Japan tax newsletter KPMG Tax Corporation 24 December 2015 KPMG Japan tax newsletter Amended Japan-Germany Tax Treaty 1. Preamble... 2 2. Hybrid Entities (Article 1)... 2 3. Business Profits (Article 7)... 2 4. Associated Enterprises (Article 9)... 3 5. Dividends (Article 10)/Interest (Article 11)/Royalties (Article 12)... 3 6. Capital Gains (Article 13)... 4 7. Entitlement to Benefits (Article 21)... 5 8. Procedural Rules for Taxation at Source (Article 27)... 7 9. Others... 8 10. Entry into Force (Article 31)... 8 On 17 December 2015, the governments of Japan and the Federal Republic of Germany signed the Agreement between Japan and the Federal Republic of Germany for the Elimination of Double Taxation with respect to Taxes on Income and to Certain Other Taxes and the Prevention of Tax Evasion and Avoidance (New Agreement). This New Agreement will supersede the current agreement (Current Agreement) concluded in 1967 (partly amended in 1980 and in 1984) by amending the business profits provision, expanding the reduction in taxes at source for investment income, introducing anti-abuse provisions, provisions for arbitration proceedings in mutual agreement procedures and for assistance in the collection of taxes, etc. We have set out in this newsletter the main points of the New Agreement.
2 1. Preamble On 5 October 2015, the Organisation for Economic Co-operation and Development(OECD)released the final reports for the Base Erosion and Profit Shifting (BEPS) project. The final report for Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances) includes a recommendation to expressly state in the preamble of the OECD Model Tax Convention that Contracting States that enter into a tax treaty intend to eliminate double taxation without creating opportunities for tax evasion and avoidance (including through treaty-shopping arrangements). The preamble of the New Agreement is in line with such recommendation. 2. Hybrid Entities (Article 1) The BEPS final report for Action 2 (Neutralising the Effects of Hybrid Mismatch Arrangements) includes a recommendation to add a clause with respect to the treatment of income derived through a hybrid entity (an entity which is treated as a transparent entity in a Contracting State and a non-transparent entity in the other Contracting State) in Article 1 (Persons Covered) of the OECD Model Tax Convention. The proposed clause was included in Article 1 (Persons Covered) of the New Agreement, which is as follows: Article 1 (2) For the purposes of this Agreement, income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State shall be considered to be income of a resident of a Contracting State but only to the extent that the income is treated, for purposes of taxation by that Contracting State, as the income of a resident of that Contracting State. Under this clause, whether income derived through a hybrid entity is eligible for benefits under the New Agreement is determined based on how the entity is treated in the Contracting State where the beneficiary of the income is resident. Various tax treaties concluded by Japan (tax treaties with the US, the UK, France, Australia, Switzerland, the Netherlands, Portugal and New Zealand) include more detailed clauses with respect to the treatment of income derived through a hybrid entity in Article 4 (Resident) basically based on the similar concept to the above clause. 3. Business Profits (Article 7) Article 7 (Business Profits) of the New Agreement introduces provisions concerning taxation of business profits attributable to a permanent establishment of a foreign enterprise, under which business profits are calculated by recognizing internal dealings between a head office and its branches and by applying the arm s length principle. This is almost the same as Article 7 of the OECD Model Tax Convention amended in 2010, which adopted the Authorised OECD Approach as an approach to calculate income attributable to a permanent establishment. Please note that the amendments to adopt the Authorised OECD Approach as an approach to calculate income attributable to a permanent establishment were also made for Japanese tax purposes, and will be applied to corporate income tax to be imposed on foreign companies for any fiscal year beginning on or after 1 April 2016 and individual income tax to be imposed on non-resident individuals for 2017 income and onwards.
3 4. Associated Enterprises (Article 9) Article 9 (Associated Enterprises) of the New Agreement includes the following provisions: A Contracting State shall make a corresponding adjustment, corresponding to a primary adjustment made in accordance with the arm s length principle by the other Contracting State, in order to avoid double taxation. In determining such adjustment, the competent authorities of the Contracting States shall undertake mutual agreement procedures, if necessary. After 10 years from the end of a taxable year, in principle, the Contracting State may not adjust the profits for the taxable year. The statue of limitations for transfer pricing taxation is generally 6 years in Japan and this will not be extended by the New Agreement. 5. Dividends (Article 10)/Interest (Article 11)/Royalties (Article 12) Taxes on investment income in source countries will be reduced as follows: Dividends (Article 10) Current Agreement Reduced Beneficial owner tax rates A company (German company) holding directly or indirectly at least 25% of the voting 10% stock of the dividend paying company (Japanese company) for 12 months (*1) Other than the above 15% New Agreement Reduced Beneficial owner tax rates A company holding directly at least 25% of the voting stock of the Exempt dividend paying company for 18 months (*2) A company holding directly at least 10% of the voting stock of the 5% dividend paying company for 6 months (*2) Other than the above 15% (*1) 12 months means a period of 12 months immediately preceding the date of payment of a dividend. (*2) 18 months / 6 months mean a period of 18 months/6 months ending on the date on which entitlement to a dividend is determined. Interest (Article 11)/Royalties (Article 12) Interest Current Agreement Interest on certain bonds issued by governments, etc. Exempt Other than the above 10% New Agreement Exempt Royalties 10% Exempt Exceptional rules Paragraph 4 of the protocol signed together with the New Agreement provides for exceptional rules for investment income, whereby the following income or gains will be taxed according to the domestic tax laws of each Contracting State:
4 Japan The following income or gains arising in Japan will be taxed according to the Japanese tax laws: dividends paid by a company which is entitled to a deduction for dividends paid to its beneficiaries in computing its taxable income for Japanese tax purposes interest that is determined by reference to receipts, sales, income, profits or other cash flow of the debtor or a related person, to any change in the value of any property of the debtor or a related person or to any dividend, partnership distribution or similar payment made by the debtor or a related person, or any other interest similar to such interest income or gains derived by a silent partner in respect of a silent partnership (Tokumei Kumiai) contract or other similar contract Germany Income arising in Germany will be taxed according to the German tax laws if the following two conditions are met: (i) It is derived from rights or debt claims carrying a right to participate in profits, including income derived by a silent partner (stiller Gesellschafter) from his participation as such, or from a loan with an interest rate linked to the borrower s profit (partiarisches Darlehen) or from profit sharing bonds (Gewinnobligationen) within the meaning of the tax law of the Federal Republic of Germany; and (ii) It is deductible in the determination of profits of the debtor of such income. Furthermore, in accordance with paragraph 5 of the protocol, the reduced tax rates of 0 and 5 percent will not apply to dividends paid by a German real estate investment trust company with listed share capital (Real Estate Investment Trust Aktiengesellschaft) and by a German investment fund. 6. Capital Gains (Article 13) Article 13 (Capital Gains) of the New Agreement provides for as follows, which is almost the same as Article 13 of the Current Agreement except that item B was added to the New Agreement. Capital gains derived by a resident of a Contracting State from the alienation of: Taxable or exempt in the other Contracting State A Immovable property situated in the other Contracting State Taxable B Shares in a company deriving at least 50% of the value of its property directly or indirectly from immovable property situated in the Taxable other Contracting State C Property forming part of the business property of a permanent establishment which an enterprise of the first-mentioned Taxable Contracting State has in the other Contracting State D Ships or aircraft operated by an enterprise of the first-mentioned Contracting State in Exempt international traffic E Any property other than the above Exempt
5 7. Entitlement to Benefits (Article 21) The final report for Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances) includes a recommendation to add an article titled Entitlement to Benefits in the OECD Model Tax Convention as a provision to prevent treaty shopping. Article 21(Entitlement to Benefits) of the New Agreement is set up based on the proposed provision in the report, which consists of both a limitation on benefits (LOB) rule and a principal purpose test (PPT) with some modifications. (1) Limitation on benefits(lob) The LOB provisions are included in paragraphs 1 to 7 of Article 21 of the New Agreement, under which where a resident of a Contracting State that derives income from the other Contracting State wishes to claim a benefit under the New Agreement, the resident must satisfy any specified conditions in the relevant provisions for the benefit and one of the following conditions: A. Qualified person test A resident of a Contracting State should fall under one of the following (qualified persons): (a) an individual (b) a qualified governmental entity (c) a listed company meeting certain conditions (d) a pension fund or pension scheme meeting certain conditions (e) certain non-profit organizations (f) a person other than an individual, if at least 65 percent of the voting shares or other beneficial interests of the person are owned, directly or indirectly, by residents of that Contracting State that are qualified persons by reason of subparagraph (a), (b), (c), (d) or (e) B. Equivalent beneficiary test One of the following conditions should be met, where a resident of a Contracting State derives an item of income from the other Contracting State: (a) At least 65 percent of the voting shares or other beneficial interests of that resident are owned, directly or indirectly, by persons who, if they had derived the item of income directly, would, under the New Agreement, be entitled to equivalent or more favourable benefits. (b) At least 90 percent of the voting shares or other beneficial interests of that resident are owned, directly or indirectly, by persons who, if they had derived the item of income directly, would, under the New Agreement or an agreement that the Contracting State from which the item of income arises has concluded with another State, be entitled to equivalent or more favourable benefits. C. Active business test The following conditions should be met, where a resident of a Contracting State derives income from the other Contracting State: (i) That resident is engaged in the active conduct of a business (other than the business of making or managing investments for that resident s own account, unless the business is banking, insurance or securities business carried on by a bank, insurance company or securities dealer) in the first-mentioned Contracting State. (ii) The income derived from that other Contracting State is derived in
6 connection with, or is incidental to, that business. (If a resident of a Contracting State derives income arising in the other Contracting State from an associated enterprise, the business carried on by that resident in the first-mentioned Contracting State should be substantial in relation to the business carried on by the associated enterprise in that other Contracting State.) D. Determination by the competent authorities Where a resident of a Contracting State that derives income from the other Contracting State is not entitled to benefits under the New Agreement by the above tests from A to C, that resident should obtain the determination by the competent authority of that other Contracting State that the establishment, acquisition or maintenance of such resident and the conduct of its operations are considered as not having the obtaining of such benefits as one of the principal purposes in accordance with its domestic law or administrative practice. Additional conditions for A (f) and B The following additional conditions are provided for with respect to (f) of A (Qualified person test) or B (Equivalent beneficiary test): In respect of taxation by withholding at source, a resident of a Contracting State will be considered to satisfy the conditions discussed in A (f) or B for the taxable year in which payment of an item of income is made if such resident satisfies those conditions during the 12-month period preceding the date of the payment (or, in the case of dividends, the date on which entitlement to the dividends is determined). In all other cases, a resident of a Contracting State will be considered to satisfy the conditions discussed in A (f) or B for a taxable year if such resident satisfies those conditions on at least half the days of the taxable year. *** LOB provisions are already included in various tax treaties concluded by Japan (tax treaties with the US, the UK, France, Australia, Switzerland, the Netherlands, New Zealand and Sweden) since the first tax treaty including a LOB provision was signed with the US in 2003, although details of the provisions and the scope for which the provisions are applied are different among them. (2) Principal purposes test (PPT) Paragraph 8 of Article 21 is the same as the PPT proposed in the final report of Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances). Article 21 (8) Notwithstanding the other provisions of this Agreement, a benefit under the Agreement shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Agreement. PPT clauses are also already included in various tax treaties concluded by Japan
7 (e.g. tax treaties with the UK, France, Australia, Switzerland, New Zealand and Sweden) although details of the clauses and the scope of the PPT are different among them. (3) Relationship with domestic tax laws Paragraph 9 of Article 21 provides that nothing in the New Agreement will be construed as restricting, in any manner, the application of any provisions of the domestic tax laws which are designed to prevent the avoidance or evasion of taxes as long as those provisions are in accordance with the object and purpose of the New Agreement. Paragraph 7 of the protocol raises examples of provisions of the domestic tax laws which are designed to prevent the avoidance or evasion of taxes in both countries. The anti-tax haven provisions and certain anti-corporate inversion provisions are indicated as such domestic tax laws in the case of Japan. 8. Procedural Rules for Taxation at Source (Article 27) The New Agreement introduces Article 27 (Procedural Rules for Taxation at Source) providing for procedural rules for taxation at source. The New Agreement is the first tax treaty for Japan to include such provision. Article 27 (1) If in a Contracting State the taxes on dividends, interest, royalties or other items of income derived by a person who is a resident of the other Contracting State are levied by withholding at source, the right of the first-mentioned Contracting State to apply the withholding of tax at the rate provided under its domestic law shall not be affected by the provisions of this Agreement. The tax withheld at source shall be refunded on application by the taxpayer if and to the extent that it is reduced or ceases to be levied in accordance with the Agreement. (2) Applications for refund of the withholding taxes of a Contracting State which are subject to reduction or exemption under this Agreement shall be submitted within the period provided for in the domestic law of that Contracting State. (3) Each Contracting State may provide for procedures to the effect that payments of income subject under this Agreement to no tax or only to reduced tax in the Contracting State in which the income arises may be made without deduction of tax or with deduction of tax only at the rate provided in the relevant Article of the Agreement. (4) The Contracting State in which the items of income arise may require the taxpayer to provide certification of his residence in the other Contracting State issued by the competent authority of that other Contracting State. (5) The competent authorities of the Contracting States may determine the mode of implementation of this Article by mutual agreement in accordance with the domestic law of each Contracting State. Although it is required to submit application forms to the competent tax offices in advance in order to obtain tax treaty benefits with respect to withholding taxes in Japan, which are provided for under the Ordinance for Enforcement of the Act on Implementation of Tax Conventions, it could be construed that the lack of submission of application forms would not affect the effectiveness of the application of tax treaty benefits. Article 27 of the New Agreement expressly provides that certain procedures will be required to obtain tax treaty benefits with respect to withholding tax. Details of required procedures will be clarified by the tax authorities in the future.
8 9. Others Mutual Agreement Procedure (Article 24) Article 24 (Mutual Agreement Procedure) of the New Agreement includes a clause for mandatory binding arbitration rules. Under the newly introduced clause, where a person has presented a case to the competent authority of a Contracting State on the basis that the actions of one or both of the Contracting States have resulted for that person in taxation not in accordance with the provisions of the New Agreement, and the competent authorities are unable to reach an agreement to resolve that case within 2 years from the presentation of the case to the competent authority of the other Contracting State, the case shall be resolved through arbitration conducted based on the request of the person. Exchange of Information (Article 25) Article 25 (Exchange of Information) of the New Agreement is in line with Article 26 (Exchange of Information) of the OECD Model Tax Convention. Assistance in the Collection of Taxes (Article 26) The New Agreement includes a new provision in Article 26 (Assistance in the Collection of Taxes) to provide for the procedural rules for cases where the Contracting States lend assistance to each other in the collection of taxes. The kinds of tax covered by Article 26 in the case of Japan are income tax, corporation tax, special reconstruction income tax, special reconstruction corporation tax, local corporation tax, consumption tax, local consumption tax, inheritance tax and gift tax. 10. Entry into Force (Article 31) Each of the Contracting States shall send in writing and through diplomatic channels to the other Contracting State the notification confirming that its internal procedures necessary for the entry into force of the New Agreement (approval by the Diet in the case of Japan) have been completed. The New Agreement shall enter into force on the 30th day after the date of receipt of the latter notification. In principle, the New Agreement shall be applicable as follows: Japan Germany Taxes levied on the basis of a taxable year Taxes not levied on the basis of a taxable year Taxes withheld at source Other taxes Taxes for any taxable years beginning on or after 1 January in the calendar year next following that in which the New Agreement enters into force Taxes levied on or after 1 January in the calendar year next following that in which the New Agreement enters into force Amounts paid on or after 1 January in the calendar year next following that in which the New Agreement enters into force Taxes levied for periods beginning on or after 1 January in the calendar year next following that in which the New Agreement enters into force Notwithstanding the above, the provisions of Article 25 (Exchange of Information) shall have effect from the date of entry into force of the New Agreement, without regard to the date on which the taxes are levied or the taxable year to which the taxes relate.
9 KPMG Tax Corporation Izumi Garden Tower, 1-6-1 Roppongi, Minato-ku, Tokyo 106-6012 TEL : +81 (3) 6229 8000 FAX : +81 (3) 5575 0766 Osaka Nakanoshima Building 15F, 2-2-2 Nakanoshima, Kita-ku, Osaka 530-0005 TEL :+81 (6) 4708 5150 FAX :+81 (6) 4706 3881 Nagoya Lucent Tower 30F, 6-1 Ushijima-cho, Nishi-ku, Nagoya 451-6030 TEL : +81 (52) 569 5420 FAX : +81 (52) 551 0580 www.kpmg.com/jp/tax info-tax@jp.kpmg.com The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2015 KPMG Tax Corporation, a tax corporation incorporated under the Japanese CPTA Law and a member firm of the KPMG network of independent member firms affiliated with KPMG The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.