Changes to Permanent Establishment Allocations
Under the most recent tax reform, approved by the Diet in March, Japan has changed its general tax rules applicable to a foreign corporation having a permanent establishment in Japan ("FCPE"). Under the current Japanese domestic tax law, which adopts the "force of attraction" principle, all income arising from sources within Japan is fully taxable regardless of whether such income is attributable to the FCPE. Under the revised Japanese domestic tax law (the "New Domestic Rules"), (i) income attributable to an FCPE will be taxable regardless of the source; and (ii) income attributed to an FCPE will be calculated in line with the Authorized OECD Approach (the "AOA"). Please note that the concept of an FCPE under the Japanese domestic tax law will remain unchanged. FCPEs are generally divided into the following three categories: (i) a branch, or any other fixed place where business in Japan is conducted; (ii) a construction site or installation project; and (iii) an agent PE. The concept of PE under Japanese domestic law is slightly broader than that under the OECD Model Tax Convention.
Under the New Domestic Rules, (i) internal dealings within a single entity will be recognized (e.g., internal royalty, internal interest, internal service fees (including appropriate mark-ups), etc., will need to be charged to calculate Japanese corporation tax); (ii) a mere purchase by an FCPE of goods for its head office will generate profits; (iii) prices of internal dealings not in line with the arm's-length principle will trigger the taxation equivalent of transfer pricing taxation; and (iv) an FCPE may claim a foreign tax credit on its Japanese corporation tax return. Reasonable cost allocation from a head office to an FCPE, such as the allocation of overhead expenses related to administrative functions performed by the head office for the benefit of the FCPE, without any mark-ups, will continue to be deductible. In addition, some documentation requirements (including documentation similar to transfer pricing documentation) will be imposed on FCPEs.
Note: The New Domestic Rules explicitly provide that if an income tax treaty not incorporating the AOA is applicable, internal interest for non-financial enterprises and internal royalties will not be recognized, and a mere purchase of goods will not generate profits for Japanese corporation tax purposes.
The New Domestic Rules will apply to the corporation tax for a fiscal year commencing on or after April 1, 2016.
Revision of the Japan–UK Income Tax Treaty
On December 17, 2013, the Protocol Amending the Convention between Japan and the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains (the "Protocol") was executed in London.
The Japan–UK income tax treaty amended by the Protocol (the "Revised Treaty") will be the first income tax treaty for Japan that adopts the Authorized OECD Approach (the "AOA"). Under the Revised Treaty, (i) shareholding requirement with regard to dividends exempted from taxation by the source country will be reduced from "50 percent or more" to "10 percent or more"; (ii) interest income will, in principle, be exempted from taxation by the source country; (iii) capital gains arising from the transfer of shares similar to business transfers by the source country will, in principle, be exempted; (iv) arbitration proceedings under the mutual agreement procedure will be introduced; and (v) the tax authorities of Japan and the UK may assist each other in the collection of revenue claims (specifically for consumption tax, value added tax, inheritance tax, and gift tax, to which the Revised Treaty is not applicable).
The Protocol will take effect 30 days after the date of the exchange of diplomatic notes indicating the approvals required under the legal procedures of both Japan and the UK.
For additional reference, as of March 1, Japan has concluded 51 income tax treaties applicable to 62 jurisdictions and eight tax information exchange agreements applicable to eight jurisdictions. Japan is also a member country of the "Convention on Mutual Administrative Assistance in Tax Matters." The income tax treaty between Japan and Germany is currently undergoing official negotiations.
Increase of Consumption Tax Rate
Effective as of April 1, the combined rate of national and local consumption taxes has increased from 5 percent to 8 percent (6.3 percent national tax and 1.7 percent local tax). The consumption tax rate is planned to further increase from 8 percent to 10 percent (7.8 percent national tax and 2.2 percent local tax) on October 1, 2015. Accordingly, subject to certain exceptions, consideration paid for the transfer or lease of assets or the provision of services for business purposes on or after April 1, is subject to the new 8 percent consumption tax rate. However, the consumption tax rate of 5 percent will apply to any transfer or lease of assets or provision of services for business purposes occurring prior to April 1, even if such consideration is actually paid on or after April 1.
The Japanese consumption tax is characterized as an indirect tax. Therefore, almost all domestic transactions and all transactions concerning the importation of foreign goods are subject to taxation. Under the Consumption Tax Law, taxable domestic transactions are defined as domestic transactions in which consideration is paid for the transfer or lease of assets or the provision of services for business purposes. Exceptions include transfers of accounts receivable, transactions involving securities and other financial or capital, and the provision of medical, welfare, educational, and other services, all of which are outside the scope of the Consumption Tax Law. The consumption tax is structured to ultimately be passed on to consumers by affixing it to the price of products and services provided by a taxable enterprise. In order to eliminate multiple taxation at each stage of manufacturing and distribution, crediting the consumption tax on purchases against the consumption tax on sales is allowed. The basic formula for calculating the consumption tax is: <total amount of consumption tax on sales> minus <total amount of consumption tax on purchases>.
New Reporting System for Offshore Assets
The 2012 tax reform, which was approved by the Diet in March 2012, introduced a reporting requirement for offshore assets. Starting from January 1, 2014, under the new reporting system, a permanent resident in Japan whose offshore assets exceed JPY 50 million (or US$500,000 at the exchange rate of JPY 100 equal to US$1) as of December 31 of the previous year must submit an Offshore Assets Report Form to the relevant tax office by March 15. This reporting requirement applies not only to Japanese citizens but also to non-Japanese citizens who have lived in Japan for more than five of the past 10 years.
"Offshore assets" means anything that has economic value and is located outside Japan, including, but not limited to, movable property, immovable property, loans receivable, intellectual property, savings, and securities and stock options. The fair market value or estimated value of each offshore asset as of December 31 must be reported on the Offshore Assets Report Form.
Any person who fails to submit the form on time without a justifiable reason or submits a false form may be subject to imprisonment of up to one year or a criminal fine of up to JPY 500,000 (this sanction is applicable to forms to be submitted on or after January 1, 2015). Further, if a form is not submitted on time or is missing a description of relevant offshore assets, and an additional tax for deficient returns or for a non-filing or delayed filing of a tax return is imposed in connection with such offshore assets, the amount of additional tax will be increased by 5 percent of the income tax imposed in connection with the offshore assets.