1 japanese international tax policy and corporate taxation tadao okamura professor of law, kyoto...
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Japanese International Tax Policy and Corporate Taxation
Tadao Okamura
Professor of Law,
Kyoto University, Japan
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Summary
Basic structure of Japanese international taxation and its recent policy– Global system and territorial system
– Entire income taxation and attributable income taxation
– Recent changes in Japanese international taxation• Introduction of Dividend exemption and change in CFC
Recent changes in Japanese Corporate Tax Act (CTA) and interaction between corporate taxation and international taxation
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Global system
Worldwide taxation– All income is subject to taxation without regard to
the place where income derived.• In the case of resident individuals and domestic
corporations
– Income of non-resident aliens and foreign corporations is subject to taxation to the extent of their domestic source income.
• Because of this treatment, the concepts such as source and territory appear.
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Territorial system
Territorial taxation– Only domestic source income is subject to
taxation.• However, in almost all the cases, residents are subject to
taxation on their worldwide income with the limited exemption of foreign source income.
Neutrality– A territorial system has been said to enhance CIN.
• In contrast, a global system has been said to promote CEN.
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Branch
American type source rules
In Japanese international taxation, income from sale by the branch located in Japan may not be sourced in Japan.
Corporation
Germany
Japan
China
Attribution
Japanese Treasury
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Branch
CorporationCorporation
Entire income principle
In Japanese international taxation, income from investment by German headquarters is taxed on the branch located in Japan.
Investment Bank
Germany
Japan
Japanese Treasury
Attribution
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Attribution and Sourcing
Difference exists between attribution and sourcing.– Income may not be sourced in Japan though it is
attributable to Japanese branch.– Japanese branch is subject to taxation on income
sourced in Japan but attributable to German headquarters.
Income attribution as a personal concept– It reveals who earns income.
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Movement towardattributable taxation
United States– Some (not all) passive income is subject to the
branch located in United States without regard to its attribution.
• Effective connected income is mixed up with business income of that branch.
– A kind of attribution rule was introduced. Japan
– All the treaties follow OECD model based on attribution principle.
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From Indirect foreign tax creditto dividend exemption
Indirect foreign tax credit– This system deemed domestic corporation to pay
the tax to which its foreign subsidiary is subject on income of that subsidiary and allowed it to credit.
Dividend exemption from foreign subsidiary– Dividend other than 5% is exempt.– The reasons why Japan introduced this system are:
• promotion of the repatriation of accumulated profits in foreign subsidiaries
• simplicity
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Exemptionand a territorial system
Exemption of foreign source income and a territorial system– Some commentators and scholars are discussing
the movement toward a territorial system by exempting all foreign source income.
Is this understanding of the relationship between that exemption and a territorial system correct?
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Exemption of all foreign sourceincome and its problems (1/2)
Branch
Corporation
Germany
Japan
ChinaGermany Treasury
Chinese Treasury
Chine cannot both practically and theoretically tax the net income from sale of the branch located in Japan.
Japanese Treasury
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Necessity for attribution rules
(Net) income as a personal concept– (Net) income cannot be calculated on an item-by-
item basis because of the necessity of connection between revenue and expense.
– Attribution rules deem a fixed place of business to be a taxpayer and make sure the association between revenue and expense.
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Operation ofattribution rules (1/2)
Branch
Corporation
Germany
Japan
ChinaGermany Treasury
Chinese Treasury
The branch located in Japan would be treated as a person just like a corporation and subject to net income taxation.
Japanese Treasury
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Operation oftypical worldwide taxation (1/2)
China
Chinese Treasury
The net income of the branch located in Japan would be taxed exclusively by German.
Branch
Corporation
Germany
Japan
Germany Treasury
Japanese Treasury
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Branch
CorporationCorporation
Exemption of all foreign sourceincome and its problems (2/2)
The expense which the headquarters in German costs could not be deducted in Japanese withholding taxation.
Investment Bank
Germany
Japan
Japanese Treasury
Germany Treasury
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Attribution rulesand a territorial system
No application of attribution rules– Source country has the tax jurisdiction on passive
income.– The passive income which is attributable to the
headquarters in German would be exempted. Adoption of attribution rules on a territorial
system– Possible from the point of view of policy and
consistent with the OECD model treaty
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Branch
CorporationCorporation
Operation ofattribution rules (2/2)
Both revenue and expense would be subject to exclusively Germany taxation.
Investment Bank
Germany
Japan
Japanese Treasury
Germany Treasury
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Branch
CorporationCorporation
Operation ofworldwide taxation (2/2)
Revenue would be taxed both on Japanese withholding taxation and German taxation. The headquarter in German would credit the taxes burdened by Japan.
Investment Bank
Germany
Japan
Japanese Treasury
Germany Treasury
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Fiction in international taxationand its questions
What degree would branch be deemed as an independent taxpayer?– Borrowing relationship between headquarters and
branch– Contribution and distribution between
headquarters and branch Conflict between developing and developed
countries exists.
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Net income taxationand attribution of income
Necessity for attribution rules on a territorial (net) income taxation system– Not for sales tax or investment surcharge– It is impossible to limit the scope in the case of net
income taxation. Source rules and attribution rules
– In Europe, the place of resident to which income is attributable seems to be regarded as the source.
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CIN and a territorial system
Does a territorial system always enhance CIN?– Probably no. A territorial system which does not
base on attribution rules may make difference in tax base and differentiate the treatments according to the place where any investment comes.
– In Japanese withholding taxation on passive income, the tax base is gross revenue. In the contrast, residents are subject to net income taxation on passive income.
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CEN and a global system
Does a global system enhance CEN?– Maybe yes. The answer depends on the degree in
which both CFC taxation (worldwide taxation) and foreign tax credit work correctly.
A global system and expatriation– A global system itself cannot prevent residents
from expatriation and enhance the neutrality of person’s movement between countries.
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Promotion of CEN with worldwide taxation
Corporation would be subject to the same burden without regard to the way of business or the place if Germany provides foreign tax credit correctly.
Branch
Corporation
Germany
Japan ChinaJapanese Treasury
Germany Treasury
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Subsidiary
Violation of CENwith non-accrual type worldwide taxation?
If income of subsidiary should be subject to the same burden as that of sale of product directly, CEN should be considered to be violated because of deferral.
Corporation
Germany
Japan ChinaJapanese Treasury
Germany Treasury
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Branch
Violation of CEN for shareholderwith non-accrual type worldwide taxation?
In the situation where CEN viewed from corporation in German is promoted, CEN viewed from shareholder in U.S. should be considered to be violated because of deferral.
Corporation
Germany
Japan
United States shareholderGermany Treasury
Japanese Treasury
China
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Subsidiary
Promotion of CENwith non-accrual type worldwide taxation
If the independence of subsidiary should be respected with regard to calculation of income, CEN should be considered to be promoted. In this viewpoint, deferral does not exist!
Corporation
Germany
Japan ChinaJapanese Treasury
Germany Treasury
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Branch
Promotion of CENwith attribution rules
If the independence of branch should be respected with regard to calculation of income, CEN should be considered to be promoted. In this viewpoint, deferral does not exist!
Corporation
Germany
Japan ChinaJapanese Treasury
Germany Treasury
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Subsidiary
CorporationCorporation
Promotion of both CEN and CINwith non-accrual type worldwide taxation
Domestic investment in both German and Japan is subject to the same burden. Income from investment by corporation in German is equally taxed without regard to the target if foreign tax credit works.
Investment Bank
Germany
Japan
Germany Treasury
Corporation
Japanese Treasury
Investment Bank
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Branch
CorporationCorporation
Promotion of CEN and violation of CENwith non-accrual type worldwide taxation
CIN for Investment bank in Japan is violated. CEN for corporation in German and CIN for investment bank in German are promoted.
Investment Bank
Germany
Japan
Germany Treasury
Corporation
Japanese Treasury
Investment Bank
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Branch
CorporationCorporation
Promotion of both CEN and CINthrough attribution rules
If the independence of branch should be respected with regard to calculation of income, CIN would be considered to be promoted. Foreign tax credit in German is not necessary.
Investment Bank
Germany
Japan
Germany Treasury
Corporation
Japanese Treasury
Investment Bank
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Dividend exemptionin Japanese corporate taxation
Indirect foreign tax credit substituted– Only dividends from subsidiary with 25% interest
are exempt. Different tax burden because of the difference
in the way to repatriate– Lower burden in the case of dividend
• Only after the introduction dividend exemption
– Lower burden in the case of deductible payment
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Subsidiary
CorporationCorporation
Preference for royalty over dividendscenario
If effective tax rate of corporate income tax in both Japan and X country is the same, domestic corporation in Japan would prefer royalty payment because of foreign tax credit for withholding tax.
Japan
X country
X country Treasury
Royalty Scenario
Subsidiary
CorporationCorporation
Japan
X country
X country Treasury
Dividend Scenario
100
10
25
65
6.5
65 58.5
100 100
0 35
Japanese Treasury
Japanese Treasury
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Subsidiary
CorporationCorporation
Preference for dividend over royaltyscenario
If effective tax rate of corporate income tax in X country is significantly lower than that in Japan, domestic corporation in Japan would prefer dividend payment.
Japan
X country
X country Treasury
Royalty Scenario
Subsidiary
CorporationCorporation
Japan
X country
X country Treasury
Dividend Scenario
100
10
25
75
7.5
65 67.5
100 100
0 25
Japanese Treasury
Japanese Treasury
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CFC taxation
Subsidiary
CorporationCorporation
X countryX country Treasury
Japan
Japanese Treasury
Investment Bank
German
Income from sale of product
Income from passive investment
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Japanese CFC taxationand its new rule
Undistributed income has been mixed up– Its target is foreign subsidiary in the country where
tax rate is 25% or less.– All undistributed income is subject to Japanese
CFC (not to the extent of tainted income). Since last year, distributed dividend has been
mixed up too.– This new rule prevents domestic corporation from
avoiding CFC taxation through the distribution of dividend.
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Operation of new rule in CFC taxation
If effective tax rate of corporate income tax in X country is significantly lower than that in Japan, domestic corporation in Japan would prefer dividend payment.
Without new CFC rule
Subsidiary
CorporationCorporation
Japan
X country
X country Treasury
With new CFC rule
85
4.25
60.75
100
15
Subsidiary
CorporationCorporation
X country
X country Treasury
85
4.25
80.75
100
15
Japan
Japanese Treasury
Japanese Treasury
0 20
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Foreign tax credit vs.dividend exemption with new CFC rule
If effective tax rate of corporate income tax in X country is significantly lower than that in Japan, domestic corporation in Japan would prefer dividend payment.
Before dividend exemption
Subsidiary
CorporationCorporation
Japan
X country
X country Treasury
85
4.25
60.75
100
15
Subsidiary
CorporationCorporation
X country
X country Treasury
85
4.25
100
15
Japan
Japanese Treasury
Japanese Treasury
2015.7565
After dividend exemption
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CFC taxation and treaties
Article 7 of the OECD model– No PE, no taxation on business income.– Foreign subsidiary subject to CFC taxation has no
PE in Japan. CFC taxation as deemed dividend taxation
– When U.S. introduced CFC taxation, it is considered to prevent the deferral of shareholder level taxation.
– This explanation no longer applies to Japan.
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Two explanations ofJapanese CFC taxation
CFC taxation as attribution rule– If foreign subsidiary is just a paper company, its
income should be considered to be attributable to domestic corporation (or personal resident).
CFC taxation as a weapon against low-level taxation
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CFC taxationas attribution rule
Subsidiary
CorporationCorporation
X countryX country Treasury
Japan
Japanese Treasury
Investment Bank
German
Income from sale of product
Income from passive investment
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CFC taxationas weapon against low-level tax
Subsidiary
CorporationCorporation
X country Treasury
Japanese Treasury
Investment Bank
German
Income from sale of product
Income from passive investment
X country
Japan
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Limit of deduction of salaryin Japanese corporate tax
Requirement for deduction of salary for officer– Regularity– Reasonable amount
One-book and book-tax conformity– Currently, salary for officer is deductible for the
purpose of financial statement– Nevertheless, this salary is subject to limitation
and rather has introduced new type limitation.
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Change of corporate tax into consumption tax
Corporate tax without salary deduction– This feature would make corporate tax a
consumption tax.– This change may be a solution instead of
increasing consumption tax rate directly.
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Implication oftax base in corporate taxation
Corporation
shareholder
Japanese Treasury
Corporation
shareholder
Japanese Treasury officer
officer
Disallowance to deduct salary for officer
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Origin-basedconsumption type corporate tax
Corporation
Germany
Japan
Subsidiary
Japanese Treasury
China
Subsidiary
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Destination-basedconsumption type corporate tax
Corporation
Germany
Japan
Subsidiary
Japanese Treasury
China
Subsidiary
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Group taxationin Japanese corporate tax
Group taxation and consolidated tax return– Mandate vs. Eligible
– Each member calculates its own taxable income in group taxation system.
• No need to apportion the tax burden
Deferral of recognition– Transferor will be subject tax on gain or loss when
transferred asset gets away from the group. Determination at level of group
– Gradual rate, etc. applied according to the size of group
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Corporation
Transfer pricing and group taxation
Japan
German Germany Treasury
Japanese Treasury
85
5.25(15 x 0.35) + 5.25 (15 x 0.35)
Subsidiary
Subsidiary
85
FMV:100
BASIS: 85100
0 ((100-100) x 0.35)FMV:100
BASIS: 85
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Implications of group taxationin international taxation
Between separate accounting and unitary tax– Setting off loss and income– Deferral of taxation on intra-group transactions
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Formulary apportionment
Arm’s length standard– It determines two arm’s length price:
• Intra-group: Transfer pricing regulation
• Intra-corporation: income attribution to branch
– It differs from American type source rules. A substitution or backstop or any other?
– American type source rules adopt the formulary apportionment.
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Corporate tax reformand international taxation
CBIT (Comprehensive Business Income Tax)– No difference between corporation and branch
BAT (Business Activity Tax)– The concept of income attribution does not work.
Any other formula– Destination-based or origin-based
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Conclusion
Japanese international taxation system– On surface, old-fashioned global system– American type source rules and entire income
taxation• In reality, attribution rules of treaties apply.
Recent changes and implications– Movement into territorial system– Change of corporate tax into consumption tax
• Formulary apportionment needed
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Any questions?