Japan: Recent Discussions on the Corporate Enterprise Tax Reform

The Japanese government is planning to expand the scope of the pro forma standard taxation regime for the Corporate Enterprise Tax, which may potentially increase the tax burdens on many multinational corporations’ subsidiaries in Japan.

What is the Corporate Enterprise Tax?

The corporate enterprise tax (the CET) is a tax paid to the metropolitan/prefectural government (i.e., local tax) and is usually levied at 7% of the taxable income. However, in order to secure and stabilize tax revenues, the "pro forma standard taxation" was incorporated into the CET in 2004. Under the pro forma standard taxation regime, the CET amounts to the sum of the (a) per income levy (taxed at the rate of 1% of the taxable income), (b) per capita levy (essentially determined based on the total amount of the stated capital and the capital reserves), and (c) value-added levy (determined based on several elements, such as the amounts of salaries, net interest, and net rents paid). Under the current tax law, the pro forma standard taxation regime applies only to companies with a stated capital amount exceeding JPY100 million, and these companies are required to pay CET (i.e., the portions derived from the per capita levy and the value-added levy) even if they are incurring losses in the fiscal year.

What is going to be proposed?

The pro forma standard taxation system was originally introduced to target large corporations. However, in recent years, there have been many cases in which relatively large corporations, especially those not performing well, reduce their stated capital amount to less than JPY100 million to avoid the taxation system. The government has viewed such capital reduction as an aggressive tax avoidance measure. Therefore, in October, the government began considering the pro forma standard taxation system reform, aiming to expand the scope to capture companies beyond those with a stated capital amount exceeding JPY100 million. At a recently held tax reform project meeting, the Ministry of Internal Affairs and Communications proposed that other criteria should also be considered and used for the application of the pro forma standard taxation system, such as "the total amount of the stated capital and the capital reserves," "net assets," and "the number of employees."

Anticipated impacts on multinationals

If the revisions as proposed by the ministry are adopted into legislation, companies with a stated capital amount of JPY100 million or less could become the subject of the pro forma standard taxation system, thereby potentially increasing the CET burdens on these companies. In practice, many Japanese subsidiaries of foreign-owned companies (especially those in the GK form) often allocate only a limited amount of the contributed capital as the stated capital, while a large portion of the contributed capital is booked as capital reserves even though the total capital contribution by the foreign parent easily surpasses the JPY100 million threshold. Such capital structure has shielded these Japanese subsidiaries from the pro forma standard taxation regime; however, depending on the outcome of the discussions, these companies may need to revisit their strategies and take appropriate actions in the near future.