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Policy Proposals  Business Law Proposal for Fiscal 2020 Tax Reform

September 17, 2019

1. Introduction

  • Japan needs to create a virtuous economic cycle by fostering innovation throughout society and raising productivity so that the nation can take a leap forward.

  • The consumption tax rate hike scheduled for the next month is crucial to ensure an all-generation social security system and achieving fiscal health.

2. Implementation of taxation measures aimed at fully realizing Society 5.0, etc.

  • Considering that major developed countries have reduced their effective corporate tax rates, Japan should swiftly reduce its rate to around 25%, a level on par with those of Asian neighbors as well as with the average for major OECD countries.

  • The research and development tax credit incentives need to be improved.

  • The current tax consolidation regime must be overhauled from the perspective of making Japanese companies more globally competitive and revitalizing the nation's economy—although no change should be made to group-based calculations of research and development tax credit and foreign tax credits (i.e., a rule whereby a corporate group can calculate the maximum tax credits allowed on a consolidated basis). Taking into account the time needed for taxpayers to modify their tax accounting systems, the government must provide a sufficient transition period before the new regime's launch.

  • An entity that has been allowed to push back the deadline for filing its corporate tax return should also be entitled to a corresponding extension of the deadline for filing its consumption tax return.

  • To motivate various entities, including companies and corporate venture capital funds, to invest in start-ups, tax credits and other effective support measures need to be introduced.

  • The government has to ensure that the current revenue-based system for enterprise tax levied on electricity and gas utilities is revised.

3. International taxation

(1) Addressing the tax challenges arising from the digitalization of the economy

i) Basic thinking
  • Keidanren is concerned about unilateral taxation by some countries on sales from digital businesses. Unilateral taxation on sales may lead not only to double taxation but also to increased uncertainty over trade and investment, causing unforeseeable damage to economic growth. For this reason, we oppose such taxation.

  • To prevent a proliferation of these unilateral tax measures going forward, the OECD/G20 initiative to develop a consensus-based long-term solution is of paramount importance.

  • The OECD/G20 Inclusive Framework's Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy published in May 2019 was endorsed by the G20 Finance Ministers and Central Bank Governors Meeting in Fukuoka and then by the G20 Summit Meeting in Osaka, both held in June. Keidanren supports these efforts as a step toward a consensus-based solution.

  • The Inclusive Framework's program consists of two pillars: revised nexus and profit allocation rules (Pillar One); and global anti-base erosion proposal (Pillar Two). It also explicitly requires that an agreement be reached on the outlines of a long-term solution by January 2020 and a final report compiled by the end of that year. It is hoped that the OECD and the G20 will demonstrate leadership in implementing the program.

ii) Pillar One: profit allocation rules
  • New profit allocation rules under Pillar One should be designed in accordance with the principle of proportionality to facilitate ease of compliance by tax administrations and taxpayers alike. In addition, the scope of the rules needs to be appropriately narrowed, for example, by limiting it exclusively to corporations with excess profit. When defining a method to allocate taxing rights, consideration should be given to how business activities actually create value. For many enterprises, research and development activities conducted in the jurisdictions in which they are headquartered carry significant weight. Accordingly, it should be ensured that marketing intangibles are not overvalued and the amount of profit reallocated to market jurisdictions is modest. Furthermore, if profits are allocated, losses also have to be allocated as a matter of course.

  • New profit allocation rules must be enforced from the perspective of ensuring effective dispute prevention and resolution while simultaneously reducing compliance burdens. There may be an increasing number of disputes in which multiple jurisdictions disagree on the way profits are allocated. Therefore, on top of the existing bilateral frameworks, a multilateral mechanism should be considered, looking into the International Compliance Assurance Programme (ICAP) as a model. Such a mechanism would be instrumental in preventing and eliminating any double taxation. As an important tool to remedy double taxation in a speedy and reliable manner, an arbitration system should also be introduced in a way that alleviates the burden on the parties involved to the extent possible. Another point of note is that country-by-country reporting (CbCR), being a high-level risk assessment tool, is not appropriate as a basis for calculating profits to be allocated in practice.

iii) Pillar Two: minimum tax
  • The minimum tax rule under Pillar Two is not deemed necessary as it seems to overlap with the recommendations on base erosion and profit shifting (BEPS) that have already been issued. Given that imposing a minimum tax entails the risk of impeding corporations from expanding business overseas and of making them less globally competitive, the introduction of this rule requires careful consideration to begin with; and a system must be designed to minimize additional compliance burden on taxpayers, by adopting a simple method to determine the minimum tax rate and taking other measures. Such measures should at least include: setting the threshold for related party status at more than 50% ownership; and excluding items linked to real economic activity (namely, active income) from the scope. Even if the minimum tax rule is determined to be introduced under Pillar Two by consensus among Inclusive Framework member countries, it is necessary before anything else to eliminate overlaps with controlled foreign company (CFC) rules. In the case of Japan, consideration should also be given, among other things, to drastically simplifying the nation's CFC rules that are more rigorous than those of other countries. We are concerned that the minimum tax rule might result in double taxation if applied along with the CFC rules, and could place an undue compliance burden on corporations.

(2) Implementing the BEPS recommendations

  • Japan's CFC rules need to be amended so that income classified as "passive" is first examined in terms of the substance of the business concerned (such as usance) and how that income was generated, among other matters, instead of it being automatically subjected to the partial income inclusion rules.

  • The deadline for submitting a Notification for Ultimate Parent Entity under the Japanese transfer pricing documentation rules should be pushed back, referring to the rules of other countries.

  • In collaboration with the OECD, the Japanese government should urge other countries to enact and enforce domestic laws governing transfer pricing documentation as required by the OECD recommendations.

  • To prevent international tax disputes on an ongoing basis, the ICAP is hoped to continue expanding the depth and breadth of its work.

  • The OECD's review of CbCR standard scheduled for 2020 should cover master and local files to harmonize requirements among countries.

(3) Enhancing the tax treaty network

  • We expect the OECD to continue properly monitoring how individual countries are working toward international harmonization of interpretation and enforcement regarding the scope of, and attribution of profits to, permanent establishments in applying tax treaties.

  • Each country must redouble its efforts to conclude tax treaties with nations with which it has not signed such agreements. In order to resolve tax disputes, it is crucial to ensure that individual countries introduce provisions stipulating corresponding adjustments and arbitration, whether by concluding bilateral tax treaties or becoming signatories to the Multilateral Instrument.

Business Law