| - | The concessionary 10% withholding tax rate (i.e. 7% national tax and 3% local tax) for dividends from shares in listed Japanese companies and capital gains arising from the sale of shares is to be extended to 31 March 2009 and 31 December 2008 respectively. The concessionary rate was introduced in 2003 reducing the existing 20% rate to 10% and was to expire on 31 December 2007. It should be noted that non-residents, domestic and foreign companies are not subject to the local tax; and | |
| - | Currently, a 20% withholding tax is applied to distributions made by a Tokumei Kumiai (TK) to residents or domestic companies provided that are not less than 10 silent partners in the TK. It is proposed to apply this rate to all TK distributions made as of 1 January 2008 regardless of the number of silent partners in the TK. |
Corporate reorganizations
(a) Definition of "business" and "related businesses"
The reform proposals are expected to provide a definition of "business" and "related businesses". Currently, the law does not provide a precise definition.
(b) Triangular mergers
A "triangular merger" is when cash/shares in the surviving company's parent (i.e. Parent Company) are distributed to the "liquidated" company's shareholders instead of shares in the surviving company. It is possible for a foreign company to acquire a Japanese company using this method.
Briefly, the proposals intend to amend the condition that require any consideration in qualifying corporate reorganizations, such as mergers, to be in the form of shares in the surviving company that is distributed to the shareholders of the "liquidated" company. In other words, if the shareholders of the "liquidated company" were to receive shares from the Parent Company, such consideration would be taxable to the "liquidated" company. Additionally, the "liquidated" company's shareholders will be subject to tax on the capital gains or losses of their shareholding in the "liquidated" company (as opposed to the deferral of recognition of capital gains). The proposed amendment will allow for a distribution of Parent Company's shares to the shareholders of the "liquidated" company as consideration.
With regard to non-resident shareholders of the "liquidated" company, it is proposed that when shares are received in the Parent Company as consideration, any capital gains (to the extent that such gains are Japanese-sourced) will be taxable at the time of the merger. This is to prevent the possibility of non-taxation if the Parent Company is a non-resident (i.e. a situation where a non-resident receives shares in a non-resident company as consideration for shares in a Japanese company).
These amendments will apply to mergers that occur as of 1 May 2007.
(c) Anti-avoidance rules for cross-border reorganizations
Anti-avoidance rules for cross-border reorganizations will be newly introduced and applicable to corporate reorganizations conducted on or after 1 October 2007 to include the following:
| - | mergers between group companies will be treated as non-tax qualified; |
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| - | contribution of shares in a foreign subsidiary by a Japanese company to a foreign parent company which does not have substance and the subsidiary is situated in a low tax jurisdiction will be treated as non-tax qualified; | |
| - | for a non-tax qualified merger, where shares of a foreign parent company which does not have substance and is located in a low tax jurisdiction are distributed, the shareholders of the liquidating company will be taxed on the capital gains of the liquidating company's shares at the time of the merger; and | |
| - | if the shareholders of a Japanese company will control the company through a foreign company which does not have substance and is located in a low tax jurisdiction, the income retained in the foreign company and in its foreign subsidiaries will be included in the taxable income of the resident shareholders of the foreign company in accordance with their respective shareholding ratio. |
International taxation
(a) Transfer pricing
Under the proposals, a taxpayer who files a request for a Mutual Agreement Procedure (MAP) with a country that has a tax treaty with Japan will be given a grace period to settle any outstanding tax payments. An exemption from tax penalties will also be provided during the grace period.
It has also been proposed to introduce new measures to improve the Advance Pricing Agreement (APA) application procedure and administration.
(b) Rules for tax havens
Currently, for the purposes of the tax haven rules, Japan defines a foreign company as a foreign related company if more than 50% of the total number of outstanding share of the foreign company is directly and/or indirectly owned by Japanese resident individuals, Japanese companies and non-residents who are related to the Japanese shareholders, and this ratio is computed by excluding any non-voting shares and/or non-dividend paying shares issued by the foreign company.
Also, currently, a Japanese taxpayer (corporate and individual) must include the undistributed retained earnings of the foreign related company as taxable income in their Japanese tax return if:
| - | 5% or more of the total number of outstanding shares (excluding non-dividend paying shares) of the foreign related company is owned directly and/or indirectly by the Japanese taxpayer; or |
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| - | 5% or more of the total number of outstanding shares (excluding non-dividend paying shares) of the foreign related company is owned directly and/or indirectly by the family shareholder group of the Japanese taxpayer. |
It has been proposed in the 2007 tax reform plans that where the foreign company issues shares that have different voting rights on the company's distribution of shares, or, shares that have different rights to claim on the company's distributions, the higher of the following will be used when computing the 50%/5% shareholding under the current rules (discussed above):
| - | the percentage of the total number of shares; |
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| - | the percentage of the total number of voting rights; or |
Leasing taxation
As of 1 April 2008, the new accounting standard for lease transactions released by the Accounting Standards Board of Japan is expected to be applied. The change in the proposed new standard would affect the exceptional rule for "non-ownership-transfer finance lease" where it is to be recorded as a sale and purchase transaction, unless there is a short lease term or small lease payment in which case it can be recorded as a rental transaction.
Currently, although the tax rules are not consistent with the accounting standards with regard to leasing, the tax treatment of lease transactions is similar to the accounting treatment. As such, in most situations, non-ownership-transfer finance lease transactions are generally treated as rental transactions for tax purposes.
Under the proposals, which are to apply to lease transactions entered into as of 1 April 2008, for a non-ownership-transfer lease transaction:
| - | the lease transaction will be treated as a sale and purchase; |
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| - | the lessor can recognize the deemed interest income based on the interest calculation and the balance of the net profit, equally over the lease period. The interest income is deemed to be 20% of the net leasing profit; |
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| - | the lessee is required to depreciate the leased asset based on the straight-line method over the leasing period until the remaining balance of the asset reaches zero; and | |
| - | if the lessee records leasing fees as expenses in its accounting books, the expenses should be treated as depreciation of the leased assets. |
Trusts taxation
By way of background, the Japanese Diet passed a bill for a new Trust Law on 8 December 2006 to replace the existing 8-decade-old Trust Law. The new law introduced a number of new types of trust including (i) Trusts issuing securities representing beneficiary rights, (ii) Limited liability trusts, (iii) Self-declaration trusts, (iv) Business trusts, and (v) Trusts of which beneficiaries are not specified. The new Trust Law was proclaimed on 15 December 2006 and will be enforced within 18 months from this date. The self-declaration trust provision are to only take effect a year after the new law is enforced.
With regards to the taxation of income derived from trusts, the current rules are as follows:
| - | General trust: Where a beneficiary is specified, the income is taxed at the level of the beneficiary. Where a beneficiary is not specified or does not exists, the income is taxed at the level of the settlor; |
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| - | Joint management trusts (Godo Unyo Shintaku), Securities investment trusts (Shoken Toshi Shintaku), etc.: The income from these types of trusts are taxed at the level of the beneficiary when the trust makes a distribution; and |
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| - | Specified trusts: The income is taxed at the level of the trust using the corporate tax. Subject to certain conditions, the trust may deduct distributions made to its beneficiaries against its taxable income. |
Under the proposed reforms, the income derived from the following types of trust will be subject to corporate tax at the level of the trust:
| - | Trusts which do not have beneficiaries |
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| - | Trusts where the settlor is a company (other than a government linked company or public interest company) that meet the following requirements: (i) a company transferring the whole or an important part of its business to a trust and the company's shareholders are to received more than 50% of the beneficiary rights. An exclusion is provided where only a single type of asset, other than monetary assets, are transferred to the trust; (ii) the term of the trust is not less than 20 years and the trustee is the corporate settlor itself or an individual/company who is related to the corporate settlor. An exclusion is provide where the main assets transferred are depreciable assets with a useful life of more than 20 years or non-depreciable assets/monetary claims with maturity terms of more than 20 years; and (iii) the trustee is the coporate settlor itself or a related party, and part of the beneficiary rights is owned by a person related to the settlor, and the profit allocation ratio can be amended; and |
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| - | Trusts issuing securities representing beneficiary rights other than a specified trust issuing securities representing beneficiary rights. |
With regard to specified trust issuing securities representing beneficiary rights, any income derived from this type of trust will be taxed at the level of the beneficiary at the time of the distribution of income, as follows:
| - | Income distribution to individual beneficiaries will be classified as dividend income while gains from the disposal of beneficiary rights will be treated as capital gains from the disposal of shares; and | |
| - | Income distribution to corporate beneficiaries will be classified as dividend income and the dividend received exclusion will not be applicable |
A trust is defined as a specified trust issuing securities representing beneficiary rights if the following conditions are met:
| - | the trustee is a company which has obtained approval from the tax authorities; | |
| - | the amount of undistributed income is not more than 2.5% of the principal of the trust's assets; and | |
| - | the term of the computation of the trust's income is not more than 1 year |
Additionally, the reforms propose to limit the beneficiary's utilization of losses incurred from a trust as follows:
| - | trust arrangements where the income from the trust, when generated, is taxed at the level of the individual beneficiary, losses from the trust that are classified as rental income from real property will be disregarded; and |
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| - | trust arrangements where the income from the trust, when generated, is taxed at the level of the corporate beneficiary, (i) the excess portion of the trust losses that exceed the beneficiary's investment will be disallowed, and (ii) the entire loss attributable to the beneficiary, when the accumulated trust profits to the beneficiary will not result in an overall loss. |
Corporate taxation
With effect from 1 April 2006, compensation in the form of (i) regular fixed compensation, (ii) fixed compensation notified in advance, and (iii) profit based compensation (subject to certain conditions), paid to directors are to be tax deductible. The following changes have also been proposed to the definition of the types of compensation:
| - | Regular fixed compensation: this is to include compensation that has been changed due to a change in the position within a company provided the amounts before and after the change are stable. Previously, regular fixed compensation was defined as any compensation which is paid in equal amounts at regular intervals of at least once a month throughout the fiscal year; |
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| - | Fixed amount compensation: this is currently defined to mean any compensation (i) which is paid at a fixed amount at a pre-determined time (which does not fall within the scope of regular fixed compensation or profit-based compensation), and (ii) for which advance notification has been submitted by the due date for submission. It has been proposed to change the due date for the submission of advance notification to the earlier of one month from the general shareholders' meeting or 4 months from the commencement of the fiscal year (currently, the earlier of the starting date of the service or 3 months (4 months for insurance companies) from the beginning of the fiscal year); and | |
| - | Under the proposals, the tax authorities need not be notified for the deduction of compensation to a director who is not paid any regular compensation. This refers to the compensation which a company other than a family corporation pays to a director. Currently, notification to the tax authorities is required. |