Dividends from foreign subsidiaries are 95% excluded from gross income.There are situations where that premise breaks down.One is where the paying subsidiary deducts the dividend.

The general rule: Article 23-2(1) of the Corporation Tax Act

Where a domestic corporationreceives from a foreign subsidiary(meaning a foreign corporation in which the number or amount of shares or equity interests held by the domestic corporation representsissued shares or equity interests,（excluding treasury shares or equity interests held by that subsidiary,of the total number or amount,at least twenty-five percent,and which satisfies the otherrequirements prescribed by Cabinet Order),meeting those requirements, foreign corporation the amounts received from it ...of dividends of surplus and similar distributions,less, in relation to those distributions,the amount calculated as prescribed by Cabinet Order as equivalent to expenses,shall, in calculating the domestic corporation's income for each fiscal year,be excluded from gross income.。

The statute does not contain the figure “95%.”It is drafted as a deduction of “the amount calculated as prescribed by Cabinet Order as equivalent to expenses.”Because the Cabinet Order sets that amount at 5%, the result is a 95% exclusion.

Note the parenthesis concerning the denominator.“Excluding itsownshares or equity interests.” If the subsidiary holds treasury shares, the denominator changes.

Cases where the rule does not apply: paragraph (2)

The preceding paragraphshall not apply。

(i) to the following dividends of surplus and similar distributions received by a domestic corporation from a foreign subsidiary, whereall or partof the distribution is, for that foreign subsidiary,deductible in calculating its income under the laws of the country or region where its head office or principal office is located:where it falls within such a distribution,the amount of that dividend of surplus or similar distribution.

(ii) (... certain dividends and similar distributions arising from events that had been anticipated)

Item (i) concerns what are known as deductible dividends.

“All or part” triggers the rule, and the effect extends to “the amount of that dividend of surplus or similar distribution.”If even part is deductible,the entire dividend is, in principle,excluded from eligibility for the gross income exemption.It is not merely the deductible portion that is excluded.

Why is the rule structured this way?If the payer deducts the amount and the recipient excludes it from gross income, that income is taxed nowhere. This provision closes that gap.

There is a route to exclude only part: paragraph (3)

to the following dividends of surplus and similar distributions received by a domestic corporation from a foreign subsidiary, whereWhere parthas been deducted in calculating the foreign subsidiary's income,notwithstanding the preceding paragraph, limited to item (i),of the dividend of surplus or similar distribution received,the amount prescribed by Cabinet Order as corresponding to the deducted portion,（……「“dividends received corresponding to deductible amounts,”This is the defined term.may be treated as the dividend amount listed in that item.。

The wording is “may.” It is an election.

By using paragraph (3),only the deducted portionis subject to paragraph (2)(i), while the remaining portion retains the 95% exclusion.

Paragraph (3) concerns cases where only part is deductible.If the entire amount is deductible, there is nothing to separate.

Where the deductible amount later increases: paragraph (4)

... Where the preceding paragraph has been applied and, in a fiscal yearfollowing the fiscal yearin which the dividend of surplus or similar distribution was received,the amount of dividends received corresponding to deductible amounts increases,the dividend amount listed in paragraph (2)(i) shall be ...the amount prescribed by Cabinet Order as the increased amount of dividends received corresponding to deductible amounts.。

If a foreign reassessment increases the deductible amount, the Japanese treatment also changes.Where paragraph (3) is used, the outcome of a later foreign tax audit can affect the Japanese return.

Two sets of procedural requirements

Separate requirements apply to paragraphs (1) and (3).

Requirements for paragraph (1): paragraph (5)

Paragraph (1) applies only wherethe final return, amended return, or request for correctionhas an attached document stating the dividend amount excluded from gross income and details of its calculation,and the documents prescribed by Ministry of Finance Order are retained.In that case, the amount excluded from gross income under that paragraphis limited to the amount stated as such.。

Both attachment and retention are required.Andthe stated amount is the ceiling.It is.

However, relief is availableunder paragraph (6). Even where documents have not been retained,When the district director of the tax office finds that unavoidable circumstances existthe authority may apply paragraph (1) to that amount,if the conditions for relief are met.。This relief concerns “retention,” not “attachment.”

Requirements for paragraph (3): paragraph (7)

Paragraph (3) applies only where ...the final return, amended return, or request for correctionthe return includesa statement of the intention to apply that paragraph,together with the amount of dividends received corresponding to deductible amounts and details of its calculation,in an attached document,anddocuments clarifying the dividend amount deducted in calculating the foreign subsidiary's incomeand other documents prescribed by Ministry of Finance Orderare retained.。

Paragraph (3) has no relief provision comparable to paragraph (6).A statement of the “intention to apply” is also required.Because this is an elective provision, the election must be stated in the return.

Points that require care in practice

• When is the 25% ownership test applied?Check the requirements prescribed by Cabinet Order, including the holding period.
• Where is the 95% figure specified?In the Cabinet Order, not the Act itself.
• Only part of the dividend was deducted abroad.Under paragraph (2)(i) alone, the whole dividend is ineligible. If paragraph (3) is elected, only the deductible portion is ineligible.
• What is needed to use paragraph (3)?The return disclosures under paragraph (7), including the intention to apply the provision, and retention of the documents.
• A foreign reassessment increased the deductible amount.Under paragraph (4), the increased amount applies.
• I forgot to retain the documents.Paragraph (6) offers relief for paragraph (1), but none is provided for paragraph (3).

Whether the foreign subsidiary's jurisdiction permits dividend deductions should be checked before deciding on a dividend.This provision addresses hybrid mismatches, so even partial applicability can substantially change the treatment. If you are considering a dividend from a foreign subsidiary, consult us starting with confirmation of the local tax treatment.

Legal basis

• Article 23-2(1) through (8) of the Corporation Tax Act (Exclusion from Gross Income of Dividends Received from Foreign Subsidiaries)
• Article 23(1)(i) of the Corporation Tax Act
• Article 66-8(2) and (3) of the Act on Special Measures Concerning Taxation (adjustments where there is a specified taxable amount)

This article does not cover the Cabinet Order requirements for foreign subsidiaries, including ownership percentage and holding period, the Cabinet Order method for calculating expenses, details of paragraph (2)(ii), or the documents prescribed by Ministry of Finance Order. Individual determinations require confirmation of the local tax treatment.