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Earthquake Recovery Law and enactment of remaining 2011 Japan tax reform proposals
On 30 November 2011, an Earthquake Recovery Bill was approved by the Diet and enacted (hereinafter, the “Earthquake Recovery Law”). In addition, the remaining 2011 tax reform proposals which had not yet been enacted were also approved by the Diet.
- Reduction of corporate tax rate
The national corporate tax rate will be reduced from 30% to 25.5% by the 2011 tax reform. However, a special surtax (10% of corporate tax due) will be levied for three years by the Earthquake Recovery Law.
As a result, the corporate tax rate for fiscal years starting on or after 1 April 2012 will be 28.05% for large companies. The effective corporate tax rate, taking into account local taxes, will be reduced from 40.69% to 38.01% for three years. After this, the effective corporate tax rate will be reduced to 35.64%.
- Review of the net operating loss (“NOLs”) carry-forward rules
Previously, total taxable income (ordinary income/capital gains) could be fully offset with available NOLs and any unused NOLs could be carried forward for up to seven years.
Under the 2011 tax reform, utilization of NOLs will generally be capped to 80% of each tax year’s income before NOL deduction. Corporations with registered capital of JPY100m or less (excluding corporations directly or indirectly wholly owned by a corporation(s) with registered capital of JPY 500m or more) and certain other corporations are exempted from this 80% cap. This reform is applicable to tax years starting on or after 1 April 2012.
The carry forward period was also revised so that NOLs arising in fiscal years ended on or after 1 April 2008 can be carried forward for nine years rather than seven.
- Introduction of special surtax for withholding tax
A 2.1% surtax will be levied on withholding taxes. Therefore, dividends, interest and royalties paid to a foreign corporation without a permanent establishment in Japan will be subject to surtax at 2.1% of the original withholding tax due. Such surtaxes will be applied to payments made from 1 January 2013 to 31 December 2037. Since a tax treaty will override the Earthquake Recovery Law, the surtax will not be imposed when a tax treaty applies.
The 2012 Japan tax reform proposals introduce earnings stripping rules
On 9 December 2011, the Japanese government released an outline of its tax reform proposals for 2012. These proposals formed the basis of a finance bill introduced in the Diet on 27 January 2012. In particular, the proposed introduction of earnings stripping rules may or may not significantly impact debt push-down structures into Japan.
The current Japanese tax law contains thin capitalization provisions, which prescribe a 3:1 debt-to-equity ratio (determined on a stand-alone financial statements basis). Interest expenses in excess of this ratio are permanently disallowed as a tax deduction for corporate income tax purposes.
As in the case of earnings stripping rules in some European countries, Japan’s proposed reforms introduce restrictions in addition to the thin capitalization rules. The new rules will cap interest deduction derived from “net” interest payments to related parties at 50% of adjusted taxable income.
Additional details are as follows:
- Interest costs subject to limitation would include guarantee fees, etc.
- Excess interest will be carried forward for up to seven years.
- Adjusted taxable income is calculated by adding back the following items to taxable income (for corporate tax purposes):
- Interest payments made to related parties
- Exempt dividends, etc.
- The 50% threshold is determined on a stand-alone financial statements basis unless the entities are part of a tax consolidation group in Japan.
Note that, Japan HoldCo structures with intercompany debt should be reviewed to ascertain if corrective action is required in order to mitigate the impact of these provisions. If an adverse result is anticipated, tax planning ideas such as tax consolidation, merger, cash repatriation or refinancing of HoldCo debt may be considered. The anticipated tax reform will be applicable to fiscal years starting on or after 1 April 2013.
The Japan-Netherland tax treaty and the Japan-Switzerland tax treaty entered into force on December 2011
The new Japan-Netherlands tax treaty and the new Japan-Switzerland tax treaty entered into force on 29 December 2011 and 30 December 2011 respectively. These tax treaties will apply as follows:
- Withholding tax payable on or after 1 January 2012
- Non-withheld tax imposed on income for fiscal years starting on or after 1 January 2012
- Taxes other than (1) and (2) for fiscal years starting on or after 1 January 2012
Tax rates on investment income and capital gains under the new treaties are as follows:
| ||Beneficiary/ income details ||Tax rate |
|Dividends ||Owning at least 50% of voting shares for 6 months; certain pension funds ||0% |
|Owning at least 10% of voting shares for 6 months ||5% |
|Other ||10% |
|Interest ||Government agencies, banks, certain pension funds, etc.; interest paid with respect to indebtedness arising as a consequence of the sale on credit of equipment, merchandise or service ||0% |
|Other ||10% |
|Royalties ||All ||0% |
|Capital gains on stock sales ||Shares of real property holding companies and bankrupt financial institutions ||Japan corporate tax rate |
|Other ||0% |
Introduction of a limitation on benefits (“LOB”) provision
Under the new treaties, the LOB provision requirements must be met in order for income to be fully exempt from Japanese tax.
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