On December 22, 2017, the Japanese Cabinet approved the 2018 Tax Reform Proposal. With respect to international taxation, the following are two key amendments to provisions concerning permanent establishments ("PEs"):
- The definition of "PE" will be revised to prevent companies from artificially avoiding being treated as having a PE. For example, under the revised definition, a person who habitually plays the principal role leading to the conclusion of contracts in Japan on behalf of a foreign enterprise, and who satisfies certain other requirements, will be treated as a PE for that foreign enterprise, even if the person is not authorized to conclude contracts in Japan. In addition, places of business used solely for such activities as storage, display, and delivery will not constitute PEs as long as such activities are "of a preparatory or auxiliary character."
- A new provision will be established to reconcile the definitions of "PE" under tax treaties and under domestic tax law.
The amendment described in 1. above is being conducted in accordance with the OECD/G20 base erosion and profit-shifting ("BEPS") project proposal and reflects the multilateral convention against BEPS ("MLI") that includes similar provisions, as mentioned in the July 2017 issue of this newsletter. However, amendment 2. above will clearly prescribe that as to the definition of "PE," bilateral tax treaties will prevail over domestic tax law. Therefore, amendment 1. above will not apply where the applicable bilateral tax treaty maintains the existing PE definition and such definition is not modified by the MLI.
Going forward, foreign enterprises carrying on business in Japan will need to consider the risks of PE treatment after taking into account domestic tax law, bilateral tax treaties, and the MLI.