The economic activity tests: Of the four tests,the first hurdle is the business activity test.Holding companies, intellectual property management companies, and ship or aircraft leasing companies:these forms generally fail the test.

Provision

Article 66-6(2)(iii)(a) of the Act on Special Measures Concerning Taxation.

Holding shares, similar interests, or bonds;andproviding industrial property rights or other rights concerning technology, production methods using special technology, or equivalents,including rights to use those rights,or copyrights,including publication rights, neighboring rights, and equivalents;providing those rights;oror leasing ships or aircrafteven if a companyas the principal business,excluding the entities listed below,must not be the company's activity.。

The requirement is negative, ending with “must not.”A company principally engaged in one of the listed businesses fails this test.

The activity must be the “principal business.”Merely holding shares incidentally does not trigger the rule.

Three exceptions

The statute says “excluding the following,”which are excluded from this categoryand provides three exceptions.

(1) Headquarters companies

Principally engaged in holding shares and similar interests: foreign related companies among foreign related companies, those holding shares in other corporations for which they performfunctions contributing to improved profitability through comprehensive management and coordination of business activities,as prescribed by Cabinet Order and referred to asheadquarters functions.headquarters functions, where both the managed corporations and the shareholding company meet the Cabinet Order's definitions

This is relief for regional headquarters companies.However, the Cabinet Order imposes detailed requirements at three levels.

(1) What are headquarters functions?Article 39-14-3(17) of the Special Measures Order

Functions performed under contracts with managed companies,concerning those companies'business policy decisions or coordination,limited to functionsindispensable to conducting the business,which the foreign related company performs fortwo or more managed companies,carrying out those functionscollectively,in a way considered tocontribute to improving those companies' profitability

“Under contracts,” “two or more,” and “collectively” are requirements.Simply giving informal instructions is insufficient.

(2) What is a managed company?Paragraph (18) of the same Article

The requirements have three stages.

First, the company must be within the group.Paragraph (18) begins with“the following corporations,”and items (i) through (iii) narrow the scope.

(i) ……The testing shareholders and similar personswhocontrol a corporation:that corporation, referred to as a“subsidiary”This is the defined term.

(ii) The testing shareholders and similar personsThe testing shareholders and subsidiarieswho control a corporation:that corporation, referred to as a “lower-tier subsidiary”This is the defined term.

(iii) The testing shareholders and similar personsThe testing shareholders, subsidiaries, and lower-tier subsidiarieswho control a further corporation:

The testing shareholders and similar personsthese testing shareholders comprise the foreign related company, the domestic corporation related to it, and entities interposed in the indirect ownership chain. foreign corporation It is.Only controlled subsidiaries, lower-tier subsidiaries, and third-tier subsidiaries qualify.The meaning of “control” follows Article 4(3) of the Order for Enforcement of the Corporation Tax Act, applied mutatis mutandis under paragraph (19).

Taking a 25% stake in a counterparty outside that control relationship and signing a headquarters agreement does not make it a managed company.

Against that background,Both the shareholding and voting-right percentages must be at least 25%,（or at least 50% if the corporation is domestic,andandthe corporation must, in its head-office jurisdiction,have personnel engaged in the business considered necessary to conduct it.These are additional requirements.

Only domestic corporations have the 50% threshold.Applying 25% to them would produce an incorrect result.

(3) What is a headquarters company?Paragraph (20) of the same Article

A foreign related company whose issued shares and similar interests are wholly held, directly or indirectly, by a single domestic corporation,and which meets the following requirements:

(i) it performs headquarters functions formultiple managed companies,（including at least two that are foreign corporations.Those headquarters functions must be performed.

(ii) In its head-office jurisdiction, it must havean office, store, factory, or other fixed facility for headquarters functions,and personnel considered necessary for those functions,engaged in those headquarters functions,（limited to persons working exclusively on them,andexcluding officers of the foreign related company and persons listed in the items of Article 72 of the Order for Enforcement of the Corporation Tax Act in relation to those officers.It must have such personnel.

The entry requirement is “100% ownership by a single domestic corporation.”Joint ventures do not qualify.

The personnel requirement in item (ii) is also strict.Personnel must work exclusively on headquarters functions, and officers and their relatives and similar persons do not count.Simply assigning one manager who also has other duties is insufficient under this structure.

In addition, the parenthesis in paragraph (20) imposes on shareholding headquarters companiestwo stages of percentage requirements.These must also be met.Do not confuse the denominators.

The first stage must be met, together with either of the two second-stage tests.The statute refers to cases where the first ratio “exceeds” the threshold andandlimits the exception to headquarters companies where either second ratio exceeds fifty percent.

The second-stage denominator is the total relating to managed companies.It is not all shareholdings or all revenue. In each case, book values arethose recorded on the balance sheet at fiscal year-end.Those figures are used.

(2) Foreign financial holding companies and similar entities

Among foreign related companies principally holding shares and similar interests, those that, through modified application of item (vii),qualify as foreign financial subsidiaries and similar entities,excluding those qualifying as foreign financial institutions and those listed in (1).

(3) Aircraft leasing

Foreign related companies principally engaged in aircraft leasing that meet requirements prescribed by Cabinet Order. Article 39-14-3(23) of the Special Measures Order providesthree quantitative requirements.These are prescribed in the Order.

Item (ii) says “must not exceed,” while item (iii) says “must exceed.”The inequalities point in opposite directions.

The denominator in item (iii) has a parenthesis:“Where there is no remaining amount,an amount equivalent to the total personnel expenses.”If depreciation exceeds revenue and there is no remaining amount, the denominator is replaced by personnel expenses, producing a 100% ratio that meets the test.It is not a zero denominator that makes the calculation impossible.

There is no corresponding exception for ship leasing.The statute lists only aircraft.

What happens if the business activity test is failed?

specified foreign subsidiary company Unless the company falls within the specified excluded category, it becomes a covered foreign related companyunder the parenthesis in paragraph (2)(iii). On a company-wide basis, the amount subject to application. the entire amount is subject to inclusion.

However,If the tax burden ratio If the tax burden ratio is at least 20%, an exemption appliesunder paragraph (7)(ii).A company failing the business activity test is not instead subject to partial inclusion.A partially covered foreign related company is defined as one meetingMeets all requirementsthe requirements in item (iii)(a) through (c), under paragraph (2)(vi).

Points that require care in practice

• We have a holding company, but it has substance.The business activity test concerns the type of business, not whether substance exists.
• Will making it a regional headquarters company solve the problem?All Cabinet Order requirements at the three levels—headquarters functions, managed companies, and headquarters company—must be met.
• Is a 25% holding sufficient for a managed company?For domestic corporations, the threshold is 50%.
• Can headquarters staff also have other duties?They must work exclusively on headquarters functions, and officers and their relatives and similar persons are excluded.
• Is there relief for ship leasing?Exception (3) covers aircraft only.
• What about a joint-venture headquarters company?Paragraph (20) requires all issued shares and similar interests to be held by a single domestic corporation.

The business activity test is largely determined when the company's form is chosen.Before establishing an overseas holding or intellectual property management company, or if you already have one, consult us starting with a review of whether the structure meets the headquarters company requirements.

Legal basis

• Article 66-6(2)(iii)(a) of the Act on Special Measures Concerning Taxation (Business Activity Test), paragraph (2)(vi) (Partially Covered Foreign Related Companies), and paragraph (7)(ii) (Exemption)
• Article 39-14-3(17) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Headquarters Functions), paragraph (18) (Managed Companies), paragraph (19) (Application of Article 4(3) of the Corporation Tax Order), paragraph (20) (Headquarters Companies), paragraph (21) (Testing 100% Ownership), paragraph (23) (Aircraft Leasing Requirements), and paragraph (33) (Timing of Determination)
• Article 72 of the Order for Enforcement of the Corporation Tax Act (Persons Related to Officers)

This article does not cover details of exception (2) concerning foreign financial subsidiaries and similar entities or insurance-related exceptions. Individual determinations require confirmation of business activities and ownership relationships.