Tax Controversy – authorities challenge merger qualification

News, information

Softbank’s reported results for the three month period ended 30 June 2010 included JPY26.4Bn in respect of an assessment to taxes raised on its subsidary, Yahoo Japan, received from the Tokyo Regional Tax Bureau (TRTB) on 30 June 2010.  Yahoo Japan has commenced an appeal.  The background to this assessment was reported as follows:

Yahoo Japan received an audit from the TRTB covering the period ended March 2009.  The authorites identified an under reporting of income of JPY54Bn (USd635m) where the authorities alleged that, despite there being no reason to do so from a business perspective, a loss making subsidiary of Softbank had been merged with Yahoo Japan and the subsidiary’s carried over loss used to offset Yahoo Japan’s taxable profits, thus exempting from taxation JPY22Bn of taxes.  In response Yahoo Japan will be appealing the decision.

Yahoo Japan was applying to the merger concerned the rules introduced in the reforms to the Japanese tax system of 2001 intended to encourage corporate reorganisation by allowing tax deferred mergers, corporate splits and other transactions.  The offset of the tax loss of this subsidiary was based on applying tax qualification under these rules.  However the tax authorities asserted that there was no logical need for the merger to take place and that the conditions required for tax qualification of the merger were not fulfilled.  In recent years the number of enterprises that have been planning on making use of the corporate reorganisation tax system has increased.  The treatment decided under this tax case is likely to have an important economic impact on these transactions.

According to Yahoo Japan, in February 2009 the company purchased from Softbank for approximately JPY45Bn shares in Softbank’s wholly owned subsidiary company ‘Softbank IDC Solutions’ (‘IDC’), which ran a data center.  Then in the following month IDC was merged into Yahoo Japan with IDC being the ceasing company in the merger.  On the applicaiton of the tax system relating to corporate reorganisations, the carried forward tax loss that was held by IDC was carried over into Yahoo Japan.

Yahoo Japan’s information office asserted that “The purchase of IDC was for the purpose of building up the data center as a strategic base. The directive of the tax authorities was one sided and coloured by their prediction of future events.  We plan to contest it”


Under the Japanese corporate reorganisation rules included in the Japanese tax code (the ‘JCR’ rules) on a Qualified Merger it is possible to carry over the loss of the Ceasing Company in the merger to the Surviving Company provided conditions for the merger to qualify for tax purposes are met.

The JCR rules define a number of criteria that apply in order for a Merger to be Tax Qualified (the ‘JCR Qualifing Criteria’).  Depending on the precise transaction – and in particular the degree of common ownership between the merging and surviving companies – then some or all of the JCT Qualifying Criteria have to be met.  These Criteria vary in their level of objectivity.

It is not clear from the reporting on the case which of the criteria the tax authorities are alleging have not been met.  However one of the more subjective criteria for tax qualification is the “Related Business Criteria” which requires a degree of commonality between the nature of the businesses of the Surviving and Ceasing company in the merger.  The authorities have introduced rules that provide more clarity to how to meet the criteria.  These rules will be outlined in an article later this month.

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