Corporations – secondary tax liabilities

Gourmet uni (sea urchin) from Rishiri Tou. Click the picture for uni related Japanese trivia

There are a number of routes in Japan by which a company may end up liable to meet another company’s tax liability.

Some of these routes – such as succeeding to tax liabilities on a merger or of other consolidated group members in a consolidated tax group – are common to other tax systems.

As explained further below, some methods are less obvious and may be more unique to Japan. These obligations are easy to overlook in an insolvency proceeding or corporate reorganisation so care should be taken in the due diligence process.

It helps to divide the ways in which these secondary liabilities can be incurred into three different categories and then go on to consider them in more detail.

  1. nozeigimu no shoukei/納税義務の承継 - Succession to Tax Obligation – taking over a tax obligation further to merger or similar

  2. rentai nouzei sekinin/連体納税責任 – Joint Tax Payment Responsbility – joint and several liability for tax obligations

  3. dainiji nouzei gimu/第二次納税義務 - Secondary Tax Payment Obligation – succession to all or some part of another company’s tax obligation in specified circumstances

Succession to tax obligations

This is the most straightforward way in which tax obligations may be succeeded to.   This arises in a merger where the survivor company will take over the tax obligations of the ceasing company including liabilities from open years.  In inheritance tax the inheritors will also succeed to the tax liabilities of the estate.

Joint Tax Payment Responsibilities

Joint tax payment responsibilities (below ‘JTPR’) arise through process of law without any confirmatory procedures required.    Two common ways they can arise in a corporate reorganisation or M&A context are as follows:

Subsidiary companies of a consolidated tax group, including companies which have left the consolidated group, bear secondary tax liability for the consolidated tax liability of the parent company of the group (i.e. not just the parent company’s liability but also that of the other companies in the group concerned).  The secondary liability is limited to the liability arising for the period the company was a member of the consolidated group.

The split off company in a “bunkatsu style” corporate split off (i.e. a split off where the original company receives new shares in the split off company rather than the shareholders) succeeds to the tax obligations of the original company for the period that arose prior to the split off.  The liability succeeded to is, however, capped to the value of the assets that were received in the split off.

In Japan 100% ownership of a subsidiary is required before it can join a consolidated tax group.  The JTPR rule above is similar to the rule for US tax consolidated groups.

Secondary Tax Liability (‘STL’)

This is the main means in which the tax authorities can recover a liability from another person when the taxpayer is not able to pay its tax debts.  Some rules are intended to catch some specific techniques used in the past in Japan to escape tax liabilities.

A STL arises when it is recognised that an unpaid tax liability cannot be recovered from the assets of the main taxpayer alone (regardless of whether or not action is or has been taken to recover late payment from the main taxpayer) and where, subject to the fulfillment of specified conditions, another person is liable to fulfill the original tax obligation.  In some senses the STL resembles a guarantee of the tax liability that can arise in certain circumstaces.  Given this, in an M&A context it is important when buying a company, especially when the seller is in financial difficulties, to consider how the STL rules apply to prevent potentially being exposed to the historic tax liabilities of the seller  – whose size and tax profile could be very different from those of the target itself.

The following are examples of cases where STLs arise.

Company liquidation

When a company is being liquidated in circumstances where there are unpaid tax liabilities at the time of  distribution of assets further to the liquidation and when recovery actions have commenced against the company concerned but it is recognised that there will be a shortfall in assets to meet the tax obligations concerned, then either the liquidator or the perons who received the distributed assets are also potentially have a STL.  An upper limit for the STL for the liquidator is the amount of the distributions and for persons receiving distributions the value of the distributions that they received.

Where a distribution or transfer of assets is made prior to the liquidation commencing assuming that it would take place, then the such distributions are also in the scope of the STL.  Clearly one to watch for when buying assets from a distressed seller.

Family companies

Readers of Japanese manga (in particular Naniwa Kinyuudo) may have come across some of the ways in which owners of family companies try to escape their tax liabilities – divorcing their wives and then transferring the business to them at an under value and similar.  Japanese tax legislation addresses some of this situations, with the problem for international groups being that their wholly owned Japanese subsidiaries are also treated as family companies.

When a taxpayer in arrears (both corporations and individuals) owns shares or has invested capital (the term for capital in certain entities other than KKs) such that the taxpayer is one of the shareholders selected when assessing whether the company is a “family company” for Japanese tax purposes  and when, in relation to those shares or invested capital, one of other of the following circumstances applies and when in relation to the assets of the taxpayer in arrears (excluding the shares or invested capital in the family company) action has been taken to recover the arrears but it is recognised that there will not be sufficient to pay the national taxes due, then the family company concerned will bear a secondary tax liability in relation to the amount of national tax in arrears concerned.  The circumstances are:

  1. when steps have been taken to sell the shares or invested capital furher to tax collection procedures but a buyer has still not been found; or

  2. when in relation to the sale of the shares or the invested capital there is a limitation in the law or in the company’s articles or alternatively when there are obstacles to disposal, including the non-issuance of a share certificate.

The STL is limited to the shares in the family company or the invested capital held by the taxpayer.  However in the case of shares in a family company or invested capital acquired more than one year before the legal time limit for the payment of the national tax in arrears, such assets are an exception in the calculation of the upper limif of STL.  The exception for such shares or invested capital held in the past arises from cases where, in order to escape from a tax payment obligation, company’s have been set up extremely rapidly and businesses have been transferred to companies where the taxpayer was the company president.  Accordigly thought should be given to this sort of case.  However in the language of the legislation it applies to both companies and individuals so cases other than the establishment of a company by an individual will also be subject to application of this rule.

Specially related persons succeeding to a business

The rule below catch related companies in an international group as well as Japanese entrepreneurs divorcing their wives and transferring to them their businesses.

In circumstances where a taxpayer has transferred his business to parents or family, a subsidiary or a brother/sister company or some other specially related person and where the transferee is carrying on the same or a similar business in the same location and where the taxpayer has an unpaid national tax liability, where measures to collect that liability have commenced and but where it is recognised that there will still be an insufficient amount to repay that liability then the transferee will bear a STL relating to the unpaid tax liability.

Only the assets subject to the transfer (but including cash or similar received on the disposal of those assets or cases where the assets have changed their nature  are included) are subject to the STL.  Also, if the transfer occured more than one year before the legal obligation to pay the unpaid taxes was confirmed, then the transfer is outside the scope of the STL.

Whether or not a transfer is subject to the STL will depend on the conditions at the time of the transfer and if, for example, through divorce or similar the special relationship is lost the transaction is still subject to the STL.  Furthermore, if the transfer was as a result of a corporate split, then such a business transfer will also be subject to a secondary liability.

Transfers for for no compensation or at a low price

When in relation to the national tax of a taxpayer, collection proceedings have commenced but is recognised that there will be insufficient funds to meet the amount due, when the legal obligation to pay the tax arose one year or less prior and where the taxpayer transferred assets at zero consideration or at clearly for a low amount of consideration or when it can be seen that measures were taken to exempt debts or to transfer benefits to a third party then, according to thos measures the person who acquired the rights or exempted the obligations will bear a STL in relation to the national taxes that are unpaid.  The upper limit to the STL is limited to the actual amount of profit that was received by the person as a result of the above measures.  However if that person was at the time of the arrangements concerned the family or other specially related person of the taxpayer in arrears, then the limit is the amount of profit that was received due to the measures (in other words, without regard to the size of the actual profit existing at the time).

In determining whether consideration was clearly low comprehensive consideration should be given to the type of asset, the quantity, the difference between market vale and the amount of consideration and judgement made on an assessment through comparison with conventional societal standards and normal transactions.  In practice this is dealt with as below:

  1. For assets where in general the market price is clear (listed shares, bonds and similar), even if the consideration is a relatively small amount below the market price then this would be expected to be judged as “clearly a low value”.

  2. For assets with variation in price (for example, real estate) where the consideration does not reach around half of the market price then, to the extent that there are no special circumstances, this will also be judged to be “clearly a low value”.  However in relation to on half, in concept this is saying look at the difference between one half and if even if more than half the value, looking closely at the actual circumstances and judging whether “clearly a low value”.

So there we have it – a tour around some of the less well known parts of Japanese tax law but a potentially very material exposure for purchasers of Japanese companies under some circumstances.


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