As explained in this post introducing the Japanese Dividends Received Deduction (‘DRD’), Article 23-1 of the Japanese Corporate Tax Law recognises that, in order to mitigate double taxation of corporate profits, certain distributions to shareholders of corporate surplus as defined in the Japanese Corporate Law can qualify for DRD treatment in the hands of the shareholders concerned.
Japanese tax law also recognises that a number of other transactions between an entity and its shareholders or members are economically equivalent to returns of surplus to those shareholders or members. These transactions, although legally not directly having the form of a return of surplus to shareholders, are treated as ‘Deemed Dividends’ for tax purposes or in Japanese as ‘みなし配当’ (minashi haitou).
This post explains which transactions are treated as Deemed Dividends for Japanese tax purposes and outlines how they are calculated and treated for DRD purposes.
Definition of Deemed Dividend
Article 24-1 of the CTL reproduced below is the key article defining Deemed Dividends, outlining the underlying concept, their calculation and listing which transactions are treated as Deemed Dividends for DRD purposes.
Deemed Dividend concept and calculation
This paragraph explains that, where one of the reasons listed from 1 to 6 below arise, then for a Japanese Domestic Company that is a shareholder of another Domestic Company (excluding Public Profit Companies and Defined Groups Without Juridical Personality) then the receipt of monetary or other assets may be treated as a Deemed Dividend. The amount of the Deemed Dividend will be the value by which the assets concerned exceed the amount of the company’s Tax Based Capital (資本金等) or Consolidated Separate Tax Based Capital (連結個別資本金等) that is attributable to the Shares or Invested Capital which the concerned shareholder owns then the excess part is deemed to be a DRD Dividend as defined under JCL Article 23-1.
The above definition makes economic logic; given that in concept the Deemed Dividend will be taxed as income it makes sense that it should be the excess over an amount of capital returned to the shareholders. However care should be taken to understand how capital is defined for Japanese tax purposes. This defintion is addressed in this post on Tax Based Capital.
Items potentially treated as Deemed Dividends
Article 24-1 then goes on to list six transactions that may give rise to Deemed Dividends to the extent that they involve a transfer of value to shareholders in excess of the Tax Based Capital attributable to the shares they own. These transactions are:
- Mergers (excluding Tax Qualified Mergers)
- Corporate Splits (excluding Tax Qualified Corporate Splits)
- Capital Repayment (out of Dividends out of Surplus (limited to those that are made along with a reduction of the amount of Capital Surplus) those Dividends out of Surplus other than those made further to a Bunkatsu Style Corporate Split). Distributions of residual assets further to liquidation.
- Acquisition of own Shares or own Invested Capital (excluding aquisitons made on-market for certain defined markets meeting other conditions and transfers of Shares or Invested Capital that meet the terms of CTL 61 no 2 14-1 to 3. Note that CTL 61 no 2 14-1 to 3 refers to the aquisition of certain shares a company may issue with attached repurchase rights, these being 取得請求権付株式, 取得条項付株式 and 全部取得条項付種類株式. Acquisitions of these shares should not give rise to Deemed Dividends.)
- Extinguishment of Invested Capital, return of Invested Capital, repayment of Ownership Interests on retirement of Members or other corporate investors or any other means that a company that has issued Shares or Invested Capital brings about its extinction other than by its acquisition.
- Re-organisations (limited to those where at the time of the re-organisation the company carrying it out exchanges assets other than its Shares or Invested Capital with its shareholders – i.e. transactions involving “boot” in the form of cash or similar).
For the benefit of Japanese readers the transactions giving rise to Deemed Dividends are reproduced in Japanese below.
Deemed Dividends and the DRD
The DRD can also be applied to Deemed Dividends. As will be discussed in later posts, the DRD is disapplied to shareholdings that are only held for a short time (less than one month before or two months after the Dividend Base Date (配当基準日）- see post for details). This is in order to prevent the abusive application of the DRD to dividends on shares that are held only for a short time in order to receive the dividend concerned. However this disapplication of the DRD does not apply to Deemed Dividends. This may be an important point in corporate reorganisation, share buy-backs or similar transactions where Deemed Dividends arise.
Calculation of the Deemed Dividend amount
In principle the amount of a Deemed Dividend is intended to reflect the amount of surplus above original invested capital that is returned to shareholders. The basic formulae to calculate the amount of a Deemed Dividend reflects this concept, as below:
A = B – C
- A = the amount of the Deemed Dividend.
- B = the total value of monetary or other assets (a their market value) exchanged with shareholders in the transaction.
- C = the amount of the Tax Based Capital of the issuer company that corresponds to the shares or other capital in the transastion giving rise to the Deemed Dividend.
The above formulae represents the general principle, the Japanese tax law provides more specific formulae to calculate the amount of Deemed Dividend for each of the above transactions. Worked examples using these formuale are given in this post.