Tax avoidance and the Takefuji case

March 1, 2011  |  Court, News

Japanese judicial decisions

On 18th February 2011 the Japanese Supreme Court handed down a decision in favor of the heir of the Japanese consumer finance company, Takefuji, in a case relating to individual tax residence for Japanese tax purposes..

Read this article for an outline of the rules relating to Japanese tax residence for an individual and this article related to an earlier case covering similar ground This article reports on recent taxpayer victories in Japanese tax litigation.

Media attention

The case received a great deal of Japanese media attention given the high profile of the case, the amounts involved and that, given the case was a victory for the taxpayer, it involved a payment out of state funds of an additional approximate USD400 million dollars of interest on the repayment of the tax originally assessed of USD[].

However, the case was also important in that as well as examining a key area of Japanese tax law, the definition of individual tax residence, it also involved careful consideration of the extent to which the existence of a tax avoidance motivation in a transaction impacted the interpretation of the relevant Japanese tax law.

Facts of the case

The facts of the case were straight forward. The taxpayer had left Japan to live in Hong Kong and subsequent to his departure was gifted a substantial portion of the shares in the Takefuji family company. Under the tax law then in force and provided that the recipient was not a Japanese tax resident at the time of the transfer, such a gift would not attract Japanese gift tax.

Note that subsequent to the events in this case the tax law was changed to bring into the scope of Japanese taxation gifts made where either the transferor or transferee was tax resident in Japan during the period five years prior to or after the transaction concerned.

At the time of the transaction the taxpayer had been spending approximately two-thirds of his time living in Hong Kong while spending around a quarter of each year in Japan and the rest of the time elsewhere overseas. Despite the relatively small proportion of his time spent in Japan the tax authorities assessed gift tax on the taxpayer, who then commenced a sequence of appeals up to the Japanese Supreme Court level.

Tokyo High Court Decision

The decision in the first Tokyo High Court was initially a victory for the taxpayer. The Court focused on objective factors related to the period and number of days in which the taxpayer had been resident in Hong Kong and Japan and other matters related to his day-to-day life in determining that he was not a Japanese tax resident.

However, the Tokyo High Court decision was overturned when the Appeal Court focused on the tax avoidance motivation underlying the taxpayer’s move to Hong Kong rather than objective facts around his residence. The Appeal Court reversed the lower court decision in favor to the tax authorities.

The Japanese Supreme Court

On further appeal the Second Sub-division of the Japanese Supreme Court (最高裁判所第二小法廷) decided the case unanimously in favor of the taxpayer, with the decision addressing the relationship of a tax avoidance motivation to the interpretation of the Japanese tax law.

The technical tax issue at the center of the case was the definition of “address” (in Japanese ‘住所’ or ‘jusho’) for Japanese tax purposes.

An individual who has an “address” in Japan is tax resident in Japan. The court stated that “unless there were any special reasons an alternative interpretation should apply, address refers to the base of an individual’s life, the center of their overall life and the place to which their daily life has its closest and deepest connection…”. In Japanese “…反対の解釈をすべき特段事由がない以上、生活の本拠、すなわち、その者の生活に最も関係の深い一般的生活、全生活の中心を指す…”.

Furthermore the court stated “….even though, subjectively, there existed as an objective the avoiding of Japanese tax, such an objective was not sufficient to override the objective facts of the individual’s life…” (in Japanese “…主観的に贈与税回避の目的があったとしても、客観的な生活の実体が消滅するものではない…”).

Tax avoidance motivation

The Senior Judge of the Supreme Court added supplementary comments around the findings of the Tokyo High Court concerning a tax avoidance motivation.

The Judge noted that tax reform in the year following the year in which the gift had been made would have rendered the gift taxable if it had been in force at that time. However, he stated that it was unacceptable to retroactively apply newly established law in order to impose a disadvantageous tax obligation on a taxpayer.

Furthermore, the comments noted that the “…theory of legal interpretation itself has limits. When, according to such interpretation of the law, an unfair conclusion is unavoidable, then the route to resolution of such a matter is to seek the establishment of a new law…” (in Japanese “…解釈には自ずから限界があり、法解釈によっては不当な結論が不可避であるならば、立法を図るのが筋である…”).

Comment

Comments by the Judges in the Supreme Court and subsequent media reporting of the case have also touched on the position in the Japanese constitution that taxation should be according to the law.

However, as discussed in this article, Japanese tax law effectively includes a general tax anti-avoidance clause that has very broad application, has been upheld in past cases and which has not been tested on constitutional grounds.

Accordingly in showing that (unless there were special circumstances to think otherwise) the existence of a tax avoidance motivation should not in itself influence the interpretation of the tax law, the case’s main significance may be narrowing the scope of and removing some of the uncertainty involved in making an interpretation of Japanese tax law.


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