The name of the amount used for income inclusion isthe amount subject to application.It is.It differs from the profit shown in local financial statements.

The statutory structure has two stages

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

the amount subject to application.　specified foreign subsidiary company Or a covered foreign related companies company, for each fiscal year,the amount of income based on its financial statementsis used to calculatethe amount determined under standards prescribed by Cabinet Order as corresponding to the calculation of fiscal-year income under the Corporation Tax Act and this Act,referred to in this item as“base income.”Using that as the basis, and as prescribed by Cabinet Order, adjustments are made for losses arising in fiscal years beginning withinseven yearsbefore the start of the relevant fiscal year,the amount of those losses,and, in relation to that base income,adjustments for tax amounts.The resulting amount is the amount subject to application.

There are two stages.

1. “base income.”Calculate base income under the standards prescribed by Cabinet Order.

2. Then adjust forlossesandand taxesto arrive at the amount subject to application.

Stage 1: base income. First choose between two calculation methods

There are two methods for calculating base income.

Paragraph (2) begins as follows.

A domestic corporation listed in any item of Article 66-6(1) of the Act may,notwithstanding the preceding paragraph,use the amount of income calculated under the laws concerning corporate income tax in the foreign related company's head-office jurisdiction,where there are two or more such laws, those governing the principal corporate income tax,under their provisions,excluding group income taxation provisions,as the amount calculated under the standards prescribed by Cabinet Order.if the conditions for relief are met.。

The wording is “may.” It is an election.AndChanging a method once adopted requires prior approval.

10 ... Where a domestic corporation that has applied paragraph (1) wishes to apply paragraph (2), or one that has applied paragraph (2) wishes to apply paragraph (1),it must obtain prior approval from the district director of the tax office with jurisdiction over its place of tax payment.。

The key word is “prior.”The method cannot simply be changed when filing.

This article assumes paragraph (1), the Japanese law method.

Calculation under the Japanese law method: Article 39-15(1) of the Special Measures Order

The statutory formula is “(item (i) + item (ii)) − (item (iii) + item (iv) + item (v)).” The opening text also containsanother formulain parentheses:if item (i) is a loss,read it as “item (ii) − (the loss + item (iii) + item (iv) + item (v)).” The result is the same subtraction.

Item (i) is central to this system.The local financial statements are not used unchanged;income is recalculated by reference to Japan's Corporation Tax Act.However, the provision excludes numerous Articles. For example, Article 23 of the Corporation Tax Act, the dividend received exemption; Article 23-2, the foreign subsidiary dividend exemption; and Article 57, loss carryforwards,do not apply.Loss carryforwards are handled separately in the second stage below.

Transfer pricing adjustments are also included.The parenthesis in item (i) provides that where Article 66-4(1) of the Special Measures Act, the transfer pricing rules, applies to a transaction between the foreign related company and its Japanese parent,the transaction is treated as having occurred at an arm's length price for purposes ofthe calculation.

The formula does not end there.Paragraph (3) of the same Article further deductsthe amount of deductible dividends and similar distributions.This amount is subtracted.

... For each fiscal year of the foreign related company,the amount of deductible dividends and similar distributions.where such amounts exist, the amount calculated under the standards prescribed by Cabinet Order shall,notwithstanding paragraph (1) or the preceding paragraph,be the amount calculated under those provisionsless the deductible dividends and similar distributions.。

This provision covers dividends from other foreign related companies that are not “subsidiaries” under paragraph (1)(iv).Where there are multiple tiers of foreign subsidiaries, it prevents the same income from being included twice at higher and lower tiers.Beginning with “notwithstanding” and ending with “shall,” it is a mandatory provision.

“Subsidiary” in item (iv): 25% and six months

The parenthesis in item (iv) defines the subsidiary paying eligible dividends as follows.

• The ownership percentage of issued shares and similar interestsandorandor the ownership percentage of voting shares and similar interests,of whichat least onemust be25% or more.（For entities meeting conditions (a) and (b) relating to fossil fuel extraction, foreign corporation the threshold is 10% or more.）
• andThat status must havecontinued for at least six months before the date the obligation to pay the dividend becomes fixedor, for a corporation established within those six months, continuously since establishment.

This is not “the percentage of voting rights.”The statute refers to the proportion of“the number or amount of voting shares and similar interests”among issued shares and similar interests. For certain distributions constituting deemed dividends under Article 24(1) of the Corporation Tax Act, the reference date isthe preceding day.That is the result.

There is also an important exclusion.“Excluding dividends received where all or part of the dividendis deductible in calculating the subsidiary's income under the laws of its head-office jurisdiction.”Such dividend amounts are excluded.Dividends deductible by the payer cannot be deducted here.

This deduction has procedural requirements.Paragraph (9) provides that deductions under paragraph (1)(iv), and paragraph (2)(xvii), are allowedonly if the final return for the fiscal year has an attached schedule detailing the calculation.That attachment is required for the deduction.There is a proviso:if the district director of the tax office finds unavoidable circumstances for the failure to attach the schedule and the schedule is subsequently submitted, the restriction does not apply.

Paragraph (8) similarly requires, for certain deductions in the calculation under paragraph (1)(i),an attached schedule,with a similar proviso.This applies only to the listed provisions.These include Article 33 of the Corporation Tax Act, valuation losses on assets; Articles 42 through 52, compressed bookkeeping, allowances, and related matters; Articles 43 and 45-2 of the Special Measures Act, special depreciation and similar measures; Articles 57-5, 57-6, and 57-8, various reserves; and parts of Articles 65-7 through 65-9.Ordinary annual depreciation under Article 31 of the Corporation Tax Act is not listed.

Stage 2: adjustments for losses and taxes under paragraph (5)

For each fiscal year of the foreign related company,“base income.”the result is the base amount less the total of the following amounts.

(i) Before the start of each fiscal year,seven yearslosses arising in fiscal years beginning within the specified period, excluding certain fiscal years,are totaled,excluding losses already deducted under this paragraph in fiscal years before the relevant year.

(ii) ... For each fiscal year,the corporate income tax becoming payableis deducted; if corporate income tax becomes refundable during the year, the amount is reduced by that refund and other specified amounts.

The seven-year rule in item (i) has exclusions.Fiscal years beginning before April 1, 1978,fiscal years in which the company was not a foreign related company,andfiscal years in which circumstances giving an exemption under the items of paragraph (7) existedare excluded from the eligible seven-year period.

The structure prevents use of losses from years not subject to inclusion.If the tax burden ratio was 20% or more and the year was exempt, that year's losses cannot be brought forward later.

Item (ii) deducts the corporate income tax added in the first stage.It is added under paragraph (1)(ii) and deducted under paragraph (5)(ii), making a round trip.

Modified application for jurisdictions with consolidated taxation or pass-through treatment

Article 39-15(6) of the Special Measures Order defines“group income taxation provisions.”That is the defined term.There are three categories.

Where these provisions exist, the calculation is redone separately as though they did not exist,producing separately calculated corporate income tax payable and refundable amounts. This creates practical work for U.S. LLCs and partnerships, and subsidiaries in jurisdictions with consolidated taxation.

The amount subject to application is not itself the final inclusion amount

There is one more stage.Article 66-6(1) of the Special Measures Act requires the amount subject to application to be multiplied bythe inclusion ratio taking account of rights to distributions and similar rights.The resulting amount, called thetaxable amount,is included in gross income (Article 39-14(1) of the Special Measures Order).

There are four stages.If the parties confuse which stage's figure they mean, the discussion will not align.

Points that require care in practice

• Is the local after-tax profit included unchanged?No. There is a four-stage calculation.
• Are dividends received included?Dividends from subsidiaries meeting the 25% and six-month tests are deducted under paragraph (1)(iv), except those deductible by the payer.
• Can past losses be used?Only losses within seven years from fiscal years when the company was a foreign related company and did not qualify for exemption.
• We use consolidated taxation locally.Calculate separately as though the group income taxation provisions did not exist.
• Can we choose the calculation method?The choice is between paragraph (1), the Japanese law method, and paragraph (2), the local law method. A change requires prior approval under paragraph (10).
• We forgot to attach the schedule.Paragraphs (8) and (9) impose the requirements. Both contain relief provisos.
• We received a transfer pricing reassessment.Under the parenthesis in item (i), calculate using the arm's length price.
• What if the ownership interest is less than 100%?Multiply by the inclusion ratio taking account of rights to distributions and similar rights.

Calculating the amount subject to application involves reconciling local financial statements with the Japanese tax return.If CFC inclusion may apply to your foreign subsidiary, consult us with the local financial statements, tax returns, and ownership chart.

Legal basis

• Article 66-6(1) of the Act on Special Measures Concerning Taxation (Inclusion of Taxable Amounts in Gross Income), paragraph (2)(iv) (Amount Subject to Application), and the items of paragraph (7) (Exemptions)
• Article 66-4(1) of the Act on Special Measures Concerning Taxation (Transfer Pricing Rules)
• Article 39-15(1), (2), (3), (5), (6), (8), (9), and (10) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Calculation of the Amount Subject to Application)
• Article 39-14(1) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Inclusion Ratio Taking Account of Rights to Distributions and Similar Rights)
• Articles 23, 23-2, 57, and other provisions of the Corporation Tax Act excluded by Article 39-15(1)(i) of the Special Measures Order

This article does not cover the details of provisions excluded by Article 39-15(1)(i), the adjustment under item (v), the items in paragraph (2), or the detailed terms in paragraphs (3) and (4) governing deductible dividends. Individual calculations require review of local financial statements and tax returns.