Paper Companies May Face Tax in Japan After U.S. Rate Cut (1)

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By Brian Yap

U.S. subsidiaries of Japanese multinationals functioning as paper companies—non-operating firms that exist for financial purposes only—could be subject to tax for the first time in Japan following U.S. tax reform.

Under Japan’s controlled foreign company (CFC) rules, income arising from a foreign subsidiary in a foreign country with a corporate rate that is lower than Japan’s is deemed income of the parent company in Japan and taxed in Japan—part of the country’s effort to quash tax avoidance. The change implicates multinationals with U.S. subsidiaries of Japanese multinationals, which could now be subject to the rules if they fail an economic activity test and qualify for the 21 percent corporate tax rate in the U.S.

The change means Japanese multinationals could pay more in tax unless they restructure their foreign operations, practitioners told Bloomberg Tax. Japanese multinationals are now studying whether their limited liability corporations located in states such as Delaware are going to be subject to the controlled foreign company rules, said Fumiaki Matsuoka, of counsel at Atsumi & Sakai in Tokyo. Currently, LLCs in Delaware don’t have to pay taxes or file returns in the state.

The CFC rules are part of Japan’s 2017 tax reform. Before the law change, income that didn’t have economic substance wasn’t subject to income inclusion if the tax burden ratio was 20 percent or more. Now, paper companies will be subject as of April 1 to income inclusion on an entity basis even if their effective tax rate is higher than the trigger rate of 20 percent.

What’s the Impact?

But the impact on U.S. subsidiaries isn’t certain, Matsuoka said. The National Tax Authority didn’t return a request for comment.

“The NTA might not apply J-CFC rules to them because they have real U.S. headquarters in other U.S. states, such as California and they pay tax to U.S. government,” Matsuoka said.

The U.S. cut its corporate tax rate from 35 percent to 21 percent in the 2017 tax act.

A spokesman for Japanese pharmaceutical giant Daiichi Sankyo Co. Ltd. told Bloomberg Tax in a March 1 email that the company’s Japanese headquarters is working with overseas affiliates to fully understand and adhere to the CFC rules.

“Based on the lowering of the corporate income tax in the U.S., it’s possible that changes to CFC tax laws may impact our company in the future. However, as of the current time there has been no such effect,” the spokesman said.

A spokeswoman for Honda Motor Co. Ltd. told Bloomberg Tax in a March 1 email that they can’t estimate the rules’ effect until the end of the fiscal year in April.

‘Cumbersome in Practice’

Some large-scale Japanese trading conglomerates have multi-layered corporate structures, which may consist of holding, operating, and special purpose companies set up to create joint ventures in the U.S. The special purpose companies, also called holding companies, may have no financial substance, Takayuki Kozu, an international corporate tax partner at KPMG Tax Corp. in Tokyo, told Bloomberg Tax.

Holding companies often derive income by charging operating companies management fees for services provided, such as human resources assistance or information technology guidance, Kozu said. Holding companies also often derive dividend income from subsidiaries and capital gains on sales of shares of subsidiaries.

But under the CFC rules, holding companies must pay for employee remuneration, in addition to charging operating companies, which is an added burden, Kozu said.

Japanese companies have been asking the tax authority to relax the CFC rules as they try to reorganize their foreign operations, Kozu said.

The National Tax Authority has established a two-year transition period for multinationals to dissolve foreign subsidiaries. Companies must dispose of or liquidate subsidiaries that qualify as paper companies within two years of their sale or acquisition. This is a major challenge for companies and can be cumbersome in practice, practitioners said.

“Clients have welcomed the new rules but argued that the transition period is too short,” Kozu said.

Blockers, Mergers

Japanese companies may set up blocker corporations in order to invest in their U.S. joint ventures, according to Kozu. Blocker corporations are entities that can be used to protect investments from taxation when tax-exempt individuals participate in private equity or hedge funds.

The blocker corporation may then distribute dividends back to Japan or reinvest in the joint venture without repatriating cash to Japan to avoid additional tax, he said.

But blocker corporations must have an office and control the management of their main business in the U.S., according to guidance from the Japanese tax authority, Makoto Sakai, a tax partner Mori Hamada & Matsumoto in Tokyo, told Bloomberg Tax.

If a blocker corporation doesn’t have sufficient business substance, it will be considered a paper company—and be taxed, practitioners said.

“This has proved to be a fairly difficult task for Japanese MNEs to undertake,” Sakai said.

One way for multinationals to ensure U.S. subsidiaries and blocker corporations have sufficient substance is to merge overseas subsidiaries into one, Sakai said.

Assess the Substance

Japanese trading conglomerates in a range of industries have been carrying out acquisitions of U.S. companies in recent years, according to Kozu. These recently acquired U.S. companies tend to have very advanced international tax planning in place, and may have multiple layers of holdings that were put in place before the CFC rules.

The tax authority will likely now review acquisitions made by Japanese multinationals, he said.

“It is important for the Japanese parent to identify the operations of these newly acquired U.S. companies in the post-merger integration context, assess their level of substance and effective income tax rates,” Kozu said.

To contact the report on this story: Brian Yap in Tokyo at

To contact the editor responsible for this story: Penny Sukhraj in London at

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