Japan has a very broad general tax anti-avoidance rule that can be applied to certain defined classes of company (referred to below as ‘Anti-Avoidance Rule Companies’ or ‘AAR Cos’). This is Article 132 of the Japanese Corporation Tax Law.
The scope of the companies to whom this rule can apply suggests that it was originally intended to prevent tax avoidance by closely held Japanese companies, especially through transactions between such a company and its individual owners or their family. However, the scope of the definition of AAR Cos is so broad it will tend to include most subsidiaries and branches of foreign multi-nationals investing in Japan.
“…inappropriately reduce the corporate tax burden…”
The rule says that where, at the time that the tax authorities make a tax assessment or determination then when, taking into account the state at that time of the facts concerning the calculation [of the tax liability] or actions [of the parties], it is recognized that as a result the burden of corporate tax has been inappropriately reduced the authorities can recalculate the corporation tax base, the amount of tax losses or the amount of taxes payable.
For reference the rule is partially reproduced below. The key phrase in Japanese is 「法人税の負担を不当に減少させる結果となる」/, paraphrased below as “…inappropriately reduce the corporate tax burden…”.
（同族会社等の行為又は計算の否認） 第百三十二条 税務署長は、次に掲げる法人に係る法人税につき更正又は決定をする場合において、その法人の行為又は計算で、これを容認した場合には法人税の負担を不当に減少させる結果となると認められるものがあるときは、その行為又は計算にかかわらず、税務署長の認めるところにより、その法人に係る法人税の課税標準若 しくは欠損金額又は法人税の額を計算することができる。
Scope of Anti-Avoidance Rule Companies
An Anti-Avoidance Rule Company is a company that falls within either of the definitions of a ‘Family Company’ or ‘Other Closely Controlled Company’ given below. Wholly owned subsidiaries or branches of foreign groups will tend to be Family Companies.
A company where three or few individual shareholders (counting along with them individuals with whom they have a special relationship) or companies hold more than 50 per cent of the number or amount of issued shares or invested capital of the company concerned. Note that where a company owns shares in itself it is not counted as an additional company for the purposes of assessment as a family company.
Other Closely Controlled Companies
This definition is more clearly aimed at closely held family businesses. This definition captures companies that meet all of the criteria from (1) to (3) below:
(1) The company has three or more branches, factories or other places of business.
(2) In relation to a half or more of the above places of business of the company, then the foreman, person with main responsibility or person presiding over the business activities of the place of business concerned or the family of that person or other individuals having a special relationship with that person were previously, as an individual, in fact managing the business concerned.
(3) The persons identified as presiding over the places of business above own an amount of shares corresponding to two thirds or more of the total number or amount of issued shares or invested capital of the company concerned.
Interpretation or comments
One might expect the tax authorities of other countries to be jealous of the Japanese authorities having within their authority such a broad general anti avoidance provision. While it is certainly true that the term “…inappropriately reduce the tax burden…” is broad, there are some limitations on the application of the rule and a number of court cases have addressed such application.
An ultimate limitation to application of the rule may be the constitutional right to be taxed according to the law (article 84 of the Japanese constitution). More practically, Japanese court cases on the article have tended to apply doctrines such as a “non-family company standard” (非同族会社基準説) or “economic person standard” (純経済人基準説) when determining how the rule may apply.
Cases have also tended to concern non-arm’s length transactions such as purchases at an excessive price, sales by a company at below market price, assumption of debt without consideration or payment of excessive salaries to owners rather than more complex tax avoidance schemes. Reform of tax rules around payment of salaries and bonuses to owners and of rules around intra-group transactions may have the effect of narrowing the scope of application of the rule further.
Japanese tax law also includes more specifically targeted anti avoidance articles as well (for example, relating to taxation of corporate reorganizations). Later articles on this site will review court cases on this article 130 and on these other specific anti-avoidance regulations in due course.
Foreign investor perspective
Japan tax law has a comprehensive set of rules addressing transactions that are potentially abusive for tax purposes and these rules are well policed by the tax authorities: Thin capitalization rules, transfer pricing, donation taxation and many others.
The principal problem with this particular rule is that, from a foreign investor’s perspective, it introduces an additional layer of uncertainty and arbitrariness to any foreign investment decision.
Notwithstanding the limitations on the application of Article 130, foreign investors without detailed knowledge of the Japanese tax landscape are easily put off by the knowledge that, regardless of that the tax law says on the topic, a transaction may be held to “…inappropriately reduce the corporate tax burden…” and hence be subject to adjustment with any appeal being a complex, uncertain and time consuming process.