is less than 10%, the tax credit is total R&D expenditure (8% + R&D ratio 0.2). For small and medium-sized companies (paid-in capital of not more than and not a subsidiary of a large-scale company, etc.), the tax credit is 12% of total R&D expenditure. In addition to the tax credit on total R&D expenditure, either of the two tax credits indicated below is available for fiscal years beginning from 1 April 2008 to 31 March 2010: Tax credit on incremental R&D expenditure If R&D expenditure in the year is larger than (i) the annual average of R&D for the preceding 3 fiscal years; and (ii) the highest annual R&D expenditure for the preceding 2 fiscal years, the company is eligible for an additional 5% tax credit for incremental R&D expenditure (R&D expenditure in the year less the amount in (i)). Tax credit on the excess of R&D expenditure over 10% of average sales proceeds If R&D expenditure in the year is over 10% of average sales proceeds, the company is eligible for an additional tax credit for the excess R&D expenditure. The creditable amount is calculated by the following formula: (R&D expenditure Average sales proceeds 10%) (R&D ratio 10%) 0.2. The maximum creditable amount is 30% of the corporation tax liability for the fiscal year (20% for the tax credit on total R&D expenditure and 10% for the additional tax credit; the 20% rate is increased to 30% from 1 April 2009 to 31 March 2011). 1.7.2. Tax credits for equipment to strengthen information technology infrastructure A company filing a blue tax return (see 1.8.2.) is eligible for a tax credit for new equipment specifically designated in the Ministry of Finance Ordinance, provided the equipment is purchased or produced and placed into use for the business in Japan in the period from 1 April 2006 to 31 March 2010. Examples of eligible equipment are computers for servers, database management software and equipment for firewall systems, most of which are required to be certified under ISO/IEC 15408. By virtue of the 2008 tax reform, certain software for intersystem coordination has been added as eligible assets if evaluated and certified by the Information-Technology Promotion Agency. The tax credit is calculated as follows: Acquisition cost 70% 10% The maximum creditable amount is 20% of the corporation tax liability for the fiscal year. 1.7.3. Non-tax incentives The Development Bank of Japan offers low interest loans to a company that is one third owned by foreign investors if the company is expected to conduct certain business activities, such as promoting the international exchange of technology and know-how. Various local governments offer corporate location promoting subsidies and funding programmes to attract investments from industries in other areas in Japan and from outside Japan. Also, Okinawa Prefecture provides a Special Free Trade Zone to promote trade and retail industries. The Invest Japan Business Support Centers operated by JETRO provide services to foreign firms seeking to set up a business in Japan, e.g. free temporary office space, consultation with expert advisors and access to a wealth of business information. 1.8. Administration 1.8.1. Taxable period The taxable period of a company is the same as its accounting period. A taxable period cannot exceed 12 months but can be less than 12 months. Corporation tax is imposed on a current year basis, i.e. the tax for a year is assessed on income earned in the same year. 1.8.2. Tax returns and assessment Japan has a self-assessment system. Tax returns are categorized as white (regular) returns and blue returns (aoiro shinkoku). A company is entitled to file a blue return with the approval of the relevant tax office, if its books are properly maintained. Companies filing blue returns are eligible for certain tax privileges and benefits, including special and accelerated depreciation (see 1.3.5.), carry-forward of tax losses (see 1.5.1.) and tax credits (see 1.7.). A company with a fiscal year longer than 6 months should file an interim tax return within 2 months from the end of the first 6 months of the tax year. If the amount of the annual corporation tax for the preceding fiscal year multiplied by 6 and divided by the number of months of the preceding fiscal year is 100,000 or less, the company is generally not required to file interim tax returns. However, a company subject to the size-based business tax or business tax imposed on gross revenue rather than net income (see 3.1.) is always required to file an interim tax return with respect to business tax regardless of the amount of the corporation tax for the preceding fiscal year. Final tax returns must be filed within 2 months from the end of the business year. Generally, an extension of 1 month can be obtained from the tax office for a Japanese company or longer for a branch of a foreign company. A 2-month filing extension can generally be obtained if a group files a consolidated tax return. The tax authorities may enquire into a company s tax returns and make any necessary adjustments within the following statute of limitations: adjustments relating to under-reporting of taxable income: 5 years; 542
Corporate Taxation Japan adjustments relating to amendment of excess tax losses: 7 years; adjustments relating to transfer pricing issues: 6 years; and adjustments relating to fraud: 7 years. 1.8.3. Payment of tax A company is required to make an interim tax payment if it is required to file an interim tax return. The due date for payment is the same as the due date for filing the interim tax return (see 1.8.2.). The final tax liability is due within 2 months from the end of the tax year. No extension is available for the payment of tax. 1.8.4. Rulings A written advance ruling system (jizen-shokai) was introduced in September 2003 and was continuously revised up to March 2008. There are two procedures: written advance ruling for an individual case raised by a taxpayer, and written advance ruling for a transaction exclusively related to a particular industry raised by an industry association and the like. Rulings do not cover certain cases, e.g. cases based on hypothetical facts and cases where the main purpose is tax saving. Rulings are generally made public. 2. Groups of Companies 2.1. Group treatment From 1 April 2002, a group of companies may elect to file consolidated tax returns. A group is made up of a Japanese parent company and its 100% directly or indirectly owned Japanese subsidiaries. Non-Japanese companies are excluded from the consolidated group. In order to become a consolidated group, an election needs to be made to the tax office in advance. The tax consolidation system is applicable to national corporation tax only. Each company in a consolidated group is required to file local tax returns individually. Consolidation allows for the effective offset of losses incurred by one company against profits of other companies in the same group. Consolidated tax losses can be carried forward and set off against future consolidated profits for up to 7 years. Special rules and restrictions apply to existing losses of subsidiaries upon joining a group (in most cases, losses incurred by subsidiaries prior to joining the group expire upon joining) and in the event of a company leaving a group. At the time of joining a consolidated group, a subsidiary may be required to revalue its assets to fair market value and pay tax on the built-in gains. Transactions among group companies should be based on fair market value. However, capital gains and losses arising on transfers of assets within a consolidated group (excluding inventory and small assets with a tax base of 10 million or less) are generally deferred until the assets leave the group or are written off. Donations among group companies constitute taxable income for the recipient company and a non-deductible expense for the company paying the donation. 2.2. Intercorporate dividends Domestic dividends not from the same tax consolidated group are exempt to the extent of dividends received less interest expenses incurred in relation to holding the shares under the Dividend Received Deduction rule. For shareholdings of less than 25%, or shareholdings of at least 25% but held for less than 6 months, 50% of the net amount of dividends received less interest expense is exempt from corporation tax. For shareholdings of at least 25% held for 6 months or more, 100% of the net amount of dividends received less interest expense is exempt. Dividends between members of a consolidated tax group are fully excluded from the consolidated taxable income, without deducting the related interest expense. See 6.1.1. and 7.4. for exemptions on dividends from foreign subsidiaries. 3. Other Taxes on Income 3.1. Business tax Business tax is a local tax imposed by prefectures. The applicable rate depends on the prefecture, which can set a rate between the specified standard and maximum rates. Business tax is deductible for both corporation tax and business tax purposes. Business tax is usually calculated on taxable net income, but business tax for companies in specified industries such as insurance and gas/electric utilities is calculated on gross revenue with different tax rates. The marginal standard and maximum tax rates are as follows: Taxable income ( ) Standard up to Maximum Standard exceeding Maximum from 1 October 2008: up to 4 million 2.7 3.24 1.5 1.8 4 8 million 4.0 4.8 2.2 2.64 over 8 million 5.3 6.36 2.9 3.48 before 1 October 2008: up to 4 million 5.0 6.0 3.8 4.56 4 8 million 7.3 8.76 5.5 6.6 over 8 million 9.6 11.52 7.2 8.64 Only the rates for income over 8 million are applicable if a company has offices in at least three different prefectures and capital of at least 10 million. 543
Corporate Taxation Size-based business tax Companies with paid-in capital exceeding are also subject to a size-based business tax as follows: added value component capital component Tax base Standard Maximum total of labour costs, net interest payment, net rent payment and income/loss for current year 0.48 0.576 capital plus capital surplus for tax purposes 0.2 0.24 Special local corporate tax With the reduction in the business tax rates, a new national tax, the special local corporate tax (chiho-hojintokubetsu-zei) will be imposed for fiscal years beginning on or after 1 October 2008. Tax revenues from the special local corporate tax will be reallocated by the national government to local governments, in order to reduce the gap in tax revenue between urban and rural areas. This is a temporary measure until an overhaul of the tax system is implemented at a future date. The business tax rates before the reduction are almost the same as the sum of the reduced business tax and the special local corporate tax. Special local corporate tax rates are as follows: Tax base ( ) up to exceeding Tax Tax taxable income standard rate of business tax 81 148 3.2. Inhabitant tax Inhabitant tax is a local tax imposed by prefectures and municipalities. Prefectural and municipal inhabitant taxes consist of two elements: an income tax calculated based on corporation tax liability and a per capita tax. The rates of inhabitant tax on corporation tax liability range from 5% to 6% for prefectural tax purposes and from 12.3% to 14.7% for municipal tax purposes. 3.3. Accumulated earnings tax for a special closely held company A special closely held company which is controlled by one shareholder and related persons of the shareholder may be liable to a special tax on retained earnings. This is to prevent shareholders from trying to avoid or defer individual income tax by not making dividend distributions. For the purposes of this rule, a family company is defined as a company where more than 50% of its shares are held by one person, or by individuals or corporations affiliated to that person. A specific formula is used to calculate taxable retained earnings. The additional tax is calculated at the rates of 10%, 15% and 20% depending on the brackets of income. A company with paid-in capital of up to is exempt from this additional tax for fiscal years commencing on or after 1 April 2007. 4. Taxes on Payroll 4.1. Payroll tax The business occupancy tax has a character similar to payroll tax in that a part of the tax is calculated based on the total payroll. The business occupancy tax is a tax imposed by designated urban municipal authorities, such as Tokyo, Yokohama, Osaka and Nagoya, and consists of two elements: a tax on floor space ( 600 per square meter, if the total floor space exceeds 1,000 square meters) and a tax on payroll (0.25% on total payroll, if the number of employees exceeds 100). The added value component of the size-based business tax is also calculated based on total payroll (see 3.1.). 4.2. Social security contributions An employer is generally required to participate in the social insurance systems (health insurance and welfare pension insurance) and the labour insurance system (unemployment insurance and workers accident compensation insurance). Social insurance premiums are required in respect of all types of compensation to employees and directors including fringe benefits, and are subject to ceilings. Labour insurance premiums are imposed on compensation and fringe benefits paid to employees. The contribution rates for an employer are as follows (effective from September 2009 for health insurance, from March 2009 for welfare pension insurance and from April 2009 for unemployment insurance). Insurance Contribution rate (%) health insurance below 40 years old 4.09* 40 years old or over 4.685 * welfare pension insurance 7.675 unemployment insurance 0.7 0.9 workers accident compensation various insurance * the rates depend on the prefecture where an employer is located; the rates indicated above are those for Tokyo. Premiums paid by the employer are fully deductible. 5. Taxes on Capital 5.1. Net worth tax There is no net worth tax. 544