TAX NEWS - NOVEMBER 2009
Japan Tax: Business foundation's recommendations for Japan's FY 2010 tax reform proposals
The Japanese Business Foundation is an economic organization with 1,609 members (including 1,295 companies, 129 industrial associations and 47 regional economic organizations) and is generally considered to be one of the most important voices for large businesses in Japan. The Foundation's proposals follow the election of a new Japanese government and the formation of a new Tax Committee.
Japan's general election held 30 August resulted in a landslide victory for the Democratic Party of Japan (DPJ) against the long-ruling Liberal Democratic Party (which had governed the country since 1955, except for an 11-month period from 1993 to 1994). The recently elected government has established a new Tax Committee comprising Cabinet ministers and senior vice ministers and replacing the previous council, which consisted mainly of academics and business leaders. At the prime minister's request, the Tax Committee will review the overall tax system, taking into account fairness, transparency and reasonableness.
The Foundation's proposals state that Japan's tax system requires fundamental reform in light of:
- The need to fund a social security system that will support a declining and aging population;
- The desire to strengthen the potential for economic growth to maintain domestic business and attract new investment from overseas; and
- The need to increase revenues to reduce the current high level of national debt.
With these factors in mind, the Foundation set out seven actions as steps toward a solution:
- The consumption tax rate should be raised gradually after the economy recovers.
- The effective corporate income tax rate should be reduced, with a target of 30%, which is in line with the rates of other countries worldwide.
- Significant reform of the income tax system should be undertaken, allowances (e.g. those for dependents) should be comprehensively reviewed and "tax credits payments" should be introduced.
- A taxpayer identification number system should be introduced to ensure fairness and transparency in capturing income.
- To revitalize the financial capital markets, the scope for individual investors to offset each year's finance-related income and losses should be enhanced, and they should have the ability to carry forward net losses (currently all types of finance-related income, such as interest and capital gains, are subject to different tax treatment).
- Suggested changes to the inheritance tax system should be articulated so that the population understands the reasons for the changes and how they will work. (The DPJ's manifesto included significant changes to the current rules, including taxing assets at the estate level rather than at the beneficiary level.) This should reduce the likelihood that individuals will be disincentivized from making and accumulating assets.
- Any environmental taxes should be designed to encourage the development of new technology and the spread of existing environmentally friendly technology and related goods. New taxes should not be introduced that would encourage manufacturers to move to less energy-efficient countries and thus reduce the industrial base in Japan.
The Foundation suggested a five-year road map for undertaking these tasks at a gradual and steady pace.
Specific corporate income tax proposals
The Foundation's specific proposals for the 2010 tax reform relate mainly to corporate income tax, particularly measures that will stimulate the economy and the development of global businesses.
Tax measures to promote investment and innovation
Review of treatment of net operating losses - In July, the Foundation, along with the American Chamber of Commerce in Japan and the European Business Council in Japan, released a joint statement urging the expeditious extension of the net operating loss (NOL) carryforward period and the revival/extension of NOL carrybacks. During the economic downturn, with many companies posting losses, one of the most immediate and effective investment promotion measures would be to extend the NOL carryforward period, the Foundation proposed.
The Foundation said that the current rules are very disadvantageous for Japanese companies, compared with the rules in other jurisdictions. Japan's NOL carryforward period is seven years; NOLs may be carried forward 20 years in the U.S. and indefinitely in Austria, France, Germany and the U.K. Also, the carryback of NOLs, which is stipulated under the corporate tax law, has been suspended to secure tax revenues. Although the 2009 tax reform reinstated the NOL carryback rule for small and medium-size enterprises, the Foundation believes that this provision effectively should be allowed for all companies. The NOL carryforward period should be extended, and the NOL carryback should be revived and/or extended, according to the Foundation.
Improvement of tax system to promote R&D - The Foundation said Japan's Tax Measures Against the Current Economic Crisis, enacted in June, extended the carryforward period for excess tax credits and increased tax credit limitations (from 20% to 30% of corporate tax). It recommended that these beneficial changes to the research and development tax credit rules be made permanent.
The Foundation also recommended that the additional tax credit for R&D investment of 5% of incremental research and experimentation expenses and the tax credit of certain percentages of R&E expenses over 10% of sales revenues, both of which will expire at the end of this fiscal year, should have their period and scope expanded.
Expansion and extension of tax measures to enhance information infrastructure - To encourage companies to increase their productivity through the use of information technology, the Foundation suggested that the scope and applicable period of tax measures to strengthen information infrastructure also be expanded. The IT-related tax incentives (that is, additional first-year tax depreciation of 35% of the standard acquisition cost, or a credit of 7% of that cost) apply only to a narrow range of assets, often requiring that the assets have received ISO certifications.
The Foundation mentioned that Japanese companies are increasingly "offshoring" production by proactively developing business activities overseas, both to survive in this era of intense global competition and as a result of Japan's declining population. The international tax system, therefore, should be improved to deal with global activities, eliminate international double taxation and improve certainty for business.
Improvement of international taxation
Review of anti-tax-haven rules - The Foundation noted that effective corporate tax rates have been decreasing in many countries. Corporate tax rates have been reduced to a level low enough (an effective tax rate of 25% or less) to trigger tax implications under Japan's anti-tax-haven (controlled foreign company) rules for Japanese companies operating in such countries as Singapore and Malaysia, as well as in China (whose effective corporate tax rate is 25%) and South Korea (24.2%). If more countries reduce their effective tax rates, the lower tax rates will also trigger taxes in Japan, potentially affecting Japanese companies' overseas businesses. With this in mind, the Foundation proposed that the current anti-tax haven threshold rate of 25% be reduced to below 20% to keep it in line with the effective corporate tax rates of other
The Foundation also suggested that Japan introduce a white list of countries or regions that satisfy certain requirements and therefore are not subject to the anti-tax haven rules. This would provide taxpayers with a predictable regulatory environment and help mitigate the administrative burden.
In some cases, tax liabilities are reduced to such low levels that Japanese taxation is triggered - for example, when dividend income or reorganization-related capital gains are treated as nontaxable in the overseas jurisdiction. Appropriate measures should be developed to ensure that such tax treatment in overseas jurisdictions will not affect the calculation of the Japanese tax liability.
The Foundation also suggested that the requirements for exemption from the anti-tax-haven rules be reviewed to ensure that an overseas business carried out for non-tax-avoidance purposes is not subject to the rules. It further proposed that subsidiaries that have met these exemption requirements in a certain year continue to be exempt for the following several years.
Review of transfer pricing rules - The Foundation said that transfer pricing rules have been improved. The transfer pricing administrative manual has been revised and the advance pricing agreement rules enhanced. However, an increasing number of countries appear to be aggressively applying their transfer pricing rules to maintain tax revenues since the financial crisis started in the fall of 2008. Also, although the mutual agreement procedure (MAP) is supposed to eliminate international double taxation, unresolved issues pose some risk for the business development of Japanese companies in foreign countries; considerable time and energy is necessary to complete a MAP and there is only a small chance of securing a refund of tax paid in other countries. The APA and MAP processes should be quicker and more efficient.
The Foundation said the rule for determining foreign related parties should be changed to include only companies that are controlled because of more than 50% ownership and to exclude those that are effectively not controlled, i.e. when ownership is 50% or less.
Finally, the Foundation suggested a review of how the tax laws relating to the treatment of intangible asset transactions, the provision of services and the transfer pricing implications of donations are applied in practice.
Foreign tax credit system - The Foundation praised the government for replacing the deemed paid foreign tax system with the foreign dividends exemption system as part of the 2009 tax reform. However, it said that international double taxation still cannot be fully eliminated under the direct foreign tax credit system because of the expiration of the carryforward period. To ensure that no constraints will be imposed on overseas business, it is still necessary, for example, to extend the carryforward period for excess foreign taxes and excess foreign tax limitations beyond the current period of three years. Improvement and expansion of tax treaty network - The Foundation recognized the importance of the tax treaty network for eliminating double taxation to ensure that Japanese companies can securely develop their business overseas. It proposed that the network be expanded and improved by amendments to current tax treaties or by negotiating treaties with countries that are not currently treaty partners. In particular, the Foundation requested that the withholding tax exemption provisions relating to dividends be improved or included. This would complement the foreign dividend exemption system and eliminate an obstacle to the repatriation of funds from overseas to Japan.
Double taxation also should be eliminated to foster an environment that promotes technological exchange, for example, by reducing or exempting withholding tax on royalties. The Foundation proposed a study on the introduction of an arbitration provision. Such a provision already exists in the OECD model treaty and the treaties of some Western countries.
Tax consolidation system
Under the consolidation regime, a Japanese domestic corporation and all its Japanese subsidiaries that are 100% owned (directly or indirectly) can elect to form a consolidated group for corporate income tax purposes. The main benefit of consolidation is that taxable income and losses can be offset between the group members, with the parent corporation being the taxpayer for the group. The Foundation has recommended improvements to the existing consolidation system (e.g. the restriction of a subsidiary's pre-consolidation tax losses from being included in consolidated losses should be removed). Also, a new 100% group taxation system should be introduced that would allow tax-free intragroup asset transfers or capital refunds among the group's companies.
Other corporate tax items
The Foundation has proposed abolishing the property tax on depreciable assets, increasing the dividend exemption percentage, perpetuating special taxation measures and reviewing the relationship between tax and accounting based on the global trend of adopting international financial reporting standards.
Next steps in development of 2010 tax reform proposals
The Tax Committee is holding hearings with interested parties, such as the Foundation and each of the Japanese ministries. Because not all the committee members are international corporate tax experts, the members were given a briefing paper on international tax, which was explained by a Ministry of Finance representative. The document summarizes the tax laws that cover measures such as the anti-tax-haven and transfer pricing rules. The document also suggests the major international tax issues to be reviewed, including:
- Anti-tax-haven rules - Specifically, a review of the definition of subsidiaries without substance, and so on, in line with changes in the business structures of companies that operate overseas; and more effective prevention of tax avoidance activities such as the transfer to foreign subsidiaries of income related to asset management. (Inclusion of this point may suggest that the preparer of the briefing document thinks some consideration should be given to replacing the current entity-based CFC rules with rules that focus more on taxing certain types of income.)
- Transfer pricing rules - The rules should be enhanced regarding the documentation required to justify arm's length pricing calculations to increase the transparency and effectiveness of tax administration. Japanese tax law does not specifically require such documents, although they are requested during tax audits. The briefing document refers to the need for Japan to secure appropriate rights of taxation through:
- Expansion of the information exchange network for tax purposes - that is, through conclusion of tax treaties that include a provision for the exchange of information with foreign tax authorities and enhancement of domestic laws for that purpose; and
- Measures for proper taxation and tax collection, such as enabling taxation (including withholding at source) of nonresidents who conduct cross-border transactions and collecting information regarding overseas assets.
The Tax Committee is expected to complete an outline of the 2010 tax reforms by mid-December. It will be interesting to see how many of the Foundation's business-friendly proposals are wholly or partly included in that outline. Based on the Tax Committee's outline, a draft bill is expected to be submitted to the parliament in January or February 2010.