Tax Controversy – Daiei taxed on forgiveness of debt to subsidiaries

July 31, 2010  |  Corporate Recovery, Developments, News

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Japanese retailer Daiei was assessed JPY25Bn (USD294m @85) for understating taxable income for four years.  The Asahi newspaper reported as follows:

It has become apparent that the Osaka Tax Authorities have identified under-reporting of income by Daiei, one of Japan’s leading supermarket chains, for a period of four years up until February 2009 relating to the forgiveness of loans to its subsidiary companies.  Daiei has completed the filing of revised tax returns and the income assessed was set off against brought forward tax losses so no additional taxes or penalties are payable.

According to persons with knowledge of the case based on Daiei’s reconstruction plan, which was progressing under the guidance of the Industrial Reconstruction Bureau, in 2006 Daiei abandoned JPY27Bn of debt with the objective of reorganising and consolidating the real estate lending businesses of nine related companies that had become insolvent that were based in Tokyo, Hyogo-ken and other locations in Japan.  The amount of abandoned debt was treated by Daiei as a tax deductible loss.

However, the plan for the reorganisation of the nine subsidiaries was changed and eleven companies, including the nine, were merged.  The Osaka tax authorities asserted that, looking at the fact that the original plan for the nine companies was not carried out, this meant that in fact no such plan existed.  Accordingly the amount of debt forgiven by Daiei was a “donation” to the subsidiaries for Japanese tax purposes and should not be treated as a deductible expense.  Therefore approximately JPY  of taxable income arose.  Daiei’s Investor Relations department reported that “There were some differences in view with the Tax Authorities, but in the end we accepted their instructions”.


This is a classic case showing that tax deductibility of the write off by a Japanese company of amounts due from an insolvent subsidiary is not guaranteed.  The Japanese tax authorities have published extensive guidance on when such a debt can be written off.  Attention should be paid to the details of this guidance but a key point is that any such forgiveness should be accompanied by a logical plan for reconstruction of the subsidiaries concerned as a result of the financial assistance that the debt forgiveness provides.

NTA guidance on the above issue, including cross references to law or Tax Instructions, can be found in Japanese in the links in this section -子会社等を整理・再建する場合の損失負担等 – ‘Bearing Losses on the Reorganisation of Subsidiary Companies’.

Donations by a Japanese company are only deductible up to certain relatively small amounts.  The denial of expenses above such limits on the grounds that they are “donations”,  as occured in this case, is common grounds in Japanese audits.

An interesting question is whether, if Daiei had originally prepared a plan to write off the debt to its subsidiaries in the merger of the eleven companies as actually took place or if, alternatively Daiei had better documented its original plan for debt forgiveness to the nine subsidiaries and then documented the changes to this plan Daiei would have been able to claim the debt forgiveness as tax deductible.  If the plans concerned  had been logical there seems some likelihood that Daiei would have been successful in these circumstances.

A further interesting question is how the transaction would be treated under the group taxation arrangements introduced in the 2010 tax reform or how treated if the companies had all been members of a consolidated Japanese tax group. In the 2010 tax reform assets can in principle (precise details should be checked) be transferred between 100% group companies without giving rise to gain or loss. Also certain transactions between 100% Japanese group companies at less than market value do not automatically give rise to taxation but rather give rise to non deductible donation in the paying company and non taxable income in the beneficiary. Would an alternative strategy be for a company to gift cash to its 100% subsidiary which could then immediately be used to repay its debt, giving more certainty of tax treatment?

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