Regulatory Developments New concepts of fundamental importance have been introduced to the corporate tax regime in Japan. The most notable of these has been the introduction of tax qualified corporate reorganisations and preferential withholding tax rates on dividends and capital gains (to stimulate the financial markets), both cornerstones of the Koizumi reform policies. Equally important is the system of consolidated taxation introduced in 2001. These reforms and the extension of the tax loss carry-forward period by two years were a crucial part of the economic restructuring process. The introduction of the Bunsho Kaito (written reply system) has somewhat enhanced transparency and accountability, especially after the system was improved in 2004, entitling tax payers to written clarification of specific individual transactions. Another area where progress can be seen is the protection of confidentiality. Press reports on tax audits and about disputes between tax payers and tax authorities are less common now than five years ago. Moreover, information regarding amended corporate tax returns, usually filed in the course of tax audits, is no longer made public. It is difficult to claim, however, that the Government of Japan has done enough to create a tax environment supportive of businesses. Tax deferral rules for cross-border mergers through the so-called triangular merger scheme are unnecessarily complex. The "business continuity test" especially imposes an insurmountable burden to market entrants. While the introduction of consolidated taxes was crucial, the qualifying conditions need to be relaxed if the system is to fulfil its potential. Prospects for EU-Japan Economic Integration A vital and robust economy is impacted by rules and regulations in the tax regime. The Government of Japan deserves credit for undertaking far-reaching tax reforms in recent years, however further measures are needed to create a tax system compatible with the globalisation of corporations and increased capital mobility. European firms continue to encounter inconsistent and arbitrary treatment from tax authorities and regulations that impede market access and growth. Discrepancies in the interpretation of common tax concepts found in European and Japanese tax laws, a deviation in the progress of tax treaty re-negotiations between Japan and European countries, inconsistent interpretation of OECD based transfer pricing policies, and a lack in clarity on rules pertaining to capital gains from cross-border mergers must be addressed. Priorities
Key Issues and Recommendations ■ Accountability and confidentiality Yearly status report: some progress. Taxpayers may now seek written clarification of specific transactions as a result of changes to the Bunsho Kaito system enacted in March 2004. Despite this improvement, an overall lack of transparency and systematic accountability continues to impede the development of business in Japan. European firms continue to report cases of arbitrary and inconsistent treatment from the tax authorities. The EBC views any "leaking" of information protected by Japanese taxpayer confidentiality laws with extreme concern. The EBC welcomes the termination of both the publication of the annual list of top income taxpayers and the names of corporate taxpayers who have filed amended tax returns. Recommendation:
■ M&A and corporate restructuring Yearly status report: progress. The tax treatment of triangular mergers, made possible through changes to the Company Law in May 2007, is in practical terms a barrier to market entrants (with no established business in Japan) using their shares to acquire a Japanese company. Current rules do not, in principle, allow for a tax deferral if the transaction is carried out using a Japanese special purpose company, although the definition of the latter is subject to debate. If the Government is committed to promoting investment to Japan, non-discriminatory treatment of foreign shares as currency in mergers with Japanese companies is the most important policy step to take. The 2006 tax reform introduced limitations on the utilization of tax loss carry forwards after the acquisition of more than 50% of the shares of a company. The EBC recommends that the new rules be applied narrowly and further clarified. Recommendation:
■ Consolidated taxation Yearly status report: no progress. Current restrictions on tax consolidation limit the consolidated tax system from being fully or actively utilized among corporate taxpayers in Japan. Recommendation:
■ Transfer pricing Yearly status report: limited progress. The Japanese tax authorities continue to base transfer pricing assessments on secret comparables which makes it difficult for the taxpayer to confirm product and functional similarities. Moreover, the use of secret comparables for audit assessments is inconsistent with the transfer pricing methodology of Advanced Price Agreements (APA), in which company-level profitability of public companies is commonly used as reference point. Recommendation:
■ Tax treaties Yearly status report: some progress. Japan is currently re-negotiating tax treaties with the Netherlands and Germany. Recommendation:
■ Factor-based taxation Yearly status report: no progress. Criteria other than profits, such as capital, employee expenses, etc., are part of the Corporate Enterprise Tax applicable to firms with share capital over ?100 million. Such a tax discourages foreign investment and defies global trends that are moving away from the use of criteria contravening the principle to tax in accordance with the ability to pay. Recommendation:
■ Financial markets Yearly status report: no progress. At present, the issue of permanent establishment taxation of private equity and hedge funds is unclear and ambiguous. Dividends and capital gains from portfolio investments are temporarily taxed at preferential withholding tax rates of 10% only. Recommendation:
■ Reduction of corporate tax rates Yearly status report: no progress. The effective corporate tax rate for companies based in Tokyo with a share capital of ?100 million and less is 42% (40.7% where the factor based tax applies imposing additional 0.48% on salaries, rents, interests, etc and 0.2% on equity). Recommendation:
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