Dividends and Attributable Interest

Wagashi traditional Japanese sweets often reflecting the seasons

The Japanese Dividends Received Deduction (‘DRD’) helps mitigate the double taxation a company would otherwise suffer through tax on dividends the company receives from other Japanese companies.  However the DRD regulations also include provisions that effectively disallow financing costs that are attributable to dividends to which the DRD is applied.  One intent of the these rules is to prevent a company increasing its leverage to lend or invest in another company while at the same time claiming a tax deduction for the additional funding costs of such an investment, especially when the investing company has another profitable business that would be able to use a tax deduction for the funding costs concerned. The effective disallowance of these funding costs or, referrred to here as DRD Dividend Attributable Interest, DRD DAI, is explained further below.

Leverage and the DRD


Note that the DRD DAI rules in the past have tended to make it more tax efficient for Japanese companies to reduce leverage at the parent company level and instead increase leverage at the subsidiary company level.  However, under the Japanese tax consolidation rules and the 2010 tax reform for dividends paid from Japanese subsidiary to its 100% parent, the DRD can be applied in full without adjustment for DRD DAI.  This is illustrated in the diagram shown.

Definition of interest subject to DRD DAI allocation

The CTL Article 23-4  referes to DRD DAI as  “….支払う負債の利子(これに準ずるものとして政令で定めるものを含むものとし、当該内国法人との間に連結完全支配関係がある連結法人に支払うものを除く。)…” which translates as “…interest paid on liabilities ( including items that are equivalent to interest as determined in Cabinet Orders, but excluding interest paid to a Consolidated Tax Group Company)…”. The CTLEO 21 and also goes on to list up further items that are similar to interest such as discount on bills or items that have interest like character included in Japanese insurance company reserve calculations.

The tax law is supplemented by Tax Instructions (‘TI’) that list up items that included or excluded from DRD DAI definition.  These can be found here (link in Japanese). Under the TI interest on loans or deposits from employees are included in the calculation of DRD DAI as is capitalized interest on the purchase or creation of fixed assets (such interest is treated as a Deferred Asset for Japanese tax purposes, see this post).  In contrast amounts equivalent to interest included in the acquisition of fixed assets in installment sales are not treated as DRD DAI, nor are certain interest like penalties for late payment of Japanese taxes (rishi zei and entai zei) nor discounts given for early settlement of trade receivables.

Calculation of the amount of DRD DAI attribution

Two amounts are totalled to calculate the DRD DAI netted against the DRD.  The first amount is for dividends from Related Company Shares and the second amount is for dividends from all shares other than those from Related Company Shares and Shares in 100% Subsidiary Companies (which as noted above apply the DRD in full without adjustment for DRD DAI).  These shares are referred to as ‘Other Shares’ below.  There are also two sets of formulae that can be used for calculating the DRD DAI – one standard set and also a simplified set of formulae.  The following definitions appear in the formulae:

Adjusted Total Assets Value

In principle the DRD for a particular class of shares is calculated by multiplying the amount of DAI interest by the ratio of the value of the shares concerned compared to total assets.  The value for total assets in the calculation is taken from the Japan GAAP financial accounts of the company receiving the dividend (below, the ‘Recipient’) but this raw total asset value is adjusted for various special items to give an ‘Adjusted Total Asset Value’.  Note that an amount deducted from total assets in reaching Adjusted Total Asset Value is unfavorable for the tax payer as the deduction will reduce the denominator in the formulae for calculating DRD DAI, hence increasing the ratio of share value to total asset value and the hence the amount of DRD DAI effectively disallowed.

Items that adjust total value to get to Adjusted Total Asset Value include:

  • Tax Basis Reduction amounts.
  • Special Tax Depreciation Reserves.
  • Land revaluation reserves.
  • Revaluations of securities that are not otherwise marked to market value.
  • The principle value of liabilities due to another 100% group company in a consolidated group on which interest is paid.
  • Deferred losses included in asset disclosure
  • Credit balances relating to special accounts for return of goods (TI 9-6-4)
  • Credit balances relating to bill discounts
  • Certain inventory adjustments for parts, other items
  • Adjustment can also be made for certain stautorialy defined bad debt and retirement reserves at the company’s option.
  • Tax Instructions explaining the above in more detail can be found here (link in Japanese).

Value of shares

Note that the value of shares that do not pay dividends subject to the DRD (for example, shares in foreign companies) are excluded from the share values used in the formulae below.  The tax book value is used for the shares, not the accounting value (CTLEO 22-1-2, 2-2)

Formulae – Related Company Shares

DRD DAI = A x ( B + C ) / ( D + E )

Formulae – Other Shares

DRD DAI = A x [( B + C) + (b + c) x 50% ( or by 25% for foreign securities investment trusts) ] / ( D + E )

Where for the formulae…

  • A = total amount of DRD DAI to be attributed
  • B = value of Related Company Shares or Other Shares (depending on the formulae) at the current period end
  • C = value of Related Company Shares or Other Shares (depending on the formulae) at the last period end
  • b = beneficiary certificates for securities investment trusts held at the current period end
  • c = beneficiary certificates for securities investment trusts held at the last period end
  • D =value of Adjusted Total Assets at current period end
  • E = value of Adjusted Total Assets at the last period end

Example DRD DAI calculation – facts

Here is an example working of the calculation based on the information below.

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Calculation:  Amount of DRD DAI

  • Amount of DAI subject to allocation and potential effective disallowance: JPY (1,575,000 + 875,000 + 2,430,000 + 1,980,000 + 640,000) = JPY7,500,000.  All of these items are within the scope of DAI.
  • Value of Adjusted Total Assets at previous period end = JPY (224,500,000 – 1,020,000 – 680,000) = JPY 222,800,000.  Special Tax Depreciation Reserves are net of the related deferred tax liability.
  • Value of Adjusted Total Assets at current period end = JPY (231,200,000 – 1,620,000 – 1,080,000) = JPY 222,500,000.

Value of shares at the end of the previous period:

  • Other Shares = JPY(7,800,000 + 4,000,000 x 50%) = JPY9,800,000
  • Related Company Shares = JPY5,000,000

Value of shares at the end of the current period:

  • Other Shares = JPY(9,500,000 + 2,000,000 x 50%) = JPY10,500,000
  • Related Company Shares = JPY5,000,000

Formule for other Shares:

  • DRD DAI = 7,500,000 x (9,800,000 + 10,500,000)/(222,800,000 + 228,500,000)
  • DRD DAI = JPY337,358

Formulae for Related Company Shares

  • DRD DAI = 7,500,000 x (5,000,000 + 5,000,000)/(222,800,000 + 228,500,000)
  • DRD DAI = JPY166,186

Total DRD DAI = JPY(337,358 + 166,186) = JPY503,544



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