CFO Insights 2021 February
2021 Japan tax reform proposal
CFO Insights is a monthly publication to deliver an easily digestible and regular stream of perspectives on the challenges confronting CFOs. In this article, we provides a high-level summary of the proposed changes that would likely be most applicable to foreign headquartered companies in Japan.
The Japanese government announced its tax reform proposal for 2021 on 10 December 2020.
- Digital measures
- Environmental measures
- Measures related to financial services
- Other measures
With the pandemic continuing to cause issues for many companies, the proposal includes a number of changes and tax incentives for digital technology in an effort to help business cope with the growing demands for digitalization and aid economic recovery.
In addition to digital incentives, the government also included various other incentives/ amendments related to areas, such as environmental, financial services, R&D tax credits, and net operating losses (“NOLs”). This article provides a high-level summary of some of the proposed changes that would be most applicable to foreign headquartered companies in Japan, and covers additional considerations that they should take into account when determining what impacts the reform proposals could have on their businesses1.
In doing so, we have broken the relevant reform measures into four groups: digital, environmental, financial services, and other.
1For additional detail on the various measures introduced in the 2021 tax reform proposal, please refer to our Tax & Legal Inbound newsletter.
The first group of reform measures relates to amendments/ incentives aimed at companies looking to digitize their operations. The pandemic has had a profound impact on the way companies and their employees work and operate. Required remote working environments, among other things, have resulted in a much larger influx of companies looking at digitalization over the past year. In response, the Japanese government included a number of measures to aid and incentivize companies transitioning to a digital working environment.
Incentives for investments in digital transformation
In an effort to create new demand and improve productivity, new incentives shall be introduced which will allow applicable companies acquiring cloud-based systems to take either special depreciation of 30% or a tax credit of 3% (5% if data is linked to external party) of the cost of certain applicable assets acquired based on a plan certified under the revised Industrial Competitiveness Enhancement Act (the “ ICE Act”). Such assets must be acquired and placed into service before the effective date of the revised ICE Act and 31 March 2023.
Note that the total value of assets (including deferred assets) that can qualify as acquisition costs for incentive purposes is limited to JPY 30 billion, and the total amount of credit that can be taken is limited to 20% of corporate tax (total combined sum of this credit and the tax credit for becoming carbon neutral described below).
Expanded scope of R&D costs
Another way that the proposal sets out to incentive digitalization is by expanding the scope of costs that are eligible for the R&D credit. While there primarily will be changes to the R&D credit (e.g., calculation method and credit limits), R&D costs included in the acquisition cost of certain cloud-based software for in-house use would be added to the costs that are subject to the R&D credit. As a result, companies that acquire and implement such cloud-based software may be entitled to tax a credit for a portion of the associated costs via the R&D credit system.
Amendments to the electronic books and records (“edocs”) preservation system
In addition to providing incentives for digital transformation and expansion of the scope of R&D costs, the 2021 reform also aims to ease the transition to digitalization by amending the current edocs system. In particular, the amendments look to contribute to the improvement of productivity through the computerization of accounting, the promotion of telework, and the improvement of bookkeeping standards through the use of cloud accounting software. The revisions shall go into effect on 1 January 2022, and some of the key changes to be introduced include particularly the following:
- Abolishment of the commissioner approval requirement and relaxation of timestamp requirements for books and records related to national tax.
- Timing changes to the confirmation of whether a company meets edocs preservation requirements related to national tax.
- Relaxation of timestamp, administrative, and search requirements related to the scanner storage system for national tax records.
- Relaxation of timestamp and search requirements related to the edocs preservation system for electronic transaction records.
Other digital measures
Finally, measures shall be introduced to help remove some of the barriers to going digital and reduce the administrative requirements in the form of no longer requiring seals to be affixed to national and local tax documents submitted on or after 1 April 2021, and allowing non-residents to submit treaty forms digitally rather than requiring them in writing.
However, while seals would generally no longer be required for tax documents, there are some exceptions that must still include seals.
The current problem at the forefront of most discussions over the past year has been Covid-19 but besides the call for digitization to address such issues, green projects are another pillar of Prime Minister Suga’s economic policies. As such, Japan has recently set the goal of carbon neutrality by 2050. To help achieve that, new tax incentives shall be introduced.
In particular, certain assets for making production processes carbon neutral and assets for manufacturing carbon neutral products are eligible for either special depreciation of 50% or a tax credit of 5% (10% in certain cases) if they are acquired by an applicable corporation as part of a plan certified under the revised ICE Act between the effective date of the revised ICE Act and 31 March 2024.
Similar to the digital transformation incentives outlined above, there are limits on the carbon neutral incentive amounts that can be taken.
Measures related to financial services
In pursuit of its goal of promoting Japan as a global financial center, the Japanese government also included amendments/ incentives related to the financial service industry. The proposals cover changes to the inheritance/ gift tax in the form of generally excluding non-Japanese property acquired by foreign nationals living outside of Japan or staying in Japan for short periods of time from the inheritance/ gift tax levy, and changes to the treatment of certain carried interests in partnerships to potentially treat associated income as capital gain based on shares rather than compensation for services.
Additionally, the reform would amend the profit-based director compensation regime. Under the proposed change, certain investment firms that could not normally satisfy the deductibility requirement of having to disclose, e.g., the compensation calculation method in an annual securities report (i.e., due to being an unlisted investment firm) may still be able to deduct director compensation if certain conditions are met.
In addition, the 2021 tax reform includes a variety of other measures aimed at promoting the economy and providing aid to businesses affected by Covid-19 including, but not limited to:
Expanded NOL utilization
Certain large or small enterprises with an approved business plan and engaging in certain investments such as digital transformation would be allowed to use NOLs arising in a year affected by Covid-19 to offset up to 100% of taxable income for certain periods.
Promote M&A activity
While the NOL measures look to aid individual companies, proposals related to M&A were introduced to aid the economy as a whole. In particular, the reform looks to promote M&A by including measures to defer gain/ loss on the transfer of shares among shareholders of companies subject to acquisition, based on the stock allocation system under the Companies Act.
Revisions to the wage and investment increase credit
Changes would also be made to the wage and investment increase credit to help stimulate the hiring and training of employees. For fiscal years beginning 1 April 2021 to 31 March 2023, companies that have increased salaries for certain new hires or increased training costs in Japan would be eligible to use the credit. In addition, the domestic capital investment requirement for eligibility would also be abolished, lowering the conditions companies must satisfy to be able to utilize the credit.
International tax related measures
In the international tax context, minor changes were proposed related to the permanent establishment (“PE”) and earnings stripping rules, which may have particular affect for some industries such as insurance. With regard to PE, interest used in calculating non-deductible interest on debt attributed to a Japanese PE of a foreign company for thin capitalization and earnings stripping purposes shall be expanded to include “other financing” related to the interest.
Earnings stripping rules shall be revised to exclude certain interest related to insurance policies from the scope of interest subject to the rules, and include interest from bond investment trusts for purposes of calculating net interest expense.
While the 2021 tax reform proposal did not contain any drastic changes to the existing tax regime, it does provide companies with opportunities through the creation of new incentives, reduction of the burden of transitioning to a more digital workplace, and provision of relief to companies affected by Covid-19. In addition, the proposal helps to lay the foundation for Japan’s efforts to achieve its long-term goals in reducing its impact on the environment and growing its economy, particularly with regard to the financial services industry.
Companies looking to go digital and planning to invest in internal-use software to do so should consider whether they qualify for some of the new incentives, such as the digital transformation incentives, and if so, make sure to seek appropriate advice to ensure the requirements are properly met. In addition, for companies looking at digitizing their record keeping processes under the new edocs rules, the specific requirements (e.g., the ability to search) for compliance with the new regime should be properly examined. As a result, it is recommended that companies understand the relevant changes and compliance requirements to ensure their systems are either already in compliance or can be modified to become compliant once the new rules go into effect.
If you would like more information, please speak to our Deloitte subject matter specialists Sunie Oue (firstname.lastname@example.org) and David Bickle (email@example.com).