Japanese taxation of a US Spin-off

August 6, 2011  |  Court, Dividend Taxation

Japanese judicial decisions

On 21 April 2011 the Tokyo High Court handed down a decision concerning whether shares acquired by a Japanese resident individual further to a spin off by an American company should be treated as dividend income for Japanese income tax purposes.

The taxpayer asserted that the receipt of the shares in the spin-off was not taxable. The court found that the receipt of the shares in the American company should be treated either as dividend income or as a deemed dividend, and accordingly rejected the tax payer’s assertion. The court also refused the taxpayer leave to appeal to a higher court.

Shares held in safe custody

The background to the case was as follows. The taxpayer had held shares in a US company (below ‘A Co’) in safe custody in their securities account with the Japanese branch of a foreign securities company.

In return for their holding of shares in A Co the taxpayer received an allotment of new shares in ‘B Co’ and ‘C Co’. The securities company wished to apply withholding tax on the value of the newly allotted shares on the grounds that their allocation under the spin-off should be treated as dividend income under Japanese tax law.

Note that a financial institution that handles the payment of dividend income in Japan should withhold 20 per cent Japanese withholding income tax when remitting such dividend income to a Japanese resident individual.

Taxpayer assertions

The taxpayer asserted at the first hearing at the Tokyo District Court that the taxation under the Japanese income tax law of a spin-off transaction was not clear, that in America the transaction was non-taxable and accordingly the transaction should not be taxable in Japan.

The Tokyo District Court found that where a company makes a distribution to its shareholders based on their position as shareholders, then, regardless of how the transaction is described, such a transaction should be treated as dividend income under the Japanese income tax law.

Findings in the Tokyo High Court

The Tokyo High Court went on to examine more closely the different components of the capital of a Japanese company and consider conceptually the implications of the definition of those components under Japanese corporate law in order to characterise the spin-off for Japanese tax purposes.

Payments out of Profit Surplus

Some part of the B Co and C Co shares acquired by allocation to the taxpayer was paid out of the Profit Surplus of A Co (in Japanese ‘利益剰余金’ or ‘rieki jyouyokin’) where Profit Surplus is a term defined in Japanese corporate law as explained in this article).

Such part was a distribution of profit to the shareholders of A Co in respect of their position as shareholders. Accordingly under Japanese Income Tax Law Article 24 (before changes under tax reforms in 2007) such amount should be treated as a distribution of profit for Japanese tax purposes and hence dividend income.

Payments out of Capital Surplus

Also some part of the B Co and C Co shares acquired through the spin-off of from A Co would have as their source the Capital Surplus (in Japanese ‘資本剰余金’ or ‘shihon jyouyo kin’, a term also defined under Japanese corporate law and explained in this article) of A Co. Such Capital Surplus would have been formed through the retention of profit of A Co.

These facts suggested that distribution of such part of the shares of B Co and C Co was somewhat different in nature from a distribution out of Profit Surplus discussed above. However, to the extent that this part exceeds the investment which gave rise to the return of capital of company a under the spin-off transaction, then Japanese Income Tax Law Article 25-3 (again prior to reform in 2007) should apply to treat this part as a return of capital of the company and hence as a deemed dividend for Japanese tax purposes.

The court recognised the right of the securities company to withhold Japanese income tax at 20 per cent from the amount treated as a dividend or deemed dividend. The court also refused leave to appeal to a higher court.


Please see the series of articles in the withholding tax section for more information on a person’s obligations to withhold Japanese tax from a payment of income.

While the facts and circumstances will differ in every case, the above court decision implies that a distribution of shares under a spin-off when made to a Japanese taxpayer will be treated as a dividend or deemed dividend to the taxpayer to the extent that the distribution exceeds the amount of capital contributed by them as investor through the shareholding that give rise to the new holding of shares under the spin-off concerned.

More information on the Japanese taxation of dividends and other distributions to shareholders can be found in the distributions section.

While this decision probably leaves a lot of practical matters to be addressed in each case, it does imply that the taxation of the transaction under the local law of the country concerned may not have a great deal of influence on the characterisation of the transaction for Japanese tax purposes given that the non-taxable nature of the transaction in the United State was not taken into consideration by the court.

Safe custody outside Japan

Note that in this case the taxpayer had put themselves within the scope of Japanese withholding tax on the transaction through holding the shares in Co A in a safe custody account at a Japanese financial institution.

It would be interesting to consider whether, if the shares in Co A had been held outside Japan (for example in securities account at any US financial institution without a branch in Japan), the transaction would have been outside the scope of Japanese withholding tax and the taxpayer need not have addressed the withholding tax point.

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