The economic activity tests: These are the second and third tests:Substance testwhether the company has fixed facilities,Management and control testand whether it manages its own business.The statute combines them in a single subitem (b).

The statutory requirements appear together in one subitem

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

In its head-office jurisdiction, the company must, for itsprincipal business,which, for a company under (a)(1), foreign related companies is treated asheadquarters functions.headquarters functions, and for a foreign related company under (a)(2), asmanagement functions prescribed by Cabinet Order,with the same meaning applying in (c),have offices, stores, factories, or other fixed facilities considered necessary for conducting that business,including circumstances prescribed by Cabinet Order as equivalent to having them,andIn its head-office jurisdiction, the company must, for itsitself manage, control, and operate the business,including circumstances prescribed by Cabinet Order as equivalent to doing so itself.Both conditions must be met.。

The wording joins them with “and” and closes with “both conditions must be met.”In practice they are counted as two tests, substance and management and control, but the statute states them as a single combined requirement.Meeting only one is insufficient.

The meaning of “principal business” is modified

The opening of subitem (b) has a parenthesis,replacing “principal business” with a different activity depending on the company type.

• Headquarters companies under (a)(1) → “Principal business” meansheadquarters functions.
• Foreign financial holding companies and similar entities under (a)(2) → “Principal business” meansmanagement functions prescribed by Cabinet Order,(Article 39-14-3(24) of the Special Measures Order defines this as management of specified foreign financial institutions)

It then says “the same applies in (c).”This modified wording also extends to the next tests, the unrelated-party and local business tests, in subitem (c). For the relevant headquarters companies, headquarters functions are examined under (c) as well.

Substance test: “considered necessary” is the key

The statute requires fixed facilities“considered necessary for conducting the principal business.”That is the requirement.Merely having facilities is not enough.Their scale and functions must be considered necessary for conducting that business.

A registered address alone, a post office box, or a single desk shared with another company:whether these constitute “necessary fixed facilities” depends on the nature of the company's business.

The parenthetical “circumstances prescribed by Cabinet Order as equivalent” are specified in Article 39-14-3(25) of the Special Measures Order.They comprise two insurance-related situations,where a specified insurance consultative party for a specified foreign insurance subsidiary or similar entity, or a specified insurance trustee for a specified insurance principal, has fixed facilities.This is not a general fallback for ordinary operating companies.

Management and control test: “itself” becomes the issue

The statute requires the business'smanagement, control, and operationeven if a companyto be performed by the company itself.It must conduct them itself.

Three activities are listed:management, control, and operation, with the emphasis on “itself.”

• Board meetings are held in Japan.
• Important decisions are made by the Japanese parent.
• Local directors are directors in name only, while actual operations are directed from Japan.

Such facts affect the assessment of whether the company acts “itself.”Even with local premises and staff, decision-making in Japan can jeopardize the management and control test.A company may therefore meet the substance test but fail the management and control test.

The parenthetical rule here, Article 39-14-3(26) of the Special Measures Order, also concerns the specified equivalent circumstances.They comprise two insurance-related situations,It is.

Failure to provide materials leads to a presumption that the tests are not met

Article 66-6(4) of the Special Measures Act.

... Documents and other materials establishing that the foreign related companymeets the requirements in that item,meaning paragraph (2)(iii),subitems (a) through (c),may be requestedfor presentation or submission.If those documents or other materialsare not presented or submitted,andfor purposes of paragraph (2), limited to that item or item (vi),the foreign related company is presumednot to meet the requirements in paragraph (2)(iii)(a) through (c).。

Do not misunderstand the direction of the presumption.What is presumed is that the requirementsare not met.Consequently,

• paragraph (2)(iii), which defines a covered foreign related company as one failing the listed requirements,Fails at least one requirementclassifies the company accordingly → it becomes a covered foreign related company.
• Paragraph (2)(vi), which defines a partially covered foreign related company as one meeting the requirements in (a) through (c),Meets all requirementsno longer applies → it does not qualify as a partially covered foreign related company.

What should have been only partial inclusion becomes company-wide inclusion.

What records should be kept?

The taxpayer's materials rebut the presumption. The statute does not list document types, but they must“establish that the requirements are met.”They must serve that purpose.

• For the local office,the lease agreementand evidence showing actual use of the premises
• For local personnel,employment contracts for officers and employeesand evidence of their duties
• Board minutesshowing the meeting location and attendees
• Evidence that decisions are made locally,such as internal proposals and approval records

These cannot be created retroactively.They should be maintained in the ordinary course.

Points that require care in practice

• Does renting an office satisfy the substance test?Assess whether its scale is considered necessary for the principal business.
• We hold board meetings in Japan.That affects the “itself” element of the management and control test.
• We have local premises and staff, but decisions are made in Japan.You may satisfy the substance test but fail the management and control test.
• What is examined for a headquarters company?“Principal business” is read as headquarters functions, including under subitem (c).
• Could the “equivalent circumstances” parenthesis help?The Cabinet Order specifies insurance-related circumstances.
• What happens if materials are not provided?The company falls within the covered foreign related company category and outside the partially covered category.

The management and control test concerns where decisions are made, rather than simply what exists locally.The design of the foreign subsidiary's board operations, approval authority, and substantive role of local directors needs review. If you have a foreign subsidiary, consult us with recent board minutes and approval records.

Legal basis

• Article 66-6(2)(iii)(b) of the Act on Special Measures Concerning Taxation (Substance and Management and Control Tests), paragraph (2)(iii) (Covered Foreign Related Companies), and paragraph (2)(vi) (Partially Covered Foreign Related Companies)
• Article 66-6(4) of the Act on Special Measures Concerning Taxation (Presumption Concerning Economic Activity Tests)
• Article 39-14-3(24) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Management Functions under (a)(2)), paragraph (25) (Circumstances Equivalent to Having Fixed Facilities), and paragraph (26) (Circumstances Equivalent to Managing and Controlling the Business Itself)

This article does not cover detailed insurance exceptions for specified foreign insurance subsidiaries, specified insurance principals, and similar entities, or treatment of foreign financial subsidiaries and similar entities. Individual determinations require confirmation of actual business activities and supporting materials.