When a foreign holding company sells a Japanese subsidiary, it is necessary to consider Japanese taxes even if there are no branches or offices in Japan. To estimate the net proceeds after the sale, it is essential to check not only the seller's location, but also the nature of the shares being sold and the applicable tax treaty in order.

How far does "no PE, no taxation" apply?

In international taxation, we often hear the phrase "no PE, no taxation." PE stands for permanent establishment, which refers to bases such as branches or offices where foreign companies conduct business. However, this phrase cannot be applied as is to all income generated by foreign corporations, because the taxation mechanisms differ depending on the type of income.

For example, the business profits earned by a foreign corporation from selling goods and the profits earned from selling shares it holds in a Japanese company do not necessarily reach a conclusion in the same order. For the sale of shares, it is necessary to check domestic law provisions regarding asset transfers and the "capital gains" article of the tax treaty. The National Tax Agency also explains that taxation arrangements for foreign corporations vary depending on the type of domestic source income and attribution to a PE. [1]

Furthermore, "not having a branch registration in Japan" and "not having a PE in Japan" are not synonymous. A determination must be made based on factors such as the place of business or the activities of agents. Here, we assume a foreign corporation that truly has no PE in Japan and explain the subsequent considerations.

First, read the domestic law, and then the tax treaty.

The first thing to check is whether the capital gains from the share transfer are subject to taxation under Japanese domestic law. When a foreign corporation sells shares in a Japanese company, certain categories related to substantial shareholdings and transfers, as well as shares in real estate-related corporations, become issues. Rather than simply categorizing it as "taxable because they are Japanese stocks" or "tax-exempt because the seller is overseas," we apply the requirements based on the ownership ratio, the ownership status of related parties, the timing of the transfer, and the asset composition of the target company. [2]

If it is subject to tax under domestic law, the next step is to examine whether Japan's taxation is restricted by the tax treaty applicable to the seller. What should be read here is not only the tax rate tables for dividends and interest, but also the provisions on capital gains, which determine in which country or region the profit from the sale of shares can be taxed, as well as the exceptions thereto.

Because conclusions can change depending on treaties, explanations regarding a holding company in another country cannot simply be applied as-is to your own company. Furthermore, even if a treaty permits Japanese taxation, that alone does not determine the specific tax amount. We must refer back to domestic tax law requirements and income calculation to verify.

What is easy to overlook is the real estate within the company

Something to watch out for in a share transfer is when Japanese real estate makes up a large portion of the company's value. Even if the land and buildings themselves are not sold, but rather the shares of the company that owns them, it will be subject to Japanese taxation under certain conditions. This is not determined solely by whether the company's business type is real estate.

For example, suppose an operating company owns a piece of land it has held for many years. In sales negotiations, people tend to focus on revenue and profits, but from a tax perspective, it is also necessary to check what proportion of the total assets that land represents. Furthermore, since indirect ownership through another company may be involved, it is important not to end the investigation with the balance sheet of just the target company being sold.

Attention must also be paid to the point in time at which the determination is made. Under Japanese domestic law, regarding the determination of real estate-related corporations, there is a mechanism that looks at any point from 365 days prior to the date of the share transfer up immediately before the transfer. Just because the asset composition changes immediately prior to the sale does not mean that the past status becomes irrelevant. On the other hand, for treaty determination periods, it is necessary to separately check the applicable treaty and its amendments. [3]

Just use the book values from the financial statements, do not calculate ratios

When examining how much real estate accounts for a company's value, financial statements serve as the starting point. However, the acquisition cost or depreciated amount recorded in the books does not necessarily match the asset value required for the determination. For land acquired a long time ago, there is often a large gap between the book value and the market value.

Therefore, we will confirm the evaluation targets and evaluation criteria required by the provision, and gather materials supporting the fair market value at the necessary point in time. We also want to avoid calculations where only real estate is replaced with fair market value while other assets are unconditionally left at book value. Unless what is being measured in the numerator and denominator is aligned, even if the resulting calculation percentage is precise, the basis for the judgment will be weak.

This is a separate task from the seller confirming the acquisition cost to calculate the capital gains on the share transfer. If you organize "the asset value for determining whether it is a real estate-related corporation" and "how much the shares were acquired for" separately, the necessary documents will also become clear.

Check both the treaty entitlement and the modifications made by the MLI.

To use a tax treaty, it is necessary for the seller to qualify as a resident under that treaty. Rather than just looking at the country of incorporation, confirmation is made in light of the definitions in the applicable treaty. In addition, if there are limitation on benefits or anti-tax avoidance provisions, those conditions must also be considered.

Some existing tax treaties are modified by the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, commonly known as the MLI. However, not all MLI provisions apply uniformly to every treaty. It is necessary to check the applicable treaties, the elections made by both countries or jurisdictions, and the dates of entry into effect. The Ministry of Finance publishes the application status and synthesized texts for each treaty. [4]

The consolidated text is a convenient material for reading with amendments incorporated. However, it is not a legal basis in itself, and a distinction is made in that the authentic texts of the treaty and the MLI are the legal documents. In major divestitures, it is useful to check the provisions affecting the conclusion down to the authentic text and to document the factual basis on which the application was determined.

Corporate reorganization prior to the sale is considered separately from the sale.

Before selling a company, shares are sometimes transferred to another holding company, or intra-group organizations are reorganized. In such cases, simply considering that "treaties can be used for the final sale" is not enough. For the preceding transfers and reorganizations as well, it must be confirmed who is transferring what, how the consideration is received, and at what point tax liabilities arise.

While breaking down the transaction by process, we will also ensure that the overall business purpose and substance can be explained. If a holding company is changed prior to the sale, it is necessary to simultaneously proceed with the consideration of the tax treatment of the reorganization itself, treaty eligibility for the capital gains, and anti-tax avoidance provisions.

Once you begin considering a sale, let's organize the shareholder structure and its transitions, asset details of the target company and subsidiaries, documents supporting value, the reality of seller management and decision-making, and the schedule for planned reorganization and sale. By aligning these with the requirements of domestic law and treaties, you can incorporate the after-tax net proceeds into negotiations as evidence-based figures.