Japanese Tax Haven Application Rule to Change

Sunday, December 13, 2009 – Osaka, Japan

Yesterday on December 12, Nikkei, Japan’s leading newspaper specialized in economy/business and politics, reported that the Japanese government has set policy of reviewing corporate tax system to change application rule of tax haven* with the objectives of eliminating tax dodge 2010 onwards. The government will lower the criteria of corporate tax burden of the regions and countries that the tax haven system is applicable for the first time, from the current 25% to just over 20%. Exceptions of the tax system will be more widely applied after the revision. These are all because emerging countries have been lowering corporate tax rate. This means bigger burden of corporate tax for Japanese companies, which could may well refrain them from starting and expanding their business in emerging countries. By reviewing the system, the Japanese government is to support Japanese companies starting and expanding business in growing markets.

1. Primary objective of changing the current tax haven application rule is to ease burden of Japanese companies.

Primary objective of the Japanese government reviewing the current corporate tax system is ease the burden of tax practices of Japanese companies. In a situation in which emerging countries have been aggressively lowering their corporate tax rate, it is not rationale to set the criteria of corporate rate tax rate for tax haven system application at 25%. And Ministry of Finance estimates that the decrease in corporate tax income by the corporate tax change is not critical.

2. Background of reviewing to change the system is the fact that corporate tax of Japan is the highest among developed countries.

Corporate tax of Japan is 40%, which is the highest among developed countries. And currently in principle, tax haven system is applicable to overseas affiliate companies located in regions and countries whose corporate tax rate is below 25%. When it is applied, a part of profit generated by the overseas affiliates is added to Japan HQ’s domestic income and the 40% of the sum is imposed as corporate tax. Under current criteria, it is quite possible that countries such as China, Korea, Vietnam and Russia, which Japanese companies are aggressive to enter and expand their business, are regarded as tax haven countries.

According to overseas business survey executed by METI (Ministry of Economy, Trade and Industry), out of overseas affiliates and subsidiaries (approximately 17,000 companies) of Japanese companies, half of them are located in tax haven countries under the current system. With problems of a Japanese company being imposed additionally for its affiliate located in Hong Kong which led to court case, Nippon Keidanren (Japan Business Federation) etc. have been requesting the government to review the current system. Therefore, the government has started to study to revise the criteria to just over 20%.

3. Currently there are exceptions to applying tax haven rule.

Under the current corporate tax system, there are exceptions to applying tax haven rule; i.e. there are some cases in which the rule mentioned above is not applied even if the corporate tax rate of countries and regions in which overseas affiliates are located is below 25%. Many companies leverage exceptions when, for example, more than half the trade of overseas affiliate is with non-affiliate companies.

Being exceptions, there are demerits such as companies bearing cost trading with non-affiliate companies. The government is to take this into account as well in reviewing the system. For example, they are to study to review the system so that the regional (e.g. Asia and Europe) HQs of Japanese manufacturers will not need to apply tax haven system even if their trade with non-affiliates is less than half the total trade.

4. The government will study and implement regulation to eliminate tax dodging of companies.

Taking the opportunity of changing the application of tax haven rule, the government will also set regulation to eliminate tax dodge of Japanese companies. The government will study to imposing corporate tax exclusively on incomes from assets such as interest and dividends for exceptions of tax haven system overseas affiliates. This is designed to eliminate tax dodge by Japanese parent company that has earned dividend by investing to overseas companies establishing substantive paper company in a third country. The U.S. has already transferred to this kind of system.

In fact, at the G20 (Pittsburgh) Summit held in September in which 20 regions/countries participated, the participants agreed to strengthen monitoring tax dodge of investors using tax haven system. The Japanese government is to closely collaborate to exchange information with respective countries about tax dodge while strengthening regulation of tax dodge from financial trade.


* Tax Haven
(Source: Nikkei, edited and translated by the author)
　　Tax haven is country or region whose corporate tax rate and/or tax of interest and/or dividend is zero or extremely low. Well known are Cayman Islands and multi-national companies and financial institutions, hedge funds etc. have been applying tax haven countries in order to making escape from being imposed of corporate tax.
　　Japanese tax haven system is applicable to countries and regions whose corporate tax is below 25%, thus many people have been pointing out that this system have been applied to regions and countries which cannot be said that it is sufficiently at a low level. In fact, it is possible that this system is applied to countries such as China and Vietnam in which many Japanese companies have started business. The Japanese government has set exceptions but the criteria are too high and Japanese business world has been requesting for review.

Major exceptions for tax haven are as below.
1) Business criteria: Major business is not owning stocks and debts
2) Reality criteria: Offices exists at head office address.
3) Administration and control criteria: Administration and control of business is performed at head office address.
4) Non-affiliate criteria: Business is mainly done with non-affiliate companies.