Under the tax haven countermeasure rules, Discussion of the CFC rules always begins with this term.foreign related companiesA company outside this category does not proceed to the subsequent analysis.

Provision

Article 66-6(2)(i) of the Act on Special Measures Concerning Taxation.There are three types.

foreign related companiesThe following foreign corporations: foreign corporation is what the term means.

(a) resident residents and domestic corporations, together withspecially related Non-residentspecified related persons (...), andforeign corporations listed in (b),collectively referred to in (a) as“resident and equivalent shareholders,”whose relevant percentages in a foreign corporation satisfy any of the following thresholds,exceeding fifty percent,that foreign corporation is covered.

(b) A foreign corporation having with a resident or domestic corporation the circumstances of the de facto control relationship, a de facto control relationshipforeign corporation

(c) (and foreign corporations that, through modified application of items (vi) and (vii), qualify asforeign financial institutions,and have with a partially covered foreign related company prescribed by Cabinet Order as equivalent to a foreign financial institution,a relationship under which that partially covered company manages them or another special relationship,as prescribed by Cabinet Order)

Subitem (a) is the main rule.Subitems (b) and (c) are separate routes. Subitem (c) has two layers of requirements; merely being a foreign financial institution is insufficient.

(a) Measuring more than 50% using three measures

Subitems (a)(1), (2), and (3) are as follows.at least oneIt is enough for any one to exceed 50%.

Looking only at the shareholding percentage can be misleading.Voting rights and dividend rights are also measures. With nonvoting or different classes of shares, (1) may produce a different result from (2) and (3).

However, the voting rights in (2) are limited.They are not all voting rights, but onlythose concerning resolutions on dividends of surplus and similar distributions.The parenthesis in Article 66-6(1)(i)(b) also applies to paragraph (2)(i)(a)(2).

Each provision in (1) through (3) contains a parenthesis referring to foreign corporations of resident and equivalent shareholders,excluding foreign corporations listed in (b).That exclusion applies to the relevant corporation.A foreign corporation under (b) already becomes a foreign related company through (b), so it is excluded from the test under (a).

The measure is not one person's interest alone.The statute creates a group called“resident and equivalent shareholders,”resident and equivalent shareholders, comprising four categories.

1. resident

2. Domestic corporation

3. Specially related nonresidents(nonresidents having special relationships prescribed by Cabinet Order with a resident or domestic corporation)

4. foreign corporations listed in (b),(foreign corporations under de facto control)

The combined holdings of all four categories are tested against more than 50%.Even if the Japanese parent holds only 40%, another 15% held by the president personally and relatives brings the total to 55%. “We do not hold a majority, so this does not concern us” should first be questioned.

Indirect holdings are not multiplied for the more-than-50% test

This is the most frequently misunderstood point. Article 39-14-2(2) of the Order for Enforcement of the Act on Special Measures Concerning Taxation provides:

(i) A foreign corporation that is a shareholder of the foreign corporation being tested,excluding a controlled foreign corporation,whoseissued shares and similar interests are held to the extent of more than fifty percent,in number or amount,by resident and equivalent shareholders,meets the condition.Use the proportion of the tested corporation's issued shares and similar interests held by that foreign corporate shareholder.

The wording uses unchanged the percentage held by a foreign corporation that is itself more than 50% owned.There is no multiplication.

If a Japanese corporation holds 60% of Company A and A holds 70% of Company B, the indirect percentage for B is not 60% × 70% = 42%, but70%the full 70%. Because A satisfies the more-than-50% condition, A's holding is counted unchanged.

Item (ii) covers longer chains. Even ifan equity-related foreign corporationis interposed,if every link is connected by more-than-50% holdings,the ownership percentage of the final foreign corporate shareholder is used unchanged.If any link is 50% or less, the chain breaks there.

For voting rights in (2) and distribution rights in (3), paragraphs (3) and (4) apply paragraph (2) with modified wording.This calculation is performed separately for each of the three measures.

However, the 10% test and inclusion amount calculation return to multiplication

Mixing these rules prevents a correct answer.Even for the same term, “indirect ownership,” different provisions use different calculations.

Article 39-14(3)(i) of the Order for Enforcement of the Act on Special Measures Concerning Taxation, for the 10% test.

The domestic corporation's or similar person's ownership percentage in the other foreign corporation, which is treated aszerowhere the issuing corporation has a de facto control relationship with a resident or domestic corporation,is multiplied by that other foreign corporation's ownership percentage in the foreign related company.

Item (ii) of that paragraph covers chains and uses“the percentage calculated by successive multiplication.”The indirectly held shares and similar interests adjusted for distribution rights used to calculate inclusion under paragraph (2)(iii) likewise use percentages calculated by multiplication or successive multiplication.

The two calculation methods are distinct.Applying the logic of one to the other gives the wrong result.

(b) A company can qualify with zero ownership

If a de facto control relationship exists, it is a foreign related company even if not a single share is held.The Cabinet Order calls a foreign corporation under (b) a“controlled foreign corporation”under Article 39-14(2)(i)(a).

De facto control is defined in Article 66-6(2)(v) of the Special Measures Act and Article 39-16 of the Order. See “What Is a De Facto Control Relationship?” for details.

“Foreign related company” is only the entry point

Merely qualifying as a foreign related company does not cause inclusion.The system has two stages.

Limiting stage 2 to “specified” and “covered” omits partial inclusion entirely.The economic activity tests: Even if all requirements in item (iii)(a) through (c) are met and the company is outside the covered category,partially targeted foreign affiliated companypartial inclusion of passive income under paragraphs (8) and (10) remains for a partially covered foreign related company.

Four types of persons subject to inclusion

Article 66-6(1) of the Special Measures Act defines the domestic corporations subject to inclusion infour items.These identify the relevant corporations.

(i) A domestic corporation for which any of the following percentages in a foreign related company isat least ten percent:that domestic corporation is covered.

(ii) With the foreign related company,a domestic corporation having a de facto control relationship

(iii) Where a foreign related company under de facto control by a domestic corporation has, inanother foreign related company,any of the percentages in item (i)(a) through (c) of at least ten percent, the domestic corporation is covered (...).

(iv) Where any percentage in item (i)(a) through (c) relating to the foreign related company is at least ten percent fora single family shareholder group,a domestic corporation belonging to that group is covered, limited to cases where any relevant percentageexceeds zero.……）

Items (ii) and (iv) are significant.

• No. 2Under item (ii), if a de facto control relationship exists,regardless of ownership,the corporation is subject to inclusion. There is no need even to calculate a 10% holding.
• Item (iv)must,If the family shareholder group holds at least 10% in total,a domestic corporation belonging to that group is subject to inclusion.Its income may be included even if its individual holding is below 10%.The statutory limitation is that either its percentage in the foreign related companyor the percentage in that company held by another foreign related company under its de facto controlmustexceed zero.That is the limitation.Even if its own direct holding is zero, it is covered if the percentage through another foreign related company under its de facto control exceeds zero.

The structure means “we hold only 5%” does not assure exemption.

There is also an easily overlooked parenthesis in paragraph (1)(i)(a).

The number or amount of shares and similar interests held in the foreign related company,treated as zero where that company has a de facto control relationship with a resident or domestic corporation）

The same parenthesis appears in (b), voting rights, and (c), distribution rights.Pay attention to the subject. The wording is“between the foreign related company and a resident or domestic corporation,”where a de facto control relationship exists.It does not say “with the taxpayer itself.”If that foreign related company is under de facto control by someone who is a resident or domestic corporation,all three percentages are treated as zero for every domestic corporate shareholder.Item (ii) then allocates inclusion to the domestic corporation having de facto control.

Points that require care in practice

• The president's personal holdings and the corporation's holdings together exceed a majority.Use the total for resident and equivalent shareholders, including specially related nonresidents.
• We have reduced the ownership interest using nonvoting shares.Voting rights under (2) and distribution rights under (3) are also tested. Voting rights are limited to those concerning dividend resolutions.
• How far do we trace lower-tier subsidiaries?For the more-than-50% test, continue as long as every ownership link exceeds 50%.
• What if it is exactly 50%?Subitem (a) says “exceeds.” Apply that wording.
• We individually hold only 5%.Check the family shareholder group rule in paragraph (1)(iv).
• What about an individual who establishes an overseas asset management company?Individuals have a separate provision, Article 40-4 of the Special Measures Act. Article 66-6 discussed here concerns domestic corporations.

Companies with foreign subsidiaries or asset management companies should start by listing their holdings.List shares, voting rights, and distribution rights side by side, and identify the full scope of resident and equivalent shareholders. If a measure exceeds 50%, proceed to classify the company as specified, covered, or partially covered. If you have an overseas corporation, consult us starting with an ownership chart.

Legal basis

• Article 66-6(1)(i) through (iv) of the Act on Special Measures Concerning Taxation (Persons Subject to Inclusion), paragraph (2)(i) (Foreign Related Companies), paragraph (2)(ii), (iii), and (vi), paragraph (2)(v) (De Facto Control), and paragraphs (8) and (10) (Partial Inclusion)
• Article 39-14-2(1) through (5) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Scope of Foreign Related Companies)
• Article 39-14(2)(i)(a) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Controlled Foreign Corporations), paragraph (2)(iii), and paragraph (3) (Calculation of Taxable Amounts and Related Matters)
• Article 39-16 of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Determination of De Facto Control Relationships)

This article does not cover individual CFC rules under Article 40-4, the special rules for foreign financial institutions in (c), or insurance exceptions. Individual determinations require confirmation of ownership relationships and contract terms.