Consolidated tax regime
The consolidated tax regime has been replaced by the group tax relief regime, as described below.
Group tax relief regime
Effective for tax years beginning on or after 1 April 2022, group tax relief replaces the previous consolidated tax regime. In order to qualify for group tax relief, (i) the applicable member corporations must be 100% subsidiaries owned (directly or indirectly) by a single Japanese parent, (ii) an application to apply group tax relief requires the filing of an application to the National Tax Agency (NTA), (iii) local tax is not subject to the group tax relief, (iv) built-in gains or losses of assets owned by a group corporation will be realised under certain circumstances prior to beginning or joining the group tax relief system, (v) tax losses of a group corporation can be carried forward into a group tax relief system if certain conditions are met, but may only be offset against that group corporation’s own taxable income, (vi) the basis of a group corporation is adjusted when it exits the group, and (vii) gains or losses from the intra-group transfer of certain assets are deferred.
Under group tax relief (i) the parent corporation and each subsidiary file their own (blue form) corporate tax returns through the e-tax system, (ii) the parent corporation is allowed to deduct losses carried forward up to its own income amount in the same manner as its subsidiaries, and (iii) in principle, other members of the group will not be required to file an amended return if one member of the group files an amended return.
In addition, the current loss of member corporations will be allocated to the group on a pro-rated basis. To reduce the administrative burden on group corporations, however, most income calculations or tax credits will be applied on a stand-alone basis (e.g. donation and entertainment expense deductions, income tax credits, incentive tax credits, etc.). On the other hand, the research and development (R&D) tax credits and foreign tax credits will be calculated on a group-wide basis, and the creditable amount will be allocated to member corporations based on their respective corporate tax liabilities.
Group taxation regime
A group taxation regime is applicable to domestic companies that are wholly owned by a domestic company, foreign company, or individual ('group companies'). Unlike the group tax relief regime, the group taxation regime automatically applies to group companies.
The key points of this regime are as follows:
- The recognition of capital gains or losses from the transfer of certain assets (including the transfer of assets as a result of a non-qualified or taxable merger) between group companies is deferred until the asset is transferred to another group company or a non-group company.
- Where a donation occurs between group companies, there are no tax implications for either the donor or donee (i.e. no deduction for the donor and no taxation for the donee). Note that this treatment is not applied to a group company owned by an individual.
- A dividend received from a group company can be fully excluded from taxable income without any reduction for allocable interest expense.
A group company that would otherwise qualify as an SME on a stand-alone basis is not eligible for SME benefits (e.g. reduced corporate tax rate, preferable allowable ratios for deductible portion of bad debt provisions, partial deductibility of entertainment expenses, carryback of tax losses) if the SME is owned by a parent company or two or more parent companies of the group that have paid-in capital of JPY 500 million or more.
Where a corporation that is a member of a 100% group is in the process of liquidation and is expected to be dissolved, any loss from the impairment or devaluation of the shares of the liquidating corporation cannot be recognised by the parent company as a tax-deductible expense.
If a corporation that is subject to corporation tax sells property to or buys property from a foreign-related person, or provides services or conducts other transactions with a foreign-related person, and consideration is received or paid by the corporation, the transaction is required to be carried out at an arm’s-length price for corporation tax purposes.
A foreign-related person is a foreign corporation that has a special relationship with the subject corporation, such as parent-subsidiary, brother-sister, or a substantial control relationship.
The ‘most appropriate’ transfer pricing method to determine the arm’s-length price shall be determined using one of the following methods:
- Comparable uncontrolled price method.
- Resale price method.
- Cost plus method.
- Other method (i.e. profit split, transactional net margin method [TNMM], Berry ratio, discounted cashflow [DCF]).
An advanced pricing agreement (APA) system is available to confirm the arm’s-length pricing proposed by a taxpayer. APAs may be unilateral, bilateral, or multilateral.
Transfer pricing compliance requirements are described in the table below.
|Country-by-Country (CbC) Report
|Country revenue, pre-tax income, taxes payable, etc.
|Must be e-filed within one year of the last tax day of the ultimate parent
|Group company structure, business outline, financial conditions, etc.
|Transfer pricing documentation
|By due date of tax return, to retain for seven years
Interest paid on debt to controlling foreign shareholders is disallowed to the extent the average balance of debt on which that interest is paid is more than three times the equity of controlling foreign shareholders.
Interest expense deduction limitation (earning stripping rule)
The deductible portion of a corporation’s net interest expense to a related party is restricted to 20% of the adjusted income. This includes net interest expense paid to third parties that is guaranteed by a related party, unless the interest income is subject to Japanese income tax in the hands of the recipient.
Net interest expense is calculated as interest expense less corresponding interest income. Interest expense does not include (i) interest expenses on specified bonds (issued to limited number of unrelated parties and not the public), (ii) interest payments subject to the Japanese taxation or paid to qualifying public service corporations, and (iii) interest on back-to-back repos.
Adjusted income is defined as taxable income, adding back interest expense and depreciation expense, but excluding extraordinary income or loss.
Limitations (de minimis and group basis) on application of the interest expense deduction limitation include (i) where the net interest expense in a tax year is JPY 20 million or less, or (ii) the aggregated net interest expense on a Japanese corporate group basis (where there is more than a 50% capital relationship) is 20% or less of the aggregated adjusted income of the same group.
Non-deductible interest incurred in the past seven years will be deductible up to 20% of the current adjusted taxable income.
Anti-tax haven (controlled foreign company or CFC) rules
Undistributed profits of a CFC (which is defined as a foreign related corporation [FRC] by (i) equity ownership [owned more than 50% by Japanese corporations or residents] or (ii) de facto control) where the applicable tax rate is 30% (in the case of a paper company) or 20% in other cases are included in the Japanese parent company’s taxable income in certain circumstances. To cope with the increased compliance burden for corporate taxpayers as a result of the introduction of Pillar 2, the 30% trigger rate for ’paper companies‘ or ’cash box companies‘ under the CFC rules will be lowered to 27% for tax years of the Japanese parent company beginning on or after 1 April 2024.
Income earned by a CFC is 'aggregated' (i.e. included within the Japanese parent’s taxable income) in three different ways:
- Entity-based aggregation: Where all of the income of the CFC is taxable to the Japanese shareholder if (a) the main business of the foreign controlled subsidiary is not ’active‘ (the criteria of the ’active business‘ test are described in the law) and (b) the foreign tax rate is lower than a 20% ’trigger‘ rate.
- Entity-based aggregation: Where all of the income of the CFC is taxable to the Japanese shareholder if (a) the CFC fails certain 'substance' and 'administration and control' tests and is thereby treated as a 'paper company' or 'cash box company' and (b) the foreign tax rate is lower than a 30% ’trigger‘ rate (27% for tax years of the Japanese parent company beginning on or after 1 April 2024).
- Income-based aggregation: Where even if the entity-based aggregation rules are not applicable, the relevant income of the CFC is taxable to the Japanese shareholder if (a) income of the CFC includes certain 'passive' categories of income and (b) the foreign tax rate is lower than a 20% 'trigger' rate.
A Japanese corporation owning a 10% or more direct or indirect interest in a CFC is required to include its pro-rata share of the taxable retained earnings of the CFC in its gross income under certain circumstances. Dividends paid by a CFC are not deductible when calculating the undistributed profits for aggregation purposes.
Anti-tax avoidance rule requiring reduction in basis of subsidiary’s shares after receiving dividends from subsidiary
Where a Japanese parent receives from certain subsidiaries*, dividends that exceed in the aggregate 10% of the book value of the shares of that subsidiary in a given year, and subject to certain exceptions that are provided in the law, the parent must reduce its basis in the shares of the subsidiary by the amount of the dividends subject to the dividend income exclusion. This rule is designed to prevent the parent from reducing any capital gain arising on a subsequent transfer of such subsidiary’s shares by first receiving dividends from the subsidiary.
* A subsidiary with which the parent has a more than 50% control relationship as of the date of the dividend resolution.
Corporate tax measures for reorganisations
Most forms of corporate reorganisation can be treated as tax qualified if certain conditions are met. One of the main conditions is that there should be no ’boot‘ (i.e. there should be no cash consideration); there is some relaxation of this rule in the case of minority squeeze outs. In addition, there should be continuity of direct or indirect shareholder ownership; if the relationship continues at less than 100% ownership, various other conditions must be met.