Case study: Thin cap – matters equivalent to a guarantee

February 10, 2011  |  Thin Capitalisation

A sculpture from the Sapporo snow festival. Hokkaido, Japan's northernmost island of which Sapporo is the capital, remains home to a high concentration of wild bears.

The following case study considers whether or not a transaction that does not have the legal form of a guarantee may still be treated as, in substance, being a guarantee from a Foreign Controlling Shareholder for the purposes of the Japanese thin capitalisation regulations.

This section should be read in conjunction with the articles on the Japanese thin capitalisation regulations which can be found here.

Capitalised terms below are as defined in the thin capitalisation section.

Case study facts

A Japanese subsidiary (‘Japan KK’) of a foreign parent company (‘Parent Inc’ – a Foreign Controlling Shareholder of Japan KK for Japanese thin capitalisation purposes) has borrowed funds (the ‘Loan’) from a Japanese bank.

Parent Inc has not formally guaranteed the Loan.  However, the CEO of Parent Inc has been included as a party to the Loan contract.

Would the lender be treated as a Capital Supplier for Japanese thin capitalisation purposes and hence the Loan within the scope of the Japanese thin capitalisation legislation?

Expected treatment

If the inclusion of the CEO in the Loan contract is in substance equivalent to a guarantee of the debt concerned, then the lender would be treated as a Capital Supplier and hence the Loan would be expected to be within the scope of the Japanese thin capitalisation regulations.


The definition of Foreign Controlling Shareholder under the Japanese thin capitalisation regulations includes foreign persons whose relationship with the Japanese borrower is an economic or substantive controlling relationship in addition to including persons who control the Japanese company through a share ownership relationship (Special Taxation Measures Law Enforcement Order article 39 no 13 (11)-3 – link in Japanese;  Tax Instruction 66 no 5-4 -link in Japanese).

More specificially, the definition of Foreign Controlling Shareholders includes persons who, in relation to a Japanese company, have the ability to decide, in substance, all or an important part of the business decisions of the Japanese company. This would likely include the Parent Inc CEO in this case.

The legislation notes that the scope of the definition specifically includes foreign persons who have a large volume of transactions with the Japanese company, who provide funding to the company and who share certain senior personnel with the company.

Furthermore the definition of Capital Supplier for Japanese thin capitalisation purposes includes persons who are providing funds to the Japanese borrower or persons related to the provision of such funds, which would typically include a Foreign Controlling Shareholder who is providing a guarantee to a third party lender. Please see this case study for further discussion of this point.

In this case study, if the inclusion of the CEO in the loan contract is required in order to facilitate the raising of funds or is a similar factor in carrying out and executing the arrangement of the Loan then, in substance these arrangements may be regarded as equivalent to a guarantee even though they do not have the legal form of a guarantee. Accordingly, the lender would be treated as a Capital Supplier for thin capitalisation purposes

The same economic substance definition used for thin capitalisation purposes is also used for Japanese transfer pricing purposes. Please refer to the diagrams in the Japanese group definition section related to transfer pricing for more information.


The following legislation is referred to in the above analysis.

Special Taxation Measures Law Enforcement Order article 39 no 13-11,3

This article defines the relationship between a foreign non-resident or a foreign company and a Japanese company that can result in the foreign person concerned being treated as a Foreign Controlling Shareholder of the Japanese company.

The wording in bold below refers to “…a relationship under which the non resident person concerned can in substance determine the whole of or some part of the business plans of the domestic company based on the facts stated as follows or other facts that resemble them…”


The facts that can give rise to the relationship are also in bold below:

(1) “…a certain [unspecified] amount of the business activity [of the Japanese company] depends on transactions with the foreign person…”

(2) “…a certain [unspecified] amount of funds required for the business activity [of the Japanese company] is borrowed from the foreign person or are raised under a guarantee from the foreign person…”

(3) “…half or more of the Directors or Directors with authority to represent the Japanese company are also directors and employees of the foreign person or directors or employees of the foreign company…”.

イ 当該内国法人がその事業活動の相当部分を当該非居住者等との取引に依存して行つていること

ロ 当該内国法人がその事業活動に必要とされる資金の相当部分を当該非居住者等からの借入れにより、又は当該非居住者等の保証を受けて調達していること

ハ 当該内国法人の役員の二分の一以上又は代表する権限を有する役員が、当該外国法人の役員若しくは使用人を兼務している者又は当該外国法人の役員若しくは使用人であつた者であること


Tax instruction 66 no 5-4

This tax instruction is a non stautory tax office interpretation of the scope of the “in-substance” definition of Foreign Related Person. It notes that a foreign person and a Japanese company may be related in this context when, translating the wording in bold below:

The business activity of the Japanese company “…relies on industrial rights (patents, manufacturing rights, Japanese “Utility Model Patents”, design rights, trademarks), nowhow and similar…” provided by the foreign person.

A half or more of the directors of the Japanese company or its directors with rights to represent the company are “…in substance determined by the foreign person…”.

66の5-4 措置法令第39条の13第11項第3号(同条第29項において読み替えて準用される場合を含む。)に規定する「その他これに類する事実」とは、例えば、次に掲げるような事実をいう。(平5年課法2-1「三十」により追加、平19年課法2-3「四十九」、平20年課法2-1「三十五」により改正)

(1) 法人が非居住者又は外国法人(当該法人が外国法人の場合には、他の外国法人)から提供される事業活動の基本となる工業所有権(特許権、実用新案権、意匠権及び商標権をいう。)、ノーハウ等に依存してその事業活動を行っていること。

(2) 法人の役員の2分の1以上又は代表する権限を有する役員が非居住者又は外国法人(当該法人が外国法人の場合には、他の外国法人)によって実質的に決定されていると認められる事実があること。

Additional disclaimer

Note that this case study is based on applying an opinion around the interpretation of the tax law to a set of hypothetical facts.  It should be read only as an example intended to elucidate ways in which the law may or may not apply under such hypothetical circumstances.

Proper advice should always be taken in a timely manner based on the actual facts concerned when considering how the law may actually be applied. If in doubt, persons can consult their local tax office.

Leave a Reply