While keeping the same overall framework, the Japanese Tax reform in 2010 proposes a number of significant changes to the THCML that are likely to have a significant impact on the taxation of outbound Japanese investment. These changes include introducing a hybrid arrangement where Current Taxation may apply to a specific type of income (certain interest, dividends etc) as well as being applied to the income of a foreign subsidiary as a whole. Also the reforms include changes that recognise that foreign operations may be split among a group of entities in a foreign jurisdiction so introduces a concept (the ‘Unified Company’ concept) that provides some loosening of the prior position that required every foreign subsidiary to qualify for for exclusion from the THCML on its own merits. This may be particularly useful for companies wishing to establish a foreign holding company with operating subsidiaries.
These different reforms are discussed further below. Also the chart in this post provides a decision tree to assess the taxtion of a foreign company under the Japanese THCML under the 2010 tax reforms.
These changes are intended to be enacted for financial years starting from 1 April 2004 onwards with the exception of the final rule below relating to the receipt of dividends from foreign companies which applies to dividends received from 1 April 2004 or later.
- Reduction in the Minimum FRC Tax Rate
- Increase in Ownership Ratio
- Unified Companies
- Introduction of Current Taxation of Asset Related Income of SFSs
- Exclusion of dividends from foreign companies
The Minimum FRC Tax Rate is lowed from 25% to 20% or below. If tax is paid by the FRC at a rate above this rate for a particular financial year Current Taxation does not apply.
Also, in 2009 dividends that were exempt from tax in the country of incorporation of the FRC by reference to the ownership ratio of the FRC in the dividend paying entity were taken out of the non taxable income that had to be included in the denominator when calculating the FRC tax rate. This is beneficial to the taxpayer in that it will tend to increase the rate of FRC tax in the calculation and bring it above the Minimum FRC Rate. The 2010 tax reform relaxes this rule further: Dividends can be deducted from non taxable income that is included in the denominator of the FRC calculation if such dividends are non taxable because of reasons other than just the shareholding ratio when the law of the country of incorporation of the FRC excludes the dividends because of an intent to prevent double taxation.
In other words the above new rule recognises that foreign countries may have criteria besides shareholding ratio to exclude dividends from taxation to avoid their double taxation under the law of the foreign country concerned.
In another change favorable to taxpayers, the Ownership Ratio required before Current Taxation applies is increased from 5% or more to 10% ore more.
The 2010 reform also introduces a new arrangement that is intended to allow more flexibility in setting up foreign countries. The reform introduces the ‘Unified Parent FRC’ (toukatsu kaisha/統括会社) and the (‘Unified FRC’ – hitoukatsu kaisha/被統括会社). These companies are defined as follows:
A ‘Unified Parent FRC’ is a foreign company that meets all of the following conditions:
- The foreign company is an FRC with respect to a domestic Japanese company which also has to own directly or indirectly 100% of the issued shares of the foreign company concerned.
- The foreign company owns two or more Unified FRCs (definition below) and carries on a unified business as a unit.
- within the jurisdiction of incorporation of the foreign company concerned, there are sufficient fixed premises and staff employed to carry out the unified business concerned (counting only persons working exclusively on the business and excluding directors of the FRC)
A Unified FRC is a foreign company that meets all of the following conditions:
- The Unified Parent FRC must hold directly 25% or more of the issued shares of the foreign company, hold directly 25% or more of the shares with voting rights of the foreign company and must be a related company of the Unified Parent FRC (for persons who are related under the Non Related Persons Standard, only those that are foreign companies and excluding those persons related to the same family company of a domestic company)
- The foreign company is carrying out actual business activity in its country of incorporation
For a foreign company to qualify as a Unified Parent FRC then the relevant domestic holding company has to attach to its tax return the capital relationship between it and the Unified FRCs and also describe the business they carry out.
Under the 2010 tax reform where a company is an SFS but is exempt from Current Taxation through meeting various conditions around its activities (see the diagram and this post) it may still be taxable on certain defined types of income referred to as ‘Asset Related Income’ (shisansei shotoku・資産性所得). This is similar to the Subpart F approach in the US.
Asset Related Income includes the following types of income:
- Dividends or gains from the transfer of shares where the holding is less than 10%
- Income from the use of industrial rights or copy rights (including publishing rights and adjacent rights – but excluding such rights that were generated by the SFS itself)
- Income from bond coupon or gains on the transfer of bonds (limited to gains on sales on exchange or over the counter)
- lease of boats and aircraft
There is a de-minimus exception to the application of the above new rules. Where the Asset Related Income is 5% or below of the pre-tax income of the SFS or when the amount of such income is JPY10m or below Current Taxation does not apply. Note also:
- The amount of taxable income of the SFS is an upper limit for taxation of Asset Related Income
- Direct expenses related to Asset Related Income can be deducted and an allocation of funding costs to dividends and coupon Asset Related Income is also recognised.
- Income from dividends and coupon can be excluded from Asset Related Income if it is a key part or basic part of a business (although not for businesses that are excluded under the Business Standard).
When a Japanese company receives a dividend from a foreign company then out of the amount of that dividend and for the smallest out of the following amounts for the financial year of receipt of that dividend and for the financial years beginning within two years prior to the first day of the financial year or receipt of that dividend, then up to that amount can be excluded from the income of the Japanese company. The amounts are:
- Where the foreign company concerned has received dividends from another foreign company (excluding persons who don’t have income that has been subject to Current Taxation), then out of the amount of those dividends the amount corresponding to the share that the Japanese company holds in that second foreign company indirectly through the first foreign company.
- For the other foreign company, out of the amount that has been subject to Current Taxation the amount that corresponds to the indirect holding in that other foreign company of the Japanese company
These rules seem to be intended to give some measure of relief for dividends received from second or lower tier foreign subsidiaries but at this stage its application seems rather unclear. Further posts will look at this once the detailed regulations are available.
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