The Ministry of Finance announced a tax reform plan for 2005 on December 19 2004. The plan includes significant changes in the area of international taxation as follows:
Tax haven rules (CFC rules)
Personnel expenses deduction from taxable retained earnings of a controlled foreign company (CFC).
A CFC can deduct 10% of personnel expenses from its undistributed income in the calculation of taxable retained earnings of the CFC under the tax-haven rules. In this case, the CFC will have to meet the "acceptable business type standard", "actual operation standard" and "effective management standard" for active business exemption purposes.
Extension of the deductible period of dividends.
Generally, a Japanese parent company can recover the taxed retained earnings of a CFC if the CFC pays a dividend to the Japanese company within a certain period after taxation under the tax-haven rules. The period will be extended from five years to 10 years. This extension will apply to previously taxed retained earnings of CFCs derived from the business years ended on or after April 1 2000.
Extension of the utilization period of tax loss carryforward
Generally, in the calculation of the taxable retained earnings of a CFC, tax loss carryforward can be deducted from the undistributed income. The utilization period of the tax loss carryforward will be extended from five years to seven years. This extension will apply to tax losses of CFCs incurred from business years ending on or after April 1 2005.
Foreign trusts
Undistributed earnings retained by foreign trusts, that are similar to a special trust (tokutei shintaku) in Japan, will be subject to taxation under the tax-haven rules.
Capital gain from a transfer of shares similar to a transfer of real estate
If a foreign corporation transfers shares in a corporation and 50% or more of the total assets of the corporation consist of real estate located in Japan, capital gain from the transfer will be treated as Japanese source income, which should be subject to Japanese taxation. Also, transfer of certain beneficial interest in a specific trust, where 50% or more of the total trust assets consist of real estate located in Japan, will be taxed in the same manner.
Capital gain from distributions to nonresidents by capital reduction
If a foreign corporation receives cash or other assets as a distribution at capital reduction of a Japanese corporation, capital gain from the distribution will be subject to Japanese taxation and the corporation will have to file a tax return.
Transfer-pricing rules
"Foreign related parties" for transfer-pricing purposes will include the following foreign corporations:
a foreign corporation which is associated with a Japanese corporation through i) substantial control and 50% or more ownership, or ii) indirect substantial control only; and
a foreign corporation which is directly or indirectly controlled by the same person through i) substantial control and 50% or more ownership or ii) substantial control only.
This change intends to treat all foreign corporations as "foreign related parties" if the foreign corporations are associated with a Japanese corporation directly or indirectly by either ownership or substantial control.
Akio Takisaki (akio.takisaki@jp.ey.com)
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