The documents made public by the Finance Tax Research Group (below ‘FTRG’), a tax committee within the Japanese Ministry of Finance, include a listing of topics that the committee considers important for discussion together with the compilation of a range of views on the topics from members of the committee.
While this document reflects more the “brainstorming” of the committee and is not intended to reflect any policy conclusions, it is of interest in giving an overview of issues in the taxation of financial transactions that are thought worthy of further study under the auspices of the Ministry.
The document concerned (below the ‘Discussion Point Summary’ or ‘DSP’, in Japanese 「金融税制研究会・論点整理」 – link also in Japanese) is relatively long. This article summarizes the first half of the document and the next policy article will complete the summary.
Introduction – principles underlying financial tax reform
The Discussion Point Summary starts by rehearsing the purposes and overall policy objectives held towards Japan’s financial and capital markets in order to give context for the tax policy discussion. Accordingly, this first section of the DSP is somewhat general. However the following sections look at more detailed issues within the tax system itself, such as the unification of taxation of different types of financial income, steps to mitigate double taxation of corporate profits through taxing dividends and other items.
Below is a selection of points from the first sections of the DSP. Background comments to the issue including links to other articles on this site are in italics and occasional clarifying wording included in square brackets.
Section 1: Overall theory
Desirable financial and capital markets
- The capital markets should aim to increase economic competitiveness by encouraging innovation through directing the financial assets of individual, which are in excess of [USD16.5 trillion at USD1=JPY85], into growth areas.
- What the capital markets should aim for is the effective investment of individual’s financial assets in order to allow them a productive old age with a sufficient return on the assets concerned. Enterprises should be able to raise funds in a diversified manner and through those funds contribute to the development of the Japanese economy.
- From the point of view of market functions being part of the public infrastructure of the country, it is important to increase the number of participants in the market and create a liquid market.
- Whether or not investment into all different classes of assets should be encouraged as part of government policy objective should be carefully considered,
- Investment from overseas into Japan should be encouraged. The causes of obstacles to such investment should be eliminated to the extent possible.
- In relation to the unification of taxation of financial income, the process should be described and decided in a manner that is also transparent to market participants.
[Editors note – unification of taxation of financial income (in Japanese 金融課税の一本化) refers here to treating different classes of financial income as a single source. At present return from different financial instruments can be taxed in a variety of different ways. See the article on taxation of dividends for individuals or on income for individual tax purposes for background].
Views from a policy perspective
- The message should be communicated that the tax system should contribute to the revitalization of financial and capital markets
- Rather than using the tax system to induce investment, the first step should be effort to make sure that any distrust of the markets is removed
- As a medium term objective it is important to maintain the neutrality of the tax system, but in the short term some aspects of limited policy encouragement [towards particular classes of investment or similar] could possibly be acceptable
- An objective at the first stage would likely be a tax system that did not bring about distortion in investment choice [for example, between debt and equity investment].
- It is necessary to establish a view on what sort of position securities taxation should have within the overall system of tax reform and rebuilding of government finances.
Views from a tax system perspective
- The securities and financial tax system applied to individuals should be effective, straightforward and be applied with continuity.
- Discussion should always be conscious of the fairness of the overall tax system.
- Incentives should be additionally introduced as policy after taking into account the preservation of neutrality between financial products.
- When making comparisons with overseas tax systems, it should be noted that the basic system of income taxation is different.
- In thoroughly reviewing the taxation of financial income, given that it is also taxation on capital, the relationship with the corporate tax rate should also be considered in sufficient depth.
Section 2: Detailed items
The following section of the DSP considers in greater detail specific technical tax topics. These are listed below and the first of these topics – the taxation of equities – is summarized below. The following policy article will look the remaining items. The headings in the DSP are as follows:
- Taxation of equity
- Concessionary tax rates on equity
- Double taxation of dividends
- Unification of taxation of financial income
- Extension of the scope of loss offset
- Taxation of debt
- Deduction for carry forward losses
- Other items
Taxation of equity
For the background to the taxation of dividend income for individuals please see this article. At present dividends on listed shares are taxed at favorable rates. However dividends from unlisted shares are taxed at both the company level and, depending on their amount, at the investor’s marginal rate. This can result in very high levels of taxation on the profits of unlisted companies as shown in the table referenced in the article (link in Japanese).
The current Japanese tax system allows only limited offset of losses between different classes of income and does not allow the offset of losses on equities against gains or income from other sources.
Concessionary tax rates on equity
Views from a policy perspective
- From the point of view of changing the make up of Japan’s financial assets that is clearly biased towards deposits, it is important to maintain the current concessionary taxation applied to equities.
- Concessionary taxation widens the footprint of individual investment, and from the point of view of raising the liquidity of the market has a policy impact.
- Taking into account current market trends, if taxes on equity are raised in haphazard manner while there is uncertainty about the direction of the system for taxing equities, this runs the risk of giving the market a negative impression.
- If it does appear impossible to maintain the concessionary tax treatment on equities and if a return is made to the original system, then this should be combined with an extension of the scope allowed to offset losses from equities against other income
- In Japan’s case, given that a drop in liquidity is not expected to give rise to a drop in stock prices, then one would also not expect to see a lowering of tax on equities leading to a reduction in transaction costs, increased liquidity and hence a rise in stock prices.
- While being in a position where, owing to the state of public finances, a large scale tax reduction is not possible then, in order to encourage the flow of “risk money” into assets, consideration should be given to ceasing concessionary taxation [of equities] but extending the scope of loss set offs available.
- The rate of investment in equities increased above the prior rate of such investment with the introduction of the concessionary tax rates mainly among middle income earners. For middle income earners a tax rate of 20 per cent seems high.
- High rate tax payers seem to be gaining the benefits from the concessionary tax rates on equity, which is a problem from the point of view of fairness in the tax system.
- An increase in tax revenues from the return to the original regulations should be used as a source for reduction in corporate tax rate.
Views from a tax system perspective
- While progress on the unification of taxation of financial income is stalled, there should be no rush to return to the tax rates under the original system.
- When offsetting tax losses, risk [of an investment for the investor] is reduced the higher the tax rate is.
- While in the process of lowering corporate tax rates and, in the opposite direction, returning the tax rate to income arising from capital to 20 per cent the objective in the long term should be to equalize the taxation on both.
- Looking from the point of view of redistribution of income, a tax rate of 10 per cent is too low. From a public finances perspective, the original tax rate should be returned to 20 per cent.
- Because a tax rate of 10 per cent is too low, there is no need to reduce the tax rate applied to capital gains. But from the point of view of avoiding double taxation on dividends and encouraging the long term holding of shares, should equities not be treated as not subject to tax?
Adjustments for the double taxation of dividend income
Recent years have seen mitigation on the double taxation of corporate profits through the taxation of dividends, for example through introducing tax consolidation. However significant double taxation, especially at the individual level, still exists in the system. The articles in this section address corporate taxation of dividend income.
- A tax system that creates distortions between raising capital as debt and raising it as equity should be avoided.
- Consideration should also be given to the demerits of creating a complicated tax system in order to adjust for the impact of double taxation of dividends. Insisting on a complete adjustment would be best.
- Adjustment for double taxation of dividends should be carried out at the company level by the reduction on the corporate tax rate or similar. However in order to completely eliminate doublet taxation of dividends would require a complete withdrawal fro the current tax system,, so in fact complete adjustments is in practice difficult.
- Changing the base of taxation of dividends to 50 per cent as a method for adjusting for double taxation of dividends has been thought of. Handling dividends in a special account would also be easy without reducing tax revenues. Also a move from 10 per cent taxation to unified taxation would be easy to undertake.
- There is not theoretical basis behind adopting a method of taxation of 50 percent of dividends as a method to adjust for double taxation. Also problems could arise in the taxation of distributions from stock investment trust.
- If consideration is being given to widening the scope of the requirement not to report dividends on the tax return then the imputation tax system, which has as a premise reporting on the tax return, should not be introduced.
- Noting that the retention of profits in a company would be reflected in a rise in its stock price, then it could be said that double taxation will also arise through taxing capital gains.
- If it is not possible to soon adopt a system allowing adjustment for the double taxation of dividends, then from the point of view of maintaining for the time being the competitive trend for business, a full exemption or 95 per cent exemption from tax on dividends should be recognized without any restrictions with respect to shareholding ratio.