Foreign tax credit
A Japanese corporation is subject to Japanese corporate income taxes on its worldwide income. However, to avoid double taxation of foreign-source income, Japanese corporations are allowed to claim a tax credit against corporation and inhabitant’s taxes for foreign income taxes paid directly.
Creditable foreign taxes are defined as taxes that (i) are incurred directly by the taxpayer; (ii) are levied by foreign governments and local authorities in accordance with local tax laws; (iii) are levied on corporate income; and (iv) have the same characteristics as Japanese income tax, corporation tax, and local income-based taxes. A tax for which a refund can be claimed optionally by the taxpayer after the tax payment, or a tax whose payment grace period can be decided by the taxpayer, is not regarded as a foreign tax.
In order to prevent the credit from reducing corporation tax on Japan-source income, certain limitations are set on the amount of foreign taxes that can actually be credited. The ceiling is currently 35% for the foreign taxes paid. The creditable foreign tax is calculated according to the following formula:
Corporate tax liabilities x (Foreign source income / Worldwide income taxable in Japan)
Any excess amount over the limitation shall be carried forward for three years for credit. If any unused limitation amount is carried over from the past three years, the excess amount in the current year shall be creditable from the unused limitation amount.
A foreign tax credit is not applicable for enterprise tax purposes, although foreign branch income attributable to a business executed outside Japan is exempt from enterprise tax.
Generally speaking, the foreign tax credit system does not apply to the extent the dividend income from the foreign subsidiary is subject to the dividend exemption system.
Foreign corporations with a PE in Japan should note that when a foreign corporation’s PE in Japan is subject to taxation in Japan as well as in jurisdictions other than its country of residence, double taxation may arise. To alleviate an unfair tax burden, a foreign tax credit regime is also applicable to PEs in Japan similar to that which applies to Japanese corporations. However, foreign tax (including WHT) paid in the enterprise’s country of residency would not, in principle, be creditable under consequential changes to the foreign tax credit regime.
Under the 2019 Tax Reform Act, the amount of foreign tax that qualifies for foreign tax credits is calculated without applying the tax consolidation or pass through provisions when the CFC is subject to the tax consolidation rule or pass through treatment in the jurisdiction of the CFC.
Under the 2020 Tax Reform Act, foreign taxes paid under the following circumstances would no longer be creditable under Japan’s foreign tax credit system: (i) foreign taxes levied on payments between foreign corporations on the grounds that such payments were deemed to have been made to the Japanese corporation and (ii) foreign taxes levied on a payment from a foreign PE to its Japanese head office or another related party as a result of the foreign tax authorities disallowing a deduction at the local level. The above amendment will apply to tax years beginning on or after 1 April 2021.
Tax credits and incentives for research and development (R&D) cost
Under the 2019 Tax Reform, R&D tax incentives (the R&D tax credit system) were revised to promote innovation by (i) increasing the tax credit ratio, (ii) increasing the limitation of tax credits for qualified venture corporations (i.e., from 25% to 40% of the corporate tax amount), and (iii) expanding the scope of open innovation R&D activities to include the cost of B2B outsourced R&D activities. These new rules apply to the tax years beginning on or after 1 April 2019.
To claim the R&D tax credit, a taxpayer is required to meet an investment amount threshold (i.e. the annual investment amount exceeding 10% of taxpayer’s aggregated annual depreciation expenses). Under the 2020 Tax Reform Act, the investment threshold was increased from 10% to 30%.
R&D tax credits (permanent measures)
The tax credit ratio formula was modified as shown in the following table:
|Movement in R&D ratio (increase or decrease in ratio)||Tax credit ratio|
|8% <||9.9%＋(movement in R&D ratio - 8%) × 0.3 (upper limit of 10% but increased to 14% through 31 March 2021)|
|8% ≧||9.9% - (8% - movement in R&D ratio) × 0.175 (lower limit is 6%)|
The upper limit of the tax credit ratio of 10% is temporarily increased to 14% until 31 March 2021.
In addition, the tax credit limitation for certain R&D venture corporations (i.e. corporations established in the past ten years or less with carryforward losses and that are not a subsidiary of a large corporation) is 40% of the corporate tax liability, while the rate of 25% is applied to other corporations.
R&D tax credits for corporations with higher R&D expenditure ratios
A preferential tax credit ratio and tax credit limitation is temporarily provided to taxpayers with higher R&D expenditure ratios (more than 10% of average gross sales). Under the 2019 Tax Reform Act, these preferential measures were incorporated into the R&D tax credit system above, and the applicable period was extended through 31 March 2021.
The formula of the preferential tax credit ratio for corporations with higher R&D expenditure ratios was modified as shown in the following table:
|R&D expenditure ratio (R&D expenditure of average gross sales in the past three years)||Tax credit ratio|
|10% <||9.9% ＋ (movement in R&D ratio - 8%) × 0.3 × α (upper limit is 10%)|
|α = (R&D expenditure ratio - 10%) x 0.5|
The preferential tax credit limitation (see below) provides additional tax credit up to 10% (therefore the total is 35%), but the applicable period was extended through 31 March 2021.
|Tax credit limitation||Additional tax credit|
|25% of corporate tax liabilities||(α - 10%) × 2 (upper limit is 10%)|
|α = ratio of R&D expenditure to average gross sales|
Open innovation R&D tax credits
The scope of R&D expenditure that qualifies as 'open innovation' includes B2B outsourced R&D activities (i.e. R&D conducted jointly with certain R&D focused venture corporations, or R&D expenditure arising from contracts with certain R&D focused venture corporations). Depending on the nature of the R&D expenditure, 20%, 25%, or 30% of the R&D expenditure is allowed for credit.
The tax credit limitation for open innovation R&D expenditure is 10%.
R&D incentives for SMEs
The special measures providing a preferential tax credit limitation (an upper limit of 35% of corporate tax liabilities) where the ratio of increased R&D expenditure exceeds a certain threshold was modified (the threshold was increased from 5% to 8% by the 2019 Tax Reform Act), and the applicable period was extended through 31 March 2021.
The previous special measures providing a preferential tax credit ratio for an increased R&D expenditure ratio (more than 10% of average gross sales) was modified in the same way as R&D tax credits for corporations with higher R&D expenditure ratios described above.
Salary increase tax credits
Under the 2018 Tax Reform Act, the salary increase tax credit was amended for large corporations so that only those corporations increasing domestic investment would be eligible for the credits. The salary increase tax credit is available for corporations filing 'blue form' tax returns that meet the conditions described below. The revised salary increase tax credit rules are applicable for tax years beginning on or after 1 April 2018 until 31 March 2021.
To claim the salary increase tax credit, a taxpayer is required to meet an investment amount threshold (i.e. the annual investment amount exceeding 90% of taxpayer’s aggregated annual depreciation expenses). Under the 2020 Tax Reform Act, the investment threshold was increased from 90% to 95%.
|Before the amendments||After the amendments|
|Conditions||(1)||Increased salary payment / (Salary payment to employees in base year) ≥ 5%||Abolished|
|(2)||Salary payment in the current tax year ≥ salary payment in the preceding tax year||Salary payment in the current tax year > salary payment in the preceding tax year|
|(3)||((Average salary payment in the current tax year - average salary payment in the preceding tax year) ÷ average salary payment in the preceding tax year) ≥ 2%||((Average salary payment in the current tax year - average salary payment in the preceding tax year) ÷ average salary payment in the preceding tax year) ≥ 3%|
|(4)||N/A||Domestic capital expenditure ≥ 90% x total depreciation|
|Tax credit||10% of the increased salary payment plus
2% of the salary payment made in the preceding year
|15% of increased salary payment;
20% if training costs have increased by 20% or more
|Limitation on tax credit||Up to 10% of the corporate tax liability||Up to 20% of the corporate tax liability|
Internet of Things (IoT) investment tax incentive
A tax incentive (either accelerated depreciation or tax credit) for costs related to the development of certain data gathering and analytic information systems under the Special Measures Act for the Improvement of Productivity (Productivity Act) was abolished by the 2020 Tax Reform Act. The tax incentive is available to companies that file blue form tax returns and have obtained approval of an 'innovative data utilisation plan'. Companies will be eligible for either accelerated depreciation (30%) or tax credit (3% or 5%) if they have acquired software as well as machinery or equipment worth JPY 50 million or more pursuant to the approved plan. Under the transitional rules provided under the 2020 Tax Reform Act, the tax incentive will be applicable for companies with the application approved by 31 March 2020 and qualified facilities put into use by 31 March 2021.
The amount of tax credit available will be higher for companies that satisfy a 'salary increase condition' (i.e. the average salary for employees of the company is increased for the year by more than 3%).
Establishment of a tax system to promote investment in innovative corporations
Where a corporation engaging in specified business activities acquires the shares of a venture company (i.e. the qualified shares are of a venture company, certified as such by the Ministry of Economy, Trade and Industry [METI]) through an equity investment in such company from 1 April 2020 through 31 March 2022, and accounts for that investment in a special tax account, the investor corporation (i.e. the corporate shareholder) will be eligible for a special income deduction.
|Requirements for investor||Corporation must be engaged in specified business activities, specifically those undertaken with the goal of developing new businesses, that are expected to be highly productive, or that make use of management resources other than those of the company itself.|
|Requirements for investee||
|Investment method||Direct acquisition or through corporate venture capital or through an Investment Limited Partnership.|
|Threshold investment amount||JPY 100 million or more per investment, subject to an upper ceiling (JPY 500 million or more if the investee is a foreign corporation).|
|Tax incentive||Deduction of up to 25% of the acquisition cost (deduction limited to the taxable income of the current year); however, if certain events (e.g. the investor transferring the shares, the investor receiving dividends, METI revoking its certification of the investee company) occur within five years of the acquisition date, a deduction taken previously may be partially or entirely reversed and become subject to income taxation.|
Establishment of a tax system to promote the introduction of 5G technology
Accredited corporations will be entitled to elect either a 30% special depreciation rate or a 15% tax credit where they invest in infrastructure to promote the introduction of 5G technology and where the corporations put such infrastructure into use. The tax benefits introduced by the 2020 Tax Reform Act will be available where the accredited corporation satisfies the requirements from the effective date of the new act (the ‘Act to Promote Introduction of Specified Advanced Information Communication Systems’) through 31 March 2022.
Special tax treatment for investment in certain equipment
SMEs filing 'blue form' tax returns may elect, under certain conditions, to claim accelerated depreciation of 100% of the base acquisition cost or a special tax credit equivalent to 10% of the base acquisition cost on designated equipment to the extent that it is acquired between 1 April 2014 and 31 March 2021. The maximum tax credit is limited to 20% of the taxpayers’ corporate tax liability.
The 'Incentive for New Investment into Production Facilities' is applicable to any industry that invests in new production facilities (30% special depreciation or 3% tax credit on acquisition cost, up to 20% of corporate tax liability, etc., and subject to certain conditions). In addition, an investment incentive applies to SMEs that invest in equipment and furnishings pursuant to certain facility remodelling (30% special depreciation or 7% tax credit on acquisition cost, up to 20% of corporate tax liability [one-year carryforward of any excess], and subject to certain conditions). The SME tax incentive is granted to an SME engaged in the distribution, retailing, service, and/or agriculture business. This incentive is effective for tax years beginning on or after 1 April 2013 through 31 March 2021.
Incentives for the revitalisation of local ‘hubs’
A taxpayer is eligible for certain tax incentives if it relates to or expands certain kinds of operations in local areas (generally other than Tokyo, Osaka, or Nagoya). Details as to the kinds of operations eligible are included in a future Revised Regional Revitalization Law.
Any qualifying investments have the following depreciation incentives with respect to investments in buildings:
|Depreciation incentives||Investment pursuant to an approved relocation plan||Investment pursuant to expanding an existing operation|
|Type of depreciation (if plan is approved prior to 31 March 2022 and asset is acquired within two years of approval).||Additional first year depreciation of 25% of the acquisition cost (depreciation is accelerated).||Additional first year depreciation of 15% of the acquisition cost (depreciation is accelerated).|
Alternatively, a taxpayer may choose to take a tax credit rather than accelerated depreciation, as follows:
|Tax credits||Investment pursuant to an approved relocation plan||Investment pursuant to expanding an existing operation|
|Tax credits (if plan is approved prior to 31 March 2022 and asset is acquired within two years of approval)||Acquisition costs x 7%||Acquisition costs x 4%|
Minimum investment is JPY 20 million for large corporations and JPY 10 million for SMEs.
Alternate to the investment incentive above, an employment-related tax credit is allowed for increased employment in a local hub if hired within two years of the plan approval. The credit shall be JPY 900,000 times the number of increased employees at a maximum (if certain conditions are not met, the credit becomes JPY 300,000 per employee).
In either tax incentive, the amount of the above tax credits can only offset up to 20% of a corporation’s tax liability.
Local government contributions
As part of the Regional Revitalization Act, ‘blue form’ corporate tax filers who make donations to approved regional donation plans up until 31 March 2025 will be able to claim a tax credit against corporate, enterprise, and inhabitant’s taxes in addition to taking a deduction from the corporate tax. This is known as the corporate hometown tax, or furusato nozei system. Under the 2020 Tax Reform Act, the deduction rate was doubled and a corporate taxpayer will be able to claim a deduction up to 90% of the donation amount.
National strategic zones
For a ‘blue form’ filing corporation with an approved plan for qualified investment in a National Strategic Special Area up until 31 March 2022, a deduction of 20% of income is available for five years from the date of establishment.