Policy Proposals Business Law Proposal for Fiscal 2021 Tax Reform
Japan must accelerate digital transformation (hereinafter referred to as "DX") to build a resilient economy and society while focusing on both economic recovery following the downturn caused by the coronavirus disease (hereinafter referred to as "COVID-19"), and the post-COVID-19 era.
For the fiscal 2021 tax reform, it is of primary importance to introduce taxation measures to support ordinary corporate activity and help return the economy to growth as soon as possible. At the same time, the tax reform proposals should promote innovation and DX that will drive long term economic growth.
2. Implementation of taxation measures to realize Society 5.0 through DX and build a resilient economy and society with an eye toward the post-COVID-19 era
(1) Extension and improvement of the research and development tax credit incentives
Corporate R&D investment is essential to maintain and improve international competitiveness and sustain future growth. We must pursue digital and other technological innovations, which have proved vital during the pandemic and will become increasingly important in the post-COVID-19 era. We recommend the actions described below.
The maximum deduction under the total expenditure-based tax credit system (whereby a certain percentage of total research expenses can be deducted from corporate taxes) should be raised from 25% to 30% of corporate taxes. This measure will incentivize companies to maintain and expand R&D investment.
Experiment and research expenses for internal software, including tools used for cloud computing services and product development, should be included in expenses qualifying for R&D tax credits.
Qualifying requirements and application procedures for the open innovation tax credit should be streamlined and rationalized.
(2) Tax relief on DX related capital expenditure
To advance social transformation, including the shift to digitalization and remote working, tax breaks should be introduced to support investments in software, such as SaaS (Software as a Service); machinery; and equipment that contribute to DX across a wide range of industries.
Potential areas that taxation measures could target include artificial intelligence purposed for DX, cyber security to protect global supply chains, robotics, FinTech, and mobility. Additionally, measures may be implemented to encourage investment in equipment that enables remote working (for example teleworking) as well as epidemic prevention (for example thermography equipment).
(3) Digitalization and simplification of tax procedures
Tax procedures, which are still paper based, require seals, and involve face-to-face communication, should be fundamentally reviewed. The Act on Special Provisions concerning Preservation Methods for Books and Documents Related to National Tax Prepared by Means of Computers should also be comprehensively reviewed.
3. International taxation
(1) Approach to addressing the tax challenges arising from the digitalization of the economy
Keidanren does not support unilateral taxation by individual jurisdictions because it may lead to double taxation and could damage economic growth.
Keidanren hopes that discussion will progress in the Inclusive Framework (IF) under the leadership of the OECD and G20 in order to establish an international consensus-based, fair competitive environment and a predictable investment environment. Pillar One and Pillar Two should be agreed as a package. Once consensus is reached, digital service taxes (DST) should be abolished and rescinded. Presented below are the views and proposals of Japan's business community regarding the ongoing IF discussions.
a) Pillar One: profit allocation rules
- Provide a clear and concrete definition of businesses in scope. Clarify the definitions of consumer-facing businesses and automated digital services, and exclude prescription drugs from the scope.
- Clarify the revenue sourcing rule in a new nexus test or other method. If it proves overly burdensome or impossible to delineate the entire transaction process for goods or services, for example where a transaction is conducted via third-party intermediaries, additional consideration is needed, such as exempting companies from being required to determine the jurisdiction of final consumption.
- Disregard regional profitability and set high thresholds for business line segmentation. Adopt a simple and formulaic calculation method to prevent controversies between taxpayers and tax administrations, using existing disclosed business line segments whenever possible, and giving consideration to business practices and the need for investment in systems.
- Allow deductions for brought forward losses.
- Set the percentage of routine profit based on revenue of a group or operating segment in scope (X%) at a substantially high level (for example 15% or 20%) and the percentage of residual profit allocable to market jurisdictions (Y%) at a modest level (for example up to 10%).
- Simplify tax return and tax audit procedures, for example introducing a "one stop shop" system.
- Consider a "marketing and distribution profit safe harbor" to avoid excessive complexity in the system.
- Establish a simple and reliable double taxation elimination mechanism that is not based on the foreign tax credit method.
- Keidanren understands the intention of this rule in the context of simplifying transfer pricing and ensuring tax certainty. Currently, however, existing transfer pricing methods for cross-border related party transactions (such as those involving limited risk distributors) generally work well. Accordingly, new rules should not be introduced in haste. If Amount B must be introduced, the next step should be to define the meaning of "baseline" marketing and distribution activities in an unambiguous manner such that no difference in interpretation may arise among jurisdictions.
- Set a reasonable fixed percentage of return and a cap on the amount of allocable profit. If the fixed percentage of return is set high, this may negatively impact low-margin companies as well as in cases involving DST. The profitability of companies should be also considered.
- The concept of a guaranteed minimum return should be based on normal economic conditions. In extraordinary circumstances such as the COVID-19 pandemic, special treatment should be permitted.
- To avoid complexity, the scope of local subsidiaries subject to the new rules should be limited. Commissionaires, sales agents, and service providers, for example, should be excluded.
- For Amount A, considering the large number of concerned jurisdictions, introduce a binding process to ensure early tax certainty and prevent disputes.
- For Amount B and other regular transfer pricing and permanent establishment matters, introduce a highly effective dispute resolution mechanism such as arbitration or equivalent measures.
b) Pillar Two: minimum tax
- If a jurisdictional blending approach is adopted for the income inclusion rule, administrative burdens will increase dramatically. It is essential to set thresholds and simplify the effective tax rate calculation on a jurisdictional basis.
- Exclude dividends, equity method profit or loss, and other similar items from the tax base. Also exclude the portion corresponding to active income by a simplified formula.
- Apply the income inclusion rule only in a jurisdiction where the ultimate parent entity of a multinational enterprise group is located.
- Organize the order of application among the income inclusion rule, the undertaxed payments rule, and the subject to tax rule to avoid double or multiple taxation. We understand that if the income inclusion rule is adopted, the undertaxed payments rule will not be implemented.
- Keidanren does not support the subject to tax rule because it appears to overlap with other taxation rules. If the adoption of this rule is inevitable, the scope of the payments covered and set the top-up tax rate must be limited to a modest level.
(2) Country-by-Country Reporting 2020 Review
Jurisdictions must respect the necessary conditions that underpin the obtaining and use of Country-by-Country (CbC) Reports— confidentiality, consistency, and appropriate use.
CbC reporting was recently introduced and is in a phase of stabilization so hasty changes should be avoided. Even if the system is revised, the methods of presenting information by jurisdiction and of using aggregated data should be maintained.
We are also concerned about the expansion of items to be described in Table 1 (income and expenses relating to interest, royalties, and service fees). If this change is confirmed, the definition and scope of additional items must be clarified, and consideration should be paid to practical matters such as the increase in costs such as updating IT systems.
Furthermore, we continue to disagree with the proposal for public disclosure of CbC reporting information as this would contravene the essential requirement to maintain confidentiality.
For the Master File, formats and information requested should be standardized among jurisdictions, and the submission deadline in the jurisdiction where the ultimate parent entity is located should be respected.
(3) Establishment and implementation of temporary transfer pricing guidelines taking account of the economic downturn
With countries around the world facing unprecedented economic conditions due to the COVID-19 pandemic, the OECD should publish additional guidelines while also considering how to prevent the over-enforcement of transfer pricing rules. The OECD should consider the measures below.
- Allow flexible treatment of macro corrections in economic analyses.
- Clarify the definition of extraordinary losses caused by unforeseeable economic circumstances. In addition, given that losses may be inevitable for companies, as mentioned in Amount B in (1) above, permit special treatment such as allocating losses to jurisdictions where group companies are located.
- Provide guidance on the use of data and comparability adjustments to improve the reliability of comparability analysis when multiple-year data used for comparability analysis may be affected by the COVID-19 pandemic.
- Assess the impact on customs duties of payments for transfer pricing adjustments, and provide transfer pricing guidelines on this matter.