Statutory definition

“Where a domestic corporation enters into a lease transaction, its income for each business year, as lessor or lessee, shall be calculated as if the asset subject to the transaction (hereinafter ‘leased asset’ in this paragraph) were sold when delivered by the lessor to the lessee.”

Corporation Tax Act Article 64-2 requires a domestic corporation entering into a “lease transaction” to calculate income as if a sale occurred upon delivery. Even a rental-form contract is treated as a sale if it meets the Article's definition of a lease transaction. Income Tax Act Article 67-2 provides a similar rule for residents.

Overview

Is an aircraft lease automatically treated as a “lease” for tax purposes?

Tax treatment of an aircraft rental contract depends on whether it meets the “lease transaction” requirements of Corporation Tax Act Article 64-2. The Article covers asset leases, excluding land leases without ownership transfer and other leases prescribed by Cabinet Order, and sets two requirements: noncancelability during the lease term or equivalent conditions, and substantive enjoyment of economic benefits and bearing of costs by the lessee.

The Article also addresses sales conditional on leaseback from buyer to seller, limited to qualifying lease transactions. Where the asset type, circumstances leading to the sale and lease, and other factors show the series of transactions to be substantively lending, income is calculated as if no asset sale occurred and a monetary loan was made. Income calculation depends on the statutory requirements and circumstances, regardless of whether the contract is labeled a lease or sale.

Are losses from partnership investments automatically deductible?

Article 67-12 governs the extent to which corporations may deduct partnership business losses. Its definition of “partnership agreement” includes Civil Code partnerships, investment limited partnerships, and silent partnerships, etc. Where an investor is a “specified partner” or “specified beneficiary” and liability for partnership business or similar debts is limited to partnership property value or similar circumstances apply, the portion exceeding an amount calculated under Cabinet Order based on contribution value, etc. is nondeductible. In cases prescribed by Cabinet Order where no substantive loss is expected, the entire partnership or similar loss is nondeductible.

LLP investments are separately governed by Article 67-13. Where a corporate partner's partnership business loss prescribed by Cabinet Order exceeds an amount calculated under Cabinet Order based on contribution value, the excess is nondeductible. Both Articles also provide, for corporations filing final returns and other required documents, for deductions up to an amount prescribed by Cabinet Order out of profits.

What happens if an individual invests in the same arrangement?

For individuals, Article 41-4-2 applies only where partnership or trust income is classified as real estate income; the statutory basis for classification is beyond this article's scope. It deems prescribed partnership or trust real estate losses of specified partners or beneficiaries not to have arisen. Unlike Articles 67-12 and 67-13, it treats the loss itself as nonexistent. Its “partnership agreement” means Civil Code Article 667(1) agreements, investment limited partnership agreements under Article 3(1) of the relevant Act, and similar foreign agreements including those prescribed by Cabinet Order; unlike Article 67-12, it does not list silent partnership agreements, etc.

Points that require care in practice

• The scope of “land leases without ownership transfer and other leases prescribed by Cabinet Order” must be checked in the relevant corporation tax Order provision.
• For “cases prescribed by Cabinet Order” under Article 67-12, the nondeductible amount is the entire partnership or similar loss, rather than only the excess over the contribution-based amount. Those cases and calculation methods for each prescribed amount must be checked in the Order for Enforcement of the Act on Special Measures Concerning Taxation.
• Whether a person is a “specified partner” depends on involvement in decisions on important property disposals or acquisitions or substantial borrowing, personal conduct of contract negotiations and similar matters, and whether the person is an “other partner prescribed by Cabinet Order.” The latter must be checked in the Special Measures Act's Enforcement Order.

Legal basis

• Corporation Tax Act, Article 64-2(1) (Income calculation for lease transactions) / Quoted wording: “Where a domestic corporation enters into a lease transaction, its income for each business year, as lessor or lessee, shall be calculated as if the asset subject to the transaction (hereinafter ‘leased asset’ in this paragraph) were sold when delivered by the lessor to the lessee.”
• Corporation Tax Act, Article 64-2(2) / Quoted wording: “Where a domestic corporation sells or purchases an asset conditional on leaseback from buyer to seller (limited to a qualifying lease transaction), and the asset type, circumstances leading to the sale and lease, and other factors show the series of transactions to be substantively lending, the corporation's income for each business year as buyer or seller shall be calculated as if no asset sale occurred and the buyer made a monetary loan to the seller.”
• Corporation Tax Act, Article 64-2(3), introductory wording / Quoted wording: “Lease transactions in the preceding two paragraphs mean asset leases (excluding leases of land without ownership transfer and others prescribed by Cabinet Order) satisfying the following requirements.”
• Corporation Tax Act, Article 64-2(3)(i) / Quoted wording: “The lease contract cannot be terminated during the lease term, or is equivalent thereto.”
• Corporation Tax Act, Article 64-2(3)(ii) / Quoted wording: “The lessee can substantively enjoy the economic benefits arising from the leased asset and is required substantively to bear the costs arising from its use.”
• Corporation Tax Act, Article 64-2(4) / Quoted wording: “Determination of whether the lessee is required substantively to bear the costs arising from use of the asset under item (ii) of the preceding paragraph, and other necessary matters for application of the preceding three paragraphs, shall be prescribed by Cabinet Order.”
• Income Tax Act, Article 67-2(1) (Income calculation for lease transactions) / Quoted wording: “Where a resident enters into a lease transaction, each category of income for each year for that resident, as lessor or lessee, shall be calculated as if the asset subject to the transaction (hereinafter ‘leased asset’ in this paragraph) were sold when delivered by the lessor to the lessee.”
• Income Tax Act, Article 67-2(3), introductory wording / Quoted wording: “Lease transactions in the preceding two paragraphs mean asset leases (excluding leases of land without ownership transfer and others prescribed by Cabinet Order) satisfying the following requirements.”
• Act on Special Measures Concerning Taxation, Article 67-12(1) (Special taxation where partnership business, etc. incurs losses) / Quoted wording: “...The portion of the corporation's partnership or similar loss for the business year (meaning the amount prescribed by Cabinet Order as its loss from that partnership business or trust; hereinafter the same in this paragraph) exceeding an amount calculated under Cabinet Order based on its contribution value or the trust property's book value (or, in cases prescribed by Cabinet Order where no substantive loss attributable to the partnership business or trust property is expected, the entire partnership or similar loss) (referred to in paragraph (3)(iv) as ‘excess partnership or similar loss’) shall not be included in deductible expenses in calculating income for that business year.”
• Act on Special Measures Concerning Taxation, Article 67-12(2) / Quoted wording: “Where a corporation filing final tax returns, etc. has an aggregate excess partnership or similar loss in a business year, the portion up to the amount prescribed by Cabinet Order as its profit for that year from the relevant partnership business or trust shall be included in deductible expenses in calculating income for that year.”
• Act on Special Measures Concerning Taxation, Article 67-12(3)(i) / Quoted wording: “Partnership agreement: partnership agreements prescribed in Civil Code Article 667(1), investment limited partnership agreements prescribed in Article 3(1) of the Investment Limited Partnership Act, similar foreign agreements (including those prescribed by Cabinet Order), and silent partnership agreements, etc.”
• Act on Special Measures Concerning Taxation, Article 67-12(3)(ii) / Quoted wording: “Silent partnership agreements, etc.: silent partnership agreements (including equivalent agreements prescribed by Cabinet Order) and similar foreign agreements.”
• Act on Special Measures Concerning Taxation, Article 67-13(1) / Quoted wording: “Where the amount prescribed by Cabinet Order as a corporate partner's loss for the business year from business under a limited liability partnership agreement prescribed in Article 3(1) of the Limited Liability Partnership Act (hereinafter ‘partnership business’ in this Article) exceeds an amount calculated under Cabinet Order based on the corporation's contribution value in that business, an amount equal to the excess (referred to in paragraph (3) as ‘excess partnership loss’) shall not be included in deductible expenses in calculating income for that business year.”
• Act on Special Measures Concerning Taxation, Article 67-13(2) / Quoted wording: “Where a corporation filing final tax returns, etc. has an aggregate excess partnership loss in a business year, the portion up to the amount prescribed by Cabinet Order as its profit for that year from the relevant partnership business shall be included in deductible expenses in calculating income for that year.”
• Act on Special Measures Concerning Taxation, Article 41-4-2(1) (Special rules on loss offsetting, etc. for real estate income of specified partners, etc.) / Quoted wording: “...Where there is an amount prescribed by Cabinet Order as a real estate loss from the partnership business or trust in calculating the year's real estate income, an amount equal to that loss shall be deemed not to have arisen for purposes of Articles 26(2) and 69(1) of the Income Tax Act and other income tax laws and regulations.”
• Act on Special Measures Concerning Taxation, Article 41-4-2(2)(i) / Quoted wording: “Partnership agreement: partnership agreements prescribed in Civil Code Article 667(1), investment limited partnership agreements prescribed in Article 3(1) of the Investment Limited Partnership Act, and similar foreign agreements (including those prescribed by Cabinet Order).”