Due to the disruption caused by the coronavirus disease 2019 (hereinafter referred to as "COVID-19"), the Japanese economy remains under downward pressure.
In this context, it is crucial that the Japanese government uses the fiscal 2022 tax reform to support corporate activity and consumer spending; and implement bold and decisive tax measures to stimulate digital transformation (hereinafter "DX"), green transformation (hereinafter "GX"), and other innovative initiatives towards the post COVID-19 era.
Furthermore, considering future years from 2022 onwards, the Japanese Government should explore tax measures that are aligned with sustainable capitalism in the medium term, as proposed by Keidanren in ".THE NEW GROWTH STRATEGY" published in November 2020.
2. Retain and strengthen Japanese companies' value creation and competitiveness in the post-COVID-19 era
To establish a tax regime that can effectively promote DX and GX, the Japanese government should extend and enhance the measures to promote open-innovation activities and 5G-related equipment installation.
Further measures to digitize and simplify tax procedures should continue to be introduced.
3. Tax measures contributing to GX looking toward the achievement of a sustainable economic society
To achieve the Japanese government's ambitious goal of "carbon neutrality by 2050," Japan's public and private sectors must make a determined effort to create a virtuous cycle of economy and environment (green growth).
It will be fundamental to examine carbon pricing, such as carbon taxation and emissions trading schemes, from both technical and technological perspectives to determine whether they can be developed into a framework that can contribute to economic growth.
Detailed discussions and analyses should be undertaken to identify the appropriate measures to implement, focusing on global trends, the availability of alternative carbon neutral (CN) technologies, the timetable for technological development and the integration into society, and economic security considerations.
We consider the following three areas to be fundamental for the tax regime to be compatible with economic growth:
The regime should provide incentives for companies to take proactive measures that contribute to CO2 reduction. It must encourage businesses to make R&D investments in innovative technologies and not limit the opportunities for capital investment for the introduction of such technologies in society;
Japan's energy costs are high relative to global standards. The Japanese government should ensure that high energy costs do not adversely affect citizens' lives and the international competitiveness of Japan's industrial sector; and
Considerations must be given to the importance of international cooperation and establishment of a basis for industrial competitiveness.
From these perspectives, the current situation does not seem to endorse the reasonability of a carbon tax. The scope of energy-related taxes should be comprehensively reviewed, considering the level of CO2 emissions in the years to come.
On the subject of international regime design, the Carbon Border Adjustment Mechanism has been proposed in the EU and other jurisdictions. However, such mechanisms must be consistent with WTO rules and the Japanese Government should ensure active engagement and flexibility when contributing and cooperating with other countries.
4. Toward an international taxation framework that contributes to the reconstruction of the international economic order
Keidanren considers the reconstruction of the international economic order as one of its key policy areas under ".The NEW GROWTH STRATEGY". In order to address the global challenges arising from the digitalisation of the economy, we first need to build international solidarity.
(1) Matters relating to Pillar One
Once an international agreement is reached on Pillar One and it comes into effect, unilateral measures including the Digital Services Tax (DST) and the Equalisation Levy in India should be withdrawn promptly and assuredly.
Under the Statement by the Inclusive Framework in July 2021 (hereinafter referred to as the "Statement"), multinational enterprises are deemed to fall within the Pillar One scope when their global turnover is above 20 billion euros and pre-tax profitability is above 10%. While we support, to a certain extent, the adoption of the criteria themselves for the simplification of the rules, turnover and pre-tax profitability may fluctuate in a range close to the threshold due to external factors such as the macroeconomic environment, business restructuring, and so forth. The applicability of Pillar One is closely related to the predictability of corporate management in the future. Accordingly, further discussions should be held concerning how to determine the year in which an enterprise falls under the criteria. One idea is to use average financial data over multiple (e.g. five) years. In addition, further considerations should be given to the possibility of excluding enterprises that reach the threshold to be included in the scope but have a de-minimis level of foreign source income. Moreover, enterprises that do not reach the threshold should be exempted from all calculation procedures associated with Amount A, including new rules to allocate taxation rights to market jurisdictions under Pillar One.
The Statement confirms that in the future the turnover threshold should be reduced to 10 billion euros. However, this is contingent on successful implementation, including tax certainty on Amount A. The relevant review is scheduled to begin seven years after the agreement comes into force, with the review being completed in no more than one year. The Pillar One rules may also apply to so-called B to B transactions such as the sale of finished products and components, as well as to B to B to C transactions that are integral to cloud computing businesses, device component businesses, and software content provision businesses. Under the current revenue-sourcing rules, end-user information in these industry categories is difficult to specify and obtain in practice. When designing the regime, sufficient considerations should be given to these commercial aspects, applying a realistic and pragmatic way of thinking to the extent possible.
Approaches for the segmentation and identification of paying entities, including the allocation of common costs, must be simple and cause only minor administrative burdens, so as to ensure tax certainty for both tax authorities and taxpayers.
Furthermore, regarding the marketing and distribution profits safe harbour (MDSH) — an approach to address issues related to double counting by adjusting the quantum of Amount A allocated to eligible market jurisdictions — discussions should be held to ensure simplicity, including setting of the level of the fixed return.
When considering the adjustment of double taxation relating to Amount A, we insist that the exemption method should be adopted. The credit method may not guarantee a full deduction due to the limit on the available credit and a heavy administrative burden will be imposed when a variety of in-scope jurisdictions are involved.
With the aim of simplifying tax return filing, payment and tax audit procedures, further considerations should be given to the introduction of a "one stop shop" system. We also recommend that an inter-tax authority remittance mechanism is established to ensure efficient tax payment procedures to market jurisdictions.
In this respect, we must emphasize that the establishment of a mandatory and binding dispute resolution mechanism should be made available for all transfer pricing and permanent establishment taxation practices at least for companies in scope of Amount A.
(2) Matters relating to Pillar Two
First, the top down approach, which allows entities to calculate and pay tax relating to the Pillar Two income inclusion rule (IIR) in the country of their ultimate parent company's residence, should remain applicable. The same should apply to the sandwich structure where the parent country subject to IIR holds a subsidiary in the US which may be caught by GILTI. Then, a deeper exploration of the below-mentioned technical issues should be conducted to alleviate practical burdens on businesses. Sufficient consideration for transitional measures should be given to entities with sound economic rationality that have already expanded into jurisdictions where the tax rate is below the minimum rate.
Additionally, the international shipping industry should be excluded as proposed in the Statement.
The Statement includes a definition of "carve-outs," which exclude an amount of income that is at least 5% (or at least 7.5% during a transition period of five years) of the carrying value of tangible assets and payroll.
In order to avoid any sharp increase in tax burdens, discussions should be undertaken to ensure that the percentages are set at a sufficiently high level provided that this does not lead to an increase in the minimum tax rate.
(b) Relationship with the CFC tax regime
To manage the overlap between the CFC tax regime and the IIR, the aggregate of CFC taxes should be pushed down, without limitation, to subsidiaries' jurisdictions and included in the numerator of the effective tax rate (ETR) calculation.
(c) Split-ownership rule, etc.
The Statement clarified that under the split-ownership rule when a parent company has a shareholding of less than 80% in its subsidiary, the IIR also applies to the subsidiary, termed a Partially Owned Intermediate Parent (POIP). We are concerned that companies are obliged to shoulder a significant practical burden if the IIR taxes paid by a POIP need to be deducted (credited) at the level of the parent company. In the future, even if the split-ownership rule remains, the applicability of more simplified approaches, such as exemption rather than deduction (crediting), should be explored.
We also urge that the application of simplified IIR to equity-method entities (affiliates and joint ventures) be withdrawn as multinational enterprise groups do not control equity-method entities and are therefore highly unlikely to use these entities for tax evasion purposes. Moreover, there is typically very limited access to information compared to subsidiaries.
(d) Dealing with temporary differences
According to the Statement, the tax base to be used in the calculation of the effective tax rate (ETR) will be determined by reference to financial accounting income. We understand that discussions are underway to decide on whether a carry-forward approach or a deferred tax accounting approach should be used to deal with fluctuations in the ETR associated with temporary differences between tax and accounting income. When adopting the deferred tax accounting approach, it is important to apply a method that is as simple as possible. This may include minimizing the recapture of once-recognized tax expenses that correspond to deferred tax liabilities. At the same time, considering the burdens that may be borne by relevant companies, the tax authorities should provide detailed explanations and guidance.
(e) Simplification option, etc.
Tax administrative guidance, country-by-country reporting (CbCR) ETR safe-harbour, and de-minimis profit exclusion should be implemented without excessively increasing the number of adjustment items.
Furthermore, the jurisdictional ETR calculation should use an approach similar to the current CbCR that does not require the country-by-country consolidation of country-based financial data, including the elimination of intra-group transactions within the same country, exclusion of unrealized profits, and so forth. We remain unsupportive of the CbC reporting disclosure, as it violates the requirement to protect the confidentiality of the CbC reporting.
In addition, the minimum tax rate for the Subject to Tax Rule (STTR) should be kept at a lowest possible level within the range (from 7.5% to 9%) set forth in the Statement. At the same time, the scope of payments subject to the taxation, i.e. interest, royalties, and a defined set of other payments, should be made as limited as possible. Moreover, it is extremely important to provide practical support by making the payments payable on an annual basis in order to avoid additional administrative burdens to determine whether the payments are undertaxed or not each time.
With the implementation of the IIR it is vital to create an environment for fair competition among businesses and strengthen Japanese companies' international competitiveness. To achieve these goals, the Japanese government should study tax measures that ensure the accumulation of data and other intangible assets and that encourage reinvestments in new R&D investments, referring to other countries' patent box tax systems and the US tax regime.
Furthermore, in anticipation of Pillar Two enforcement in Japan, the Japanese government must promptly undertake a wholesale simplification of the domestic CFC tax regime from the following three viewpoints:
Viewpoint 1: Make Japan's CFC tax regime more focused on true tax evasion cases. For example, by abolishing the 30% threshold and maintaining the 20% threshold only.
Viewpoint 2: Adapt the tax regime to changing corporate activities while looking ahead to the post COVID-19 era by regularly reviewing the business purpose test, substance test, and management and control test.
Viewpoint 3: Give appropriate consideration to administrative burdens and ensuring simplicity by introducing measures such as consolidating and reducing the number of appendices and attachments.