Japan 2010 tax reform – deferral of tax on intra group transactions

June 22, 2010  |  basics, Business combinations

Pine trees are typically planted at the gate to large shrines.

This post outlines the rules introduced in the Japanese 2010 tax reform that allow sales of certain assets to be made between defined Japanese entities within a group of wholly owned companies without immediately recognizing taxable gain or loss.  This system is referred to in Japanese as the グループ内取引等に関する税制・guruupu nai torihiki tou ni kansuru zeisei, translated below as the ‘Intra Group Transactions Tax System’ abbreviated as IGTS.  The system should apply to transactions from 1 October 2010 onwards but professional advice from qualified Japanese tax professionals must be taken to confirm how the system can be applied.

The IGTS is best understood as a separate set of rules from those relating to Japanese tax consolidation given that the scope of entities that can apply the IGTS is broader than for consolidation purposes and, unlike the Japanese tax consolidation system, pre approval of group formation is not required.  Note that prior to the introduction of the IGTS system it was possible to achieve deferral of gain or loss on transactions within a Japanese tax consolidated group.

The IGTS rules cross reference a large number of terms defined in the Japanese tax code which makes them difficult to understand without additional context.  The attached definitions list is intended help understand some of these terms.  Where a term is capitalised or abbreviated in this post, please search for the term on the list for further details.

There are also a variety of issues to consider when applying the IGTS.  The diagram linked here is intended to give a rough overview of the issues. Please click on the links below for further details.

Ordinary Japanese Companies and Defined Japanese Co-operative Associations – entities subject to the IGTS

In order for a transaction (referred to below as ‘Qualifying’ or a ‘Qualified Transaction’) to be eligible for deferral of gain or loss the transaction must be between ‘Ordinary Japanese Companies’ or ‘Defined Japanese Co-operative Associations’. More detailed definitions of these terms can be found here.  The term Ordinary Japanese Companies includes Kabushiki Kaisha, Goudou Kaisha (the so called “Japanese LLC”), Goumei Kaisha and Goushi Kaisha. Back to top

Complete Controlling Relationships – ownership criteria required for IGTS

In order for a transaction to Qualify the Transferor and Transferee must be in a Complete Controlling Relationship (‘CCR’).  That is, either one party owns, directly or indirectly, all of the issued shares of the other party or both parties are held, directly or indirectly, by a common owner.

The attached NTA pamphlet gives more detail around the definition of CCR in Japanese.  Where a company owns its own shares they are excluded from assessing whether or not a CCR exists.  Also, certain employees or directors of a company can own up to 5% (excluding shares the company owns in itself) of a company’s shares or defined options over the company’s shares and the company can still be treated as being in a CCR.

Note that for Tax Accounting Years starting from 1 April 2010 onwards companies that have a CCR with another company or companies should attach an organisation chart showing that relationship. Back to top

Assets Adjusted for Gains or Losses on Transfer (‘GLOT Adjusted Assets’) – scope of assets qualifying for the IGTS

A transaction must be in certain specified assets (‘IGTS Qualifying Assets’) in order to Qualify under the IGTS system.  IGTS Qualifying Assets are:

  • Fixed Assets
  • Land
  • Rights Over Land (excluding Fixed Assets)
  • Marketable Securities (with some exclusions discussed below)
  • Monetary Assets
  • Deferred Assets (i.e. certain defined capitalized intangibles)

Marketable Securities held as Trading Securities by the Transferor or that would be treated as Trading Securities if purchased by the Transferee are excluded from being IGTS Qualifying Assets.  Such securities are in any case marked to market for tax purposes and gains and losses taxable or deductible currently.  The notification rules (see below) include rules to allow the Transferor and Transferee to exchange information about the status of Marketable Securities.  Shares in subsidiaries would be included in the definition of Marketable Securities.   An important ommission from this is goodwill (although to the extent that seperable intangibles may be included under Deferred Assets or Fixed Assets above the they could potentially be subject to the IGTS).

There is a de-minimus exemption for certain assets with a Book Value below JPY10m and also rules for different categories of asset around how netting and aggregation is treated when applying the de-minimus limit (e.g. it is applied to each type (銘柄) of Marketable Security). Back to top

Subsequent realization of Gain or Loss on Transfer depending on Transferee circumstances

Taxable Gains or Losses deferred by the IGTS may be subsequently realized by the Transferor in certain defined circumstances which may be dependent on actions taken by the Transferee.  For example for certain assets, such as Depreciable Assets or Marketable Securities held to maturity, the IGTS allows the deferred gains or losses to be realized by the Transferor at a similar time to when they would have otherwise been realized if the transfer had not taken place.

The Transferor recognizes the deferred gain or loss on GLOT Adjusted Assets when the following circumstances apply.  Note that the Transferee will also recognise incremental gain or loss over the acquisition price from the Transferor.  The Transferor will recognise the deferred gain or loss in the Tax Accounting year of the Transferor that includes the last day of the Tax Accounting Year of the Transferee in which the circumstances arose.  The circumstances are:

  • On:
    • Further transfer by the Transferee
    • Disposal (abandonment) by the Transferee
    • Conversion of the Transferee to a Public Purpose Company
  • On a taxable upwards revaluation of the assets.  Note that revaluations of assets (for accounting purposes) that are not on a mark to market basis are not normally taxable.  They are however taxable in certain special circumstances, such as further to procedures under the Japanese corporate rehabilitation or insolvency, law and at those times this IGTS rule would apply to recognise the deferred gain.
  • Over the period of depreciation for Depreciable Assets
  • Over the period of amortization for Deferred Assets
  • For assets subject to tax deductible impairment, at the time of such impairment
  • For Marketable Securities already owned by the Transferee where further identical securities are acquired as GLOT Adjusted Assets, proportionate to subsequent disposals of such securities
  • For Marketable Securities generating taxable gain or loss on an accumulating or amortizing basis, proportionate to such accumulation or amortization.
  • For assets subject to mark to market at the time of entry or commencement into Japanese consolidated tax group, at the time of such event.

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Simplified Method to calculate subsequent realization of Gain or Loss on Transfer

The above rules on subsequent recognition of deferred Gain or Loss for the Transferor include proportionate recognition of gain or loss over time by reference to the period of amortization or depreciation of Deferred or Depreciable Assets.

In recognition of the additional bookkeeping complexity this causes, the IGTS allows a simplified method of calculation of recognition of deferred gain or loss by reference to remaining months of the GLOT Adjusted Assets useful life.  This method has to be elected and details supplied in the tax return. Back to top

Subsequent realization on loss of Complete Controlling Relationship

In circumstances where the Complete Controlling Relationship between the Transferor and Transferee comes to an end, the Transferor is required to recognize the gain or loss deferred in the Tax Accounting Year including the day in which the CCR ended.

An exception to the above rule applies when the reason for the ending of the CCR is as a result of the dissolution on Merger of the Transferor or Transferee company.  The merger must be a Tax Qualified Merger and the Surviving Company of the merger (including a newly established company) must have had a CCR with the ceasing Transferor or Transferee.  When the exception applies gain or loss recognition is not required as a result of the transfer on merger. Back to top

Subsequent realization on entry or commencement of a Japanese Consolidated Tax Group

Gain or loss deferred under the IGTS is also recognized on entry of the Transferor into a consolidated Japanese tax group (as well as the Transferee – see above).

The Japanese tax law includes what is effectively an anti-avoidance provision that requires an entity entering a consolidated tax group (not including the parent entity and subject to some exemptions such as an exemption for subsidiaries that have been held for a long period) to mark to market certain defined assets and liabilities and pay taxes on the resulting pre-entry gains or losses.

Where a Transferor company that has applied deferral under the IGTS enters into a consolidated tax group and is subject to such mark to market treatment this will crystallize the recognition of any remaining deferred gain at the time of entry.

De-minimus exemptions also apply to the above along with detailed exemptions that relate to certain merger and other transactions, but these are not discussed further in this post. Back to top

Dissolution of Transferor Company on a Qualified Merger

When a Transferor company that has deferred gain or loss further to the IGTS is subsequently dissolved further to a Tax Qualified Merger then the Merger Surviving Company is deemed to take over the original status of the Transferor under the IGTS.  In addition to being a Tax Qualified Merger the relationship between the Merger Surviving Company and the Transferor as Merger Ceasing Company must be a Complete Controlling Relationship.

Without this exemption applying the Transferor company may be seen as no longer in a Complete Controlling Relationship with the Transferee company as a result of the merger, giving rise to subsequent recognition of any IGTS deferred gain or loss by the Transferor. Back to top

Transfer of GLOT Adjusted Assets by Transferee on a Qualified Japanese Corporate Reorganization

Where the Transferee company transfers, further to certain defined transactions (discussed below), GLOT Adjusted Assets it has acquired in the past, then the company receiving those assets from the Transferee will be deemed to be taking over the position of the Transferee with respect to the application of the IGTS system.  The benefit of this rule is to avoid immediate recognition of any deferred gain or loss to the Transferee on the special defined set of transactions concerned.

Transactions under which the above deeming rule can apply are transfers further to Tax Qualified Mergers, Tax Qualified Corporate Splits, Tax Qualified Capital Contributions and Tax Qualified Dividends with the additional proviso that the counterparty to the Transferee in the transaction concerned (for example the Merger Surviving Company in a Tax Qualified Merger) and the Transferee were in a Complete Controlling Relationship prior to the transaction. Back to top

Non Qualified Mergers and transfers of GLOT Adjusted Assets

Not-withstanding the rules above , the IGTS can also apply to transfers of GLOT Adjusted Assets further to a Non Tax Qualified Merger.

In Non Tax Qualified merger in which a Transferee, with respect to earlier acquired GLOT Adjusted Assets, is the ceasing company and where the Transferee does not recognize for tax purposes any deferred gain or loss on the transfer of the assets further to the merger, then the Merger Surviving Company will take over the GLOT Adjusted Assets from the Transferee at an acquisition price adjusted for the deferred gain or loss, hence allowing the continued deferral of the gains or losses concerned.

The gain or loss deferred is also an adjusting item for the period end retained reserves of the Merger Surviving Company (thus impacting future withholding taxes and other tax attributes of the company concerned). Back to top

Notification requirements

The IGTS system also includes a number of notification obligations applicable to the Transferor and Transferee intended to facilitate easy administration of the system.  These are briefly as follows:

Notification by the Transferor at the time of Transfer

The Transferor has to advise the Transferee without delay after the Transfer of GLOT Adjusted Assets that the Transferor is applying IGTS deferral.  This obligation does not apply to Trading Securities nor de-minimus assets excluded from IGTS application.

Notification by the Transferee at the time of Transfer

Without delay after receiving a notification as described above, the Transferee has to send to the Transferor a notification covering the following items:

If the assets concerned are treated as Trading Securities by the Transferee (the IGTS cannot apply to such assets).

If the assets are Depreciable Assets or Deferred Assets whether the Transferee will be applying the Simplified Method of deprecation or amortization and if so the lifetime of the assets and period of time over which the assets will be written down.

Notification of Circumstances arising for subsequent recognition of deferred gain or loss

Where circumstances arise for the Transferee company such that the Transferor should subsequently recognize deferred gain or loss then, without delay after the year end in which the circumstances concerned arose, the Transferee has to advise the Transferor that such circumstances arose and the date they arose. Back to top

Repeal of the Tax Qualified Post Incorporation Transfer system

The Tax Qualified Post Incorporation Transfer system (that provided tax deferral for certain defined transactions whereby a company was incorporated with cash and then purchased assets from the incorporating entity) is repealed as being redundant with the adoption of the IGTS. Back to top

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