On 16 October 2009 the Osaka High Court determined, in favor of the tax authorities, an appeal from a taxpayer concerning the timing of tax deductibility of bonus payments.
The case is of interest in that it addresses the relationship between the corporate tax law itself and related corporate tax law enforcement orders (‘CTLEO’). The facts of the case also provide a practical example of the application of the law related to the timing of deductions of bonuses for Japanese tax purposes.
The appellant had determined the amount to pay in bonuses for each of the company’s employees prior to the end of its financial year on 31 May. This amount had been recorded as a tax deductible expense in the company’s tax return for the same period as either cost of goods sold or general and administrative expenses. The actual payment of the bonuses was made in the following year on 16 July based on the company’s rules for salary payment [Editor’s note: 16 July would have been before the due date for the tax return for 31 May but is after the one month allowed for payment of bonuses to allow their deduction in the financial year prior to payment under the CTLEO. These criteria are explained further below.]
Deductibility of the above bonuses was denied by the head of the responsible tax office of the company and an assessment issued accordingly. The appellant first appealed against the assessment to the Osaka Local Court but this appeal was dismissed on 30 Jan 2009 and appeal made to the Osaka High Court.
Point of contention
Whether or not the CTLEO Article 134-2 (timing of tax deduction for employee bonuses) deviates from the scope of authority that can be delegated to the CTLEO by Article 65 of the Corporation Tax Law (‘CTL’) (details of the calculation of taxable income for each financial year).
The Japanese constitution recognizes the doctrine that taxes should be assessed according to the tax law (‘租税法律主義’). Accordingly the criteria for imposing tax should not be delegated generally and comprehensively to the CTLEO but rather the basic criteria for taxation should be determined under the principal corporate law and technical details delegated to the CTLEO. CTL Article 65 should be interpreted as delegating the determination of the technical details of the implementation of the tax law in CTL Articles 22 to 64 to the related CTLEO in order to allow their implementation.
CTLEO Article 134 no 2 (currently CTLEO 72 no 5) provides in paragraphs 1 and 2 the criteria that have to be met in order to deduct bonuses in a financial year end prior to financial year end in which the date of payment falls. Paragraph 3 is the default rule for bonuses that do not meet the criteria in paras 1 and 2, which is deduction in the financial year of payment (even when related to an earlier financial year). When the criteria specified in paragraphs 1 and 2 are met this is consistent with also meeting the “matching standard” (for expenses against revenues, in Japanese 収益対応基準 ) and the “confirmation of indebtedness standard” (債務確定基準).
The purpose of the criteria in CTLEO 134-2 is, when taking into account the circumstances around the payment of bonuses to employees, to make clear how the amount of taxable income is calculated and preserve the fairness of taxation. Accordingly paragraph 2 determines the necessary technical details to implement Article 22-3 1 and 2 as the article relates to the timing of tax deduction of employee bonuses. Therefore CTLEO 134-2 does not deviate from the scope of matters delegated by CTL Article 66 and is appropriate law, not in breach of the doctrine of taxation according to the law.
In the facts of this case, it is recognized that for all of the employees on an individual employee basis, the amount of bonus to be paid had been determined. The amount had also been properly recorded as an accrual in the accounts of the company. However the amount of the bonuses was not paid until the following year. Furthermore, prior to the payment of the bonuses concerned notification was not given to each individual employee at the same time at the period for payment as required under the criteria in CTL 134-2. Therefore CTLEO Article 134-2 Para 3 applies and the bonus payment is deductible at the time of payment, which was the following year from the year concerned.
The text of the Japanese tax law is often outlining general principles, with a wide range of details then delegated to the CTLEO. Important points in CTLEOs are then also interpreted by tax instructions issued by the tax authorities, although these tax instructions do not have statutory force. Accordingly this case is examining an important principle, the extent to which regulations in the CTLEO may deviate or add to rules originating in the corporate law.
CTLEO Article 134 no 2 (now CTLEO 72 no 3) provides some relatively clear criteria that, if met, allow a company to deduct bonuses to employees prior to their being paid. These are briefly as follows:
The date on which tax deduction may be taken is the latest out of three specified days, being a date determined under terms of labor agreements (労働協約) or employment terms or the date on which notification is given to employees.
Also, the following three conditions all have to be met:
- The amounts to be paid are notified to the employees on an individual basis and in the same period of time in order for the bonuses to be deductible in the period concerned.
- The bonuses are actually paid within one month from the last day of the financial year end in which the above notification is made.
- The amounts were accounted for as an expense in the financial period in which the notification above was made.
The taxpayer failed to meet these conditions strictly in that a notification had not been provided to individuals and also bonuses were not paid within one month from the period end as required in order to claim a deduction for that period end. However the taxpayer did properly accrue the bonuses in its accounts and also
The taxpayer’s argument is that the CTLEO is only intended to regulate technical details of the implementation of the CTL itself and that given the criteria of that law in Article are limited to matching revenue and expenses and the liability itself arising the CTLEO goes beyond such delegated authority. An appeal is planned.