Acquisitions (from the buyer’s perspective)Tax treatment of different acquisitions
What are the differences in tax treatment between an acquisition of stock in a company and the acquisition of business assets and liabilities?
From the perspective of corporation (income) tax, an acquisition of stock in a target company generally has no effect on the tax attributes of the target company. Thus, if the target company has net operating losses deductible from the taxable income, they may be carried forward to the years after the acquisition under the requirements provided by the law. (See question 7 as to the limitations to carrying forward net operating losses.) However, as the nature of the acquisition of stock has no effect on the target company’s tax attributes, step-up of the basis of the target company’s underlying assets is unavailable. Further, amortisable goodwill is not recognised even if the purchase price of the stock exceeds the aggregated value of the underlying assets of the target company.
A buyer may further benefit from acquiring the stock in the target company. For example, no consumption tax, real-estate acquisition tax and registration and licence tax are imposed on the purchase of stock.
Contrary to acquisition of stock, a buyer of business assets of the target company does not inherit the tax status of the target company (ie, the seller). The buyer is generally free from the potential tax liabilities of the target company. Further, goodwill may be recognised and the basis of the assets may be stepped up, which can be, except for certain assets including lands, depreciated or amortised for tax purposes. As a flip side, no benefit of net operating losses of the target company can be enjoyed by the buyer of the business assets.
However, unlike with stock purchase, in the case of asset purchase, consumption tax may be imposed on the asset transfers. Further, real-estate acquisition tax and registration and licence tax are imposed on the transfers of real estates.Step-up in basis
In what circumstances does a purchaser get a step-up in basis in the business assets of the target company? Can goodwill and other intangibles be depreciated for tax purposes in the event of the purchase of those assets, and the purchase of stock in a company owning those assets?
As mentioned in question 1, a buyer of stock in a target company does not achieve step-up in basis of the underlying assets. In asset purchase, assets may generally be stepped up and depreciated or amortised for tax purposes.
In the case of purchase of intangibles, including goodwill, as a part of acquisition of business, the intangibles may be amortised for certain years specifically stipulated under Japanese tax law. Goodwill is amortised over five years, 20 per cent of the basis each year. On the other hand, no goodwill or intangible is recognised in connection with purchase of stock; therefore, no amortisation is available. See also question 1.Domicile of acquisition company
Is it preferable for an acquisition to be executed by an acquisition company established in or out of your jurisdiction?
It is preferable to establish an acquisition company in Japan if the foreign investor wishes to offset financing costs for the acquisition against the target company’s taxable income. This is because the offsetting can be achieved either through tax consolidation or merger between the acquisition company and target company, and a tax consolidation or merger can only be conducted between Japanese corporations. However, if the foreign purchaser wishes to offset financing costs for the acquisition against its own taxable profits, it is preferable to acquire the Japanese target company directly.Company mergers and share exchanges
Are company mergers or share exchanges common forms of acquisition?
Although we see mergers and share exchanges, within the meaning of Japanese corporate law, used in M&A transactions involving foreign entities, we are unaware of merger or share exchange conducted directly between foreign entities and Japanese corporations. This is for, rather than tax-related reasons, the corporate-law-related reason that according to the dominant view among practitioners, the corporate law of Japan does not allow such mergers or share exchanges. Note that there are M&A transactions designed to achieve the effects similar to those of mergers and share exchanges between a foreign entity and a Japanese corporation.Tax benefits in issuing stock
Is there a tax benefit to the acquirer in issuing stock as consideration rather than cash?
Paying cash as consideration in restructure transactions, such as mergers, generally disqualifies the transaction from being recognised as qualified restructuring for tax purposes. This means that by paying cash, the transaction will be categorised as unqualified restructuring, where the capital gains and losses of the target company’s assets will be recognised; net operating losses may not be able to be carried forward; and built-in losses of the target company’s assets may not be utilised. However, certain exemptions to this rule were introduced on 1 October 2017. For example, if a merging company owns two-thirds of the shares of a merged company, the merging company’s payment of cash to shareholders of the merged company is allowed in the context of qualified restructuring. Another similar exemption will be available in relation to certain share exchange transactions. Paying consideration by issuing stock is not the only requirement to be treated as qualified restructuring, but the benefit of issuing stock may be fulfilling one of the requirements of qualified restructuring.Transaction taxes
Are documentary taxes payable on the acquisition of stock or business assets and, if so, what are the rates and who is accountable? Are any other transaction taxes payable?
The documents specified in the law are subject to stamp tax. Although agreements of acquisition of stock are not taxable, various documents that may be produced in M&A transactions, such as business transfer agreements, merger agreements, real-estate agreements and ‘receipts of cash other than sales price or securities’, are listed as taxable documents. Note that stamp tax is imposed only on the documents physically executed, and thus, electronic copies and documents executed out of Japan are not subject to stamp tax.
The rule to determine the amount of stamp tax varies according to the type of the documents. However, the amount of stamp tax does not exceed ¥600,000. Stamp tax is owed by the person who prepared a taxable document, which means that in the case of agreement, both parties are jointly subject to stamp tax thereof.
Further, if real estate is transferred, registration and licence tax at a rate of up to 2 per cent and real-estate acquisition tax at a rate of up to 4 per cent of the taxable value of the transferred real estate are applicable.Net operating losses, other tax attributes and insolvency proceedings
Are net operating losses, tax credits or other types of deferred tax asset subject to any limitations after a change of control of the target or in any other circumstances? If not, are there techniques for preserving them? Are acquisitions or reorganisations of bankrupt or insolvent companies subject to any special rules or tax regimes?
Although there is no provision that generally imposes limitations after a change of control, there are provisions applicable to specific types of deferred tax assets. For example, net operating losses in the target company that experienced change of control may be restricted as explained below.
In general, net operating losses of a corporation may be carried forward for the next 10 fiscal years (nine fiscal years, for the fiscal years commencing before 1 April 2018). Note that carry-forward of net operating losses is allowed only if the corporation files a blue return upon an approval of a relevant tax authority.
It should be further noted that net operating losses can be utilised to offset only up to 50 per cent of the taxable income for each fiscal year, under certain conditions specified by the law. For example, this limitation may apply if the target company is a large company, within the meaning provided by the law, with more than ¥100 million in capital. In order for the limitation not to be applied, it may be worthwhile to consider reduction of the capital of the target company in some cases.
In M&A transactions, restrictions on the carry-forward of net operating losses may be triggered if more than 50 per cent of the ownership of a target company with the losses is acquired and any of the events specified by the law occurs within five years of the acquisition. For example, the restriction may be triggered if the target company ceases its previous business and receives a significant amount of investment or loan in comparison with the scale of the ceased business.
There is no comprehensive tax regime applicable to acquisitions or reorganisations of bankrupt or insolvent companies. However, some exceptions to the limitations to deferred tax assets are provided for the purpose of encouraging reorganisation of those companies. For instance, net operating losses of a corporation under the kosei-tetsuzuki revitalisation procedure are not subject to the nine-year limitation of carry-forward, which is mentioned above, if it is utilised to offset the benefit of debt relief provided by certain creditors specified by the statute.Interest relief
Does an acquisition company get interest relief for borrowings to acquire the target? Are there restrictions on deductibility generally or where the lender is foreign, a related party, or both? In particular, are there capitalisation rules that prevent the pushdown of excessive debt?
Interest is generally deductible from the taxable income of the paying corporation. Under this general rule, corporation (income) tax can be avoided in such a manner as follows.
A resident corporation can receive funding from its foreign shareholder in the form of a loan. In such an event, the resident corporation can reduce the amount of its profits (thereby reducing its corporation tax burden) by deducting the interest paid with respect to such loan under the general rule allowing such deduction as mentioned above. By contrast, dividends must be paid from the profits that are calculated after taking into account taxes. Therefore, a resident corporation may try to receive a loan from the shareholder and include the interest as a deductible expense rather than obtaining additional capital from the shareholder and distributing dividends to such shareholder.
To counter such a scheme, the thin capitalisation regime and excess interest regime may limit the deductibility of interest payable from the acquisition company to its foreign shareholders. Under the thin capitalisation regime, a resident corporation that receives a loan from its foreign parent company in the amount of more than three times the amount of capital contributed by such foreign parent into the resident corporation is not allowed to include in deductible expenses the interest corresponding to such excess. Further, the excess interest regime may be applicable to the interest payable from the acquisition company. Under the excess interest regime, net interest payments to affiliated persons in excess of 50 per cent of the adjusted revenue of a corporation cannot be offset against the corporation’s revenues. The regime is not applicable if:
- the amount of net interest paid to affiliated persons in a given fiscal year is not more than ¥10 million; or
- the total amount of interest paid to affiliated persons in a given fiscal year is not more than 50 per cent of the total interest payments made by a corporation.
If both the thin capitalisation regime and excess interest regime apply to a corporation, the larger of the amounts disallowed to be deducted will be deemed to be the amount against which the revenues of the corporation in the relevant fiscal year cannot be offset.
Under the domestic statute of Japan, interest paid to a foreign lender is subject to withholding tax at the rate of 20.42 per cent, including reconstruction special income tax imposed until the end of 2037. However, the tax treaties entered into by the Japanese government basically comply with the OECD Model Tax Convention, and most of them limit the rate to zero or 10 per cent with several exceptions.
There is no rule generally prohibiting debt pushdown, which is allocating debts to a resident corporation by way of merger to reduce its taxable income by offsetting with interest payment of the debt.Protections for acquisitions
What forms of protection are generally sought for stock and business asset acquisitions? How are they documented? How are any payments made following a claim under a warranty or indemnity treated from a tax perspective? Are they subject to withholding taxes or taxable in the hands of the recipient? Is tax indemnity insurance common in your jurisdiction?
It is common for the seller of stock or business assets to provide indemnities or warranties regarding any undisclosed or potential liabilities of the target company or defect of the assets (however, it is not common for tax indemnity insurance to be purchased by the parties to an M&A transaction). The tax treatment of the payment made under such indemnities or warranties is fact-specific and cannot be determined without looking into the facts in detail. However, the payment generally has the nature of compensation for the damage suffered by the recipient (ie, buyer or target company). If the payment is characterised as such, it is not subject to the withholding tax and is included in the taxable revenue of the recipient. Whether or not the damage is deductible is a separate issue that is determined by the character of the damage. If the damage is deductible, it will be offset with the revenue accrued by receiving the payment under indemnities or warranties.