The deemed joint business requirements do not require all five conditions to be met. This article explains Article 57, paragraph 3 of the Corporation Tax Act concerning restrictions on transferring tax losses and the two combinations prescribed by Article 112, paragraph 3 of its Enforcement Order.

Statutory definition

Article 57 of the Corporation Tax Act governs whether a surviving corporation may take over the disappearing corporation’s tax loss carryforwards. Restrictions may apply to qualified mergers between corporations whose controlling relationship arose only recently. Article 57 also sets out one situation in which the restriction is lifted.

If neither the condition that the qualified merger is one prescribed by Cabinet Order as a merger for conducting business jointly, nor the condition prescribed by Cabinet Order that a controlling relationship has continued between the disappearing corporation, etc. and the domestic corporation referred to in that paragraph from the latest of the following dates is met, the following loss amounts shall be excluded: the date five years before the start of the domestic corporation’s business year containing the qualified merger date (or the merger date for a merger establishing a corporation), or five years before the start of the business year containing the day after the residual assets are determined; the date the disappearing corporation, etc. was incorporated; or the date the domestic corporation was incorporated.

Put simply, where a controlling relationship has continued between the disappearing corporation, etc. and the surviving corporation from a date such as five years before the start of the business year containing the merger, or where the qualified merger is “prescribed by Cabinet Order as a merger for conducting business jointly,” the restriction excluding pre-control losses and losses corresponding to losses on transfers, etc. of specified assets does not apply. The substance of losses on transfers, etc. of specified assets is addressed in Losses on Transfers, etc. of Specified Assets. In practice, these conditions are generally called the deemed joint business requirements, with details set out in Article 112 of the Order for Enforcement of the Corporation Tax Act.

The mergers prescribed by Cabinet Order under Article 57, paragraph 3 of the Act shall be qualified mergers satisfying the requirements in items 1 through 4, or those in items 1 and 5.

Article 112 of the Enforcement Order specifies qualified mergers meeting either items 1 through 4 or items 1 and 5. There are two combinations, and satisfying either one is sufficient.

Overview

Satisfying either combination is sufficient. The definitions and assessment dates for each requirement are discussed below. Cases prescribed by Cabinet Order involving a continuous controlling relationship provide a separate route to removing the transfer restriction.

Which Combinations Satisfy the Requirements?

The deemed joint business test consists of combinations of five conditions. The first requires a relationship between the disappearing and surviving businesses and is generally called the business-relatedness requirement. The second compares business size using revenue, employees, stated capital, or similar measures and is generally called the business-size requirement. The third and fourth require each business to continue from when the controlling relationship arose until immediately before the merger, with changes in size kept within a specified range; these are generally called the business-size continuity requirements. The fifth requires specified officers of both corporations to remain involved in management after the merger and is generally called the specified-officer continuity requirement. Article 112 of the Enforcement Order provides that either the first four conditions or the first and fifth conditions are sufficient. The requirements for a qualified merger itself are discussed in Requirements for a Qualified Merger We are dealing with that.

How Are Business Relatedness and Business Size Defined?

The condition generally called the business-relatedness requirement is prescribed as follows:

The disappearing business of the disappearing corporation in the qualified merger (meaning any one of its principal businesses conducted before the qualified merger; the same applies through item 3 below) and the surviving business of the surviving corporation in that merger (or, where the surviving corporation is established by that merger, another disappearing corporation in that merger; the same applies in this paragraph) (meaning any one of the surviving corporation’s businesses conducted before the merger, or, where it is established by the merger, the disappearing business of another disappearing corporation; the same applies in the following item and item 4) must be mutually related.

The wording requires one of the disappearing corporation’s principal pre-merger businesses (the disappearing business) and one of the surviving corporation’s pre-merger businesses (the surviving business) to be mutually related.

The condition generally called the business-size requirement is prescribed as follows:

The ratio of the respective sizes of the disappearing business and surviving business (limited to a business related to the disappearing business; the same applies in this item and item 4 below), measured by revenue, numbers of employees, stated capital or contributed capital of the disappearing and surviving corporations, or an equivalent measure, must not exceed approximately five to one.

The wording compares the respective businesses using revenue, employees, stated or contributed capital, or equivalent measures and requires a ratio not exceeding approximately five to one. It is understood that comparison using any one of these measures is sufficient.

How Are Business-Size Continuity and Specified-Officer Continuity Defined?

The condition requiring continuity of the disappearing business’s size is prescribed as follows:

The disappearing business must have been conducted continuously from the most recent time when the disappearing corporation in the qualified merger entered a controlling relationship with the surviving corporation (or, if between that time and immediately before the merger it received all or part of the disappearing business through a qualified merger, qualified split, or qualified contribution in kind in which it was the surviving, successor, or recipient corporation (referred to in the following item as the “surviving corporation, etc.”), the time of that qualified transaction; such transactions are hereinafter referred to in this and the following item as “qualified mergers, etc.”; the relevant time is hereinafter referred to in this item as the “time control arose for the disappearing corporation”) until immediately before the qualified merger; and the ratio between the business’s size at that time and immediately before the merger, measured only by the indicator used for the size ratio in the preceding item, must not exceed approximately two to one.

The wording requires the disappearing business to continue from the most recent commencement of the controlling relationship until immediately before the merger, with the size ratio not exceeding approximately two to one. A similarly structured condition applies to the surviving corporation.

The surviving business must have been conducted continuously from the most recent time when the surviving corporation in the qualified merger entered a controlling relationship with the disappearing corporation (or, if between that time and immediately before the merger it received all or part of the surviving business through a qualified merger, etc. in which it was the surviving corporation, etc., the time of that transaction; hereinafter referred to in this item as the “time control arose for the surviving corporation”) until immediately before the qualified merger; and the ratio between its size at that time and immediately before the merger, measured only by the indicator used for the size ratio in item 2, must not exceed approximately two to one.

The condition generally called the specified-officer continuity requirement is prescribed as follows:

At least one person who was a specified officer of the disappearing corporation before the qualified merger (meaning a president, vice president, representative director, representative executive officer, senior managing director, managing director, or equivalent person engaged in managing the corporation; the same applies in this item), limited to a person who was an officer or equivalent person engaged in its management before the most recent date on which the controlling relationship with the surviving corporation arose (or on that date if the relationship arose upon incorporation of either corporation; the same applies hereinafter in this item), and at least one specified officer of the surviving corporation before the merger, similarly limited to a person who was an officer or equivalent person engaged in its management before that date, must be expected to become specified officers of the surviving corporation after the merger (or of the corporation established by it).

Specified officers are defined as presidents, vice presidents, representative directors, representative executive officers, senior managing directors, managing directors, or equivalent persons engaged in corporate management. The wording requires that at least one specified officer from each corporation who was involved in management before the controlling relationship arose be expected to become a specified officer of the surviving corporation after the merger. For an overview of restrictions on taking over tax loss carryforwards, see Transfer of Tax Loss Carryforwards and Restrictions I am organizing with.

Points that require care in practice

• The business-size and business-size continuity ratios use the flexible term “approximately,” rather than a strict numerical cutoff.
• The business-size ratio may differ depending on which of the available measures—revenue, employees, stated capital, etc.—is used.
• Both combinations need not be satisfied. The structure requires either conditions 1 through 4, or conditions 1 and 5.
• The business-size continuity conditions start from when the controlling relationship arose, so identifying that starting point is a prerequisite.
• The specified-officer continuity condition is limited to pre-merger specified officers who had been engaged in management as officers or equivalent persons since before the controlling relationship arose.
• If the case falls within the continuous-control cases prescribed by Cabinet Order, the restriction is removed without satisfying the deemed joint business requirements. It is therefore necessary to identify which route removes the restriction.

Legal basis

• Corporation Tax Act, Article 57, Paragraph 3 (Carryforward of Losses)
• Order for Enforcement of the Corporation Tax Act, Article 112, Paragraph 3, Opening Provision (Succession to Losses through Qualified Mergers, etc.)
• Order for Enforcement of the Corporation Tax Act, Article 112, Paragraph 3, Item 1 (Succession to Losses through Qualified Mergers, etc.)
• Order for Enforcement of the Corporation Tax Act, Article 112, Paragraph 3, Item 2 (Succession to Losses through Qualified Mergers, etc.)
• Order for Enforcement of the Corporation Tax Act, Article 112, Paragraph 3, Item 3 (Succession to Losses through Qualified Mergers, etc.)
• Order for Enforcement of the Corporation Tax Act, Article 112, Paragraph 3, Item 4 (Succession to Losses through Qualified Mergers, etc.)
• Order for Enforcement of the Corporation Tax Act, Article 112, Paragraph 3, Item 5 (Succession to Losses through Qualified Mergers, etc.)