Tax

October 2003

The Japanese and U.S. governments have finalized a proposal for a revised bilateral tax treaty that would eliminate double taxation on dividends paid by subsidiaries to parents that own more than 50% of the companies. Both parties will move forward with the ratification process in an effort to have the treaty in place by 2004, with plans to take effect from 2005. The revision is the first in about 30 years. The Japanese side is expected to approve the proposal. The treaty and related legislation will be submitted during the regular Diet session starting in January. Under the revised treaty, parent-bound dividend payments made by majority-owned subsidiaries will be exempt from taxation by the host country. Dividend payments made by joint ventures in which the parent has a 50% interest will continue to face taxation. Some profit-generating Japanese firms may continue to face the same overall tax burden, since the greater dividends, due to the tax exemption, received from U.S. subsidiaries will be taxed in Japan in the form of corporate and other taxes. However, firms will no longer need to file paperwork associated with receiving tax credits on their corporate tax returns for the taxes already paid in the U.S. The elimination of the time lag between applying for and receiving the credits will improve companies' financial positions as well. Cross-border interest income received by financial institutions will be exempt from local taxation. Royalty income from trademarks and patents will also be exempt. The Japanese government hopes to include these tax reduction measures in treaties with Asian countries, among other nations. Given that Japanese companies have actively moved into the U.S. market, Japan faces a net surplus in dividend and interest payments. Reducing or eliminating taxes on dividends and interest is likely to increase the Japanese government's tax revenues from corporations. Japan faces a net deficit in royalty payments, resulting in a temporary reduction in tax revenues.　(October 30, the Nihon Keizai Shimbun)

The Ministry of Finance (MOF) says that the introduction of prices displayed with the consumption tax already included will improve consumer convenience. Retailers and other companies are not thrilled about it due to the increased administrative costs that will result from changes in pricing and register systems. Small and midsize companies, which will continue to face severe business conditions, are among the most vocal critics of the coming change. Some also argue that the inclusion of consumption taxes in product prices is aimed at blurring the consumers' sense of an additional burden in the event of a future tax hike. The government Tax Commission included the tax-inclusive price requirement in its basic guidelines for tax reform compiled in June 2002. The government and the ruling coalition then adopted it as part of tax reform for fiscal 2003. (October 22, the Nihon Keizai Shimbun)

A Fiscal System Council committee will recommend a reduction in local tax grants, in light of budgetary constraints at the national level, during a meeting discussing the trinity reforms. The three-part reforms aim to overhaul the revenue-sharing scheme between the central and regional governments. The advisory panel to the Ministry of Finance hopes to cut unnecessary expenditures in such areas as locally supervised public works projects and salaries for regional government employees. The Council will include these views in a statement due out Nov. 26 concerning next fiscal year's budget. Although local allocation tax grants allow the central government to bridge revenue shortfalls of municipalities, expenditures for such tax grants are about Y17 trillion, around 20% of the national budget, for the current fiscal year. The committee will also recommend the review of cost estimates for locally supervised public works projects that do not receive subsidies from the central government. In fiscal 2000, the gap between the estimate and the actual cost reached some Y6 trillion, leading the Council to conclude that projects need to be scaled back in line with fiscal conditions. (October 21, the Nihon Keizai Shimbun)

The government plans to set 10% preferential tax on foreign stock investment trusts managed by foreign companies in Japan, starting next January. The same rate planned for domestic trusts. A formal decision on the matter will be made in December. The preferential rate will be implemented after related laws have been revised at the regular Diet session that starts in January. The rate will be applied retroactively to the start of the year. Currently, there are about three trillion yen in foreign stock investment trusts that would be subject to the tax. Profit earned in Japan from them has been exempt from tax so far since they have been considered different from domestic investment trusts, which are easy to cancel and buy/sell. Capital gains from domestic trusts are now subject to a 20% withholding tax. The government is now set to levy a tax on them, though it has not yet revised the related laws. This summer, the National Tax Administration proposed to the securities industry that investors in foreign stock investment trusts file income tax returns and that profits from such trusts, including foreign exchange gains, be subject to a 26% tax, a figure equal to the total of income and residential taxes. However, the proposal met strong opposition, particularly from foreign securities, who claimed the rate would unfairly promote sales of domestic investment trust products in Japan. The American Chamber of Commerce in Japan (ACCJ) criticized it as well, saying that it could touch off a trans-Pacific trade dispute. The government then reconsidered the tax rate and reached a consensus on 10%, after discussions among the Finance Ministry, Public Management Ministry and Financial Services Agency. The preferential rate, both for domestic and foreign stock investment trusts, will be valid for a limited period, until March 2008. The government also plans to give investors in foreign stock investment trusts the option of having the tax withheld automatically enabling them not have to file an income tax return. (October 19, the Nihon Keizai Shimbun)

Newly appointed members of the government Tax commission face some thorny problems, as they attempt to tackle the nation's beleaguered public finances. Among the issues that must be addressed is how to finance a public pension system, which is due for comprehensive reform. The commission kicked off the debate over next year's taxation reform program. Subjects under discussion include whether the government should continue to use tax cuts as an economic stimulus measure at a time when the budget deficit is already seen as a major problem. However, a debate joined by the Liberal Democratic Party's research commission on the Tax System will begin only after the expected general election. At the commission's general meeting Prime Minister Koizumi asked members to discuss a taxation system that shares common social costs broadly and fairly, and stimulates a sustainable economic society. One of the points in the debate will be how to reform taxation policy to cope with a declining birthrate and the aging population. The focus of attention for the next fiscal year's taxation reform measures will be how to secure the Y2.7 trillion that will be needed to meet rising pension obligations. Next year the state's share of basic public pension contribution rises from one-third to one-half. In its interim report on taxation reform released in June, the commission asked to raise the consumption tax rate from the current 5% to a double-digit figure. The commission may now refrain from pressing this policy for the prime minister's position. Prime Minister Koizumi repeated that the consumption tax will not be increased. Commission members may instead consider curtailing tax deductions for recipients of public pensions in the next fiscal year. Hiromitsu Ishi, president of Hitotsubashi University said that a consumption tax hike could still be on the agenda. Depending on the state of public opinion and other factors, it is possible that consumption tax increases will still be discussed. (October 8, the Yomiuri Shimbun, the Daily Yomiuri, the Nihon Keizai Shimbun, the Japan Times)

To reform the tax system, the Tax Commission eyes hiking sales tax after Mr. Koizumi leaves office; Prime Minister Junichiro Koizumi has promised not to raise the tax while he is in office. The panel will start preparing for such a hike any way, as the government will need increased tax revenues to finance the public pension program. The tax panel was forced to focus on topics other than the sales tax. Currently it will give priority to topics like raising the income tax rates for wealthy pensioners. If public pension and elderly deductions are entirely removed, this will boost tax revenues by about \1.1 trillion a year. But such a complete removal is "unrealistic," according to the Finance Ministry. Furthermore, the number still falls far short of the \2.7 trillion needed to finance the planned increase in the government's share of the basic public pension plan from the current one-third to one-half next year. Consequently, most Tax Commission members believe that raising the sales tax is the only way to effectively deal with the increased pension burden. As an advisory panel to the prime minister, the commission is not in a position to officially conduct open discussions on the sales tax. It is technically free to draw up a scenario for the tax system after September 2006, when Koizumi's term will be up. (October 7, the Nihon Keizai Shimbun)