Tax

October 2002

The government intends to maintain the basic framework of the financial and industrial revitalization plan proposed by Economic and Fiscal Policy Minister Heizo Takenaka. The government, top legislators of the ruling parties and top executives of major banks continued to debate measures to speed up the bad-loan cleanup ahead of the government's release of an anti-deflation package. The focal point of the debate was whether to adopt stricter rules on how banks' deferred tax assets are counted as equity capital. Takenaka has been calling for standards as tough as those in the U.S. The responsibility of bank management remains an issue. But the biggest issue is deferred tax accounting. Bank executives warned that banks would be forced to reduce lending and force borrowers to repay loans if the deferred tax accounting changes proposed by Takenaka are implemented. As tougher deferred tax accounting standards would mean that banks would have less equity capital, banks would have to reduce lending in order to prevent their capital ratios from declining. Ninety percent of the opinions during meeting were from bank executives concerned about the deferred tax accounting changes. Koizumi instructed Takenaka to smooth out the differences with the ruling parties based on his basic outline of tougher asset inspections and the injection of public funds into banks with insufficient capital. Takenaka, however, began to consider measures aimed at easing the impact that the deferred tax accounting change would have on banks. The timing of the accounting changes is unlikely to be included in the government's anti-deflation package. In his original plan, Takenaka insisted on implementing the changes next fiscal year. Although the details have not yet been worked out, the government is considering the idea of keeping the accounting standard as is until fiscal 2004, the target date the government has set for banks to thoroughly dispose of bad loans, and reconsider such changes later. Takenaka's original plan called for keeping deferred tax assets to less than 10% of a bank's Tier-1 core capital. Some in the government proposed gradually tightening this level to less than 50% in the first fiscal year and less than 40% in the second fiscal year. (October 30, the Nihon Keizai Shimbun)

The Tax Commission, an advisory panel to the prime minister, discussed tax incentives related to the disposal of nonperforming loans at banks. Ahead of the government's release of measures aimed at accelerating bad-loan disposals, commission members agreed to continue to examine such tax issues. The commission will discuss the idea of extending the period that banks can carry forward losses beyond five years, as currently allowed. The practice enables banks to deduct losses incurred in a fiscal year from taxable income in following years. Other issues discussed by the commission include reinstating loss carrybacks, which have been frozen since fiscal 1992, to refund corporate taxes in the past, and easing the conditions for when tax-deductible write-offs of bad loans are allowed. The U.S. extended the period that loss carrybacks are allowed to five prior years from two prior years after last year's terrorist attacks. The Ministry of Finance argues, however, that most banks have not paid corporate taxes due to booking losses, and that most banks would not be able to receive tax refunds unless loss carrybacks are applied to longer periods in the past. (October 30, the Nihon Keizai Shimbun)

A key subcommittee of the government's Tax Commission agreed to back a proposal to cut the top inheritance tax rate from 70% to 50% as part of a broader reform of inheritance and gift taxation in fiscal 2003. At the same time, the basic issues subcommittee decided to reduce the current exclusion to inheritance taxation, a monetary threshold under which no taxes are levied, in an effort to widen the tax base and correct a distortion that has only a small percentage of heirs carrying the entire inheritance tax burden. The proposals will be featured in a report on the fiscal 2003 tax revision, to be released in mid-November. The tax exclusion was raised during the bubble economy of the late 1980s, with the result that only 5% of all estates are subject to inheritance taxes. One of the centerpieces of the fiscal 2003 tax reform is the establishment of a large exclusion to gift taxation designed to encourage lifetime gifts, thus spurring a transfer of wealth from the elderly to younger generations. The inheritance tax overhaul is designed to complement the changes to gift taxation. The top gift tax rate will also be reduced from 70% to 50% under the tax reform blueprint. Tax Commission Chairman Hiromitsu Ishi indicated that the exclusion would be reduced with the aim of expanding the inheritance tax base to "around 10%" of all estates. Separately, the basic issues subcommittee also endorsed a proposal to reduce a special tax levied on the retained profits of certain small and midsize businesses. The tax targets family businesses in which a single family owns the majority of shares. Profits retained in the business after dividends and corporate taxes are taxed at rates ranging from 10-20%, after a set exclusion. The tax was introduced about 40 years ago in order to prevent family businesses from intentionally retaining profits inside the company. But voices in business circles now argue that the tax is not suited for the current economic environment, in which the development of venture-stage firms is a key issue. The proposed tax reduction also comes in response to discussions toward ending certain special provisions that now relieve the burden of some small and midsize businesses in collecting and paying the national consumption tax. (October 23, the Nihon Keizai Shimbun)

The bad-loan task force set up by Minister Takenaka is eyeing a plan to ease tax rules on bad-loan write-offs as losses on their taxes. Takenaka's team is also considering tougher standards on how banks can count tax payments that they expect to be returned in the future as equity capital. The task force is slated to present an interim report and compile its final report by month's end. In preparation for the interim report's release, the task force has been discussing issues such as beefing up asset appraisal standards as well as the potential infusion of public funds into banks. It intends to include in the final report specific measures aimed at revamping tax code provisions related to the cleanup of nonperforming loans. Under existing rules, banks can carry out tax-deductible write-offs of bad loans only when a borrower has been legally declared bankrupt or with debt waivers approved by tax authorities. Even if a bank incurs a loss after setting aside provisions for loans to borrowers that have effectively gone bankrupt, it is not treated as a loss on a tax basis. This constitutes one factor making banks hesitant to dispose of their bad loans. The government Council on Economic and Fiscal Policy is calling for looser tax standards for bad-loan write-offs. Specifically, it wants standards to be eased so that loans assessed by banks as being irrecoverable can be treated as a loss for tax accounting purposes even if the borrower's failure has not yet been legally recognized. While tax-deductible write-offs of nonperforming loans will not directly lead to an immediate improvement in the finances of banks, losses from the disposal of bad loans will be defined more broadly as losses for tax accounting purposes. Because banks will then face less of a tax burden, an easing of the standards will make it easier for financial institutions to carry out bad-loan disposal. The Finance Ministry says tax-deductible write-offs of nonperforming loans are already allowed now even if a company has not been legally declared bankrupt. But banks counter that existing standards are somewhat unclear. The task force is also eyeing a plan to change how bank losses arising from the cleanup of bad loans are treated. In Japan, such losses can be rolled over and deducted from taxable income for five years. Such losses can be rolled over for 20 years in the U.S., while in the U.K. and Germany they can be rolled over indefinitely. Because such regulations in Japan are strict from an international perspective, the Takenaka task force seeks to extend the rollover period to 10 years or more as a way to encourage the speedy disposal of bad loans by banks. The Finance Ministry opposes the idea, however, citing the tax revenue drop that may result. In light of how such changes would work in relation to nonfinancial firms as well, negotiations are likely to run into difficulties. The biggest remaining issue is how to treat deferred tax assets. Under deferred tax accounting, tax payments from the disposal of bad loans that are to be returned in the future can be booked as assets and included in equity capital. This has been criticized as providing banks with the means to inflate their equity capital. Such deferred tax assets are said to constitute nearly 40-50% of banks' equity capital. The inability of banks to write off most losses from the disposal of bad loans is believed to be a major factor contributing to the sharp increase in deferred tax assets. Consequently, the task force intends to carry out sweeping changes to the tax structure as it relates to writing off bad loans. (October 22, the Nihon Keizai Shimbun)

Hiroshi Okuda, chairman of the Japan Business Federation (Nippon Keidanren), for the first time clearly expressed support for injecting public funds into banks to stabilize Japan's financial system, even though such a move could temporarily increase taxpayers' burdens. Okuda made the remark during a speech at a Japan Center for Economic Research conference in Tokyo. "A delay in reorganizing Japanese industry" is one reason for the deterioration of the nation's economic and financial systems, according to Okuda. He said industrial revitalization should be speeded up after stabilizing the financial system through public fund injections. Okuda also said there are many ways to fight deflation, including establishing an income tax deduction for housing loan interest payments, promoting a reverse mortgage system, which allows elderly people to pledge property against funds to cover their living expenses, making capital gains from stock trading nontaxable and abolishing real estate acquisition taxes. Regarding special structural reform zones in which deregulation is promoted intensively, Okuda is disappointed because he feels that agencies and ministries have been slow to respond in the fields of medical care/welfare and education, although local demand for deregulation in these fields has been strong, criticizing the Ministry of Health, Labor and Welfare and the Ministry of Education, Culture, Sports, Science and Technology. (October 15, the Nihon Keizai Shimbun)

The government has settled on some of the basic elements of a tax reform package for next fiscal year, including a large deduction for gifts as well as tax breaks for corporate R&D and investment. In all, the government aims for net tax cuts totaling more than 1 trillion yen. In order to encourage the transfer of assets from the older population to working generations, the government would make up to 10 million yen in gifts tax-free over a taxpayer's lifetime. Corporations would also be allowed to deduct a certain percentage of their R&D spending from their tax bills. The Council on Economic and Fiscal Policy debated the overall structure of fiscal 2003 tax reforms, while the Tax Commission discussed details of fiscal 2003 tax reforms. But the government failed to come to a conclusion on a key issue whether to lower the corporate tax rate, and decided to continue discussing the matter while considering the macroeconomic environment. Minister Takenaka said that the scale of the tax cuts and the lowering of the corporate rate will be discussed. However, the two panels did agree on maintaining fiscal discipline in a bid to reach revenue neutrality in several years. They also agreed to simplify the securities tax system and to review real estate taxes. As for increasing taxes, the government will work on eliminating or cutting the spousal income tax deduction and stopping the practice of allowing small businesses hold on to consumption tax revenue. The government would also allow certain gift taxes paid over a person's lifetime to be deducted from inheritance tax payments. (October 12, the Nihon Keizai Shimbun)

Japan's economic policy on bad-loan disposals and tax cuts has yet to take shape due to conflicts between government agencies and a lack of leadership of Prime Minister Koizumi. The Council on Economic and Fiscal Policy (CEFP) and the Ministry of Finance are at odds over the size of tax cuts slated to be implemented next fiscal year and the lowering of corporate tax rates. The two issues are the focal point of fiscal 2003 tax cuts. Meanwhile, a feud within the cabinet is heating up, with the prime minister keeping a low profile. After the CEFP meeting, Finance Minister Shiokawa stressed that the government's top economic panel has agreed not to cut corporate tax rates next fiscal year. Analysts say that Koizumi is intentionally delaying a conclusion on the two issues so that he can respond flexibly to the economic situation until year-end. However, Shiokawa is eager to reach a conclusion. The veteran politician is well aware that negotiations with the ruling parties will not proceed without a decision on the framework for tax reform. Even if the government agrees on the main points of tax reform, it will need Diet approval to put them into action. It will also require deliberations with the Liberal Democratic Party's high-powered Tax Research Council, a de facto designer of tax reforms in the past. The CEFP, which is charged with working out economic policy independently of the interests of government agencies and political parties, has not budged either. Takenaka and private-sector members of the council are insisting on tax cuts of at least 2.5 trillion yen for fiscal 2003. The debate over tax reform, however, is fitting into the perennial pattern of the Finance Ministry deciding the larger framework and the LDP tax panel making the final conclusion. Analysts warn that the tax reform discussions could end with the Finance Ministry, for which restoration of fiscal health is a top priority, getting its way. But the biggest reason that economic policy is still in midair is the prime minister himself, who, as head of the CEFP, has not made a decision on the key issues. (October 12, the Nihon Keizai Shimbun)