An overseas subsidiary earns profits but has not distributed them to its Japanese parent. The cash remains abroad, so surely Japan does not tax it—or so one might think.

In certain cases, subsidiary income is included in the Japanese parent's income even without a dividend. These are controlled foreign company (CFC), or tax haven countermeasure, rules. Focusing on corporate ownership, this article explains why undistributed income is taxed and whether genuine local operations suffice. Separate rules exist for direct individual ownership; the corporate explanation cannot simply be applied unchanged.

Why Japan Taxes Another Company's Profits

An overseas subsidiary is normally a taxpayer separate from its Japanese parent. Local taxation of subsidiary income and the parent's receipt of dividends are distinct events.

But taking that separation alone would allow profits to accumulate indefinitely in an overseas entity with little activity, deferring Japanese tax by withholding dividends. The rules therefore tax all or part of certain foreign-company income in Japan regardless of distribution. For terminology, see “What Are Tax Haven Countermeasure Rules?”.

The key is not whether cash was remitted to Japan. Start with control relationships, then examine activities and income character.

Look at Control Rather Than Company Size

The basic category includes foreign corporations more than 50% directly or indirectly owned by Japanese residents, domestic corporations, and others. Voting rights, dividend rights, and substantive control tests can also apply, so registered share percentages may not complete the review.

Separately, identify Japanese shareholders subject to inclusion, generally requiring at least 10% direct or indirect ownership and other conditions. Whether the foreign company is covered and which Japanese shareholder includes income are separate questions.

A Japanese company's wholly owned overseas subsidiary does not avoid review merely because it is small. SMEs expanding overseas should consider the rules from establishment.

20% and 27% Are Not Japanese Tax Rates on the Income

The tax burden ratios of 20% and 27% determine eligibility for exemption from the regime. They do not mean included profits are taxed in Japan at those rates.

The ratio is not simply the headline corporate tax rate in a local brochure. It is calculated under statutory rules using company income and foreign corporate taxes. Incentives, exempt income, and credits can make the result differ from the apparent rate. Overview of the Ministry of Finance system also explains these categories and exemptions.

Conversely, a ratio below 20% does not always mean all income is included. Economic activity tests become important.

Four Perspectives on Genuine Local Operations

After determining the company is not a specified foreign related company, the economic activity tests are central to whether full inclusion can be avoided.

A company with local shops and employees, local customers, and local management deciding purchases and hiring differs materially from one renting only an address and receiving all instructions from Japan.

No single condition, such as hiring one employee or holding board meetings abroad, decides the issue. Assess actual activities in light of the business and transactions. The NTA's Q&A on the FY2017 Amendments provides a foundation for the tests, but later changes to rate thresholds and other matters must be reflected.

Investment Income Needs Separate Review Even in an Operating Company

Even if all economic activity tests are met, a tax burden below 20% may require partial inclusion of passive income, commonly interest, dividends, and securities gains. Each category has exclusions; the existence of those receipts does not automatically include all of them.

Genuine local product sales and substantial investment returns on surplus cash must be considered separately. Business substance does not remove the need to analyze income composition.

Suppose a company meets all activity tests, has JPY 30 million of statutorily calculated income subject to partial inclusion, and the Japanese parent's inclusion percentage is 100%, with no small-amount exemption. Inclusion is based on that income, not total revenue or dividends. Exemptions and foreign tax adjustments mean accounting interest receipts are not simply added unchanged to Japanese taxable income.

Does Local Tax Mean Full Double Taxation in Japan?

Where included income bears local corporate tax, specified foreign tax credits provide adjustments. Later dividends of previously included income also receive relief within prescribed limits.

Local tax payment does not remove the need to test inclusion. First calculate covered income, then apply foreign tax and later-dividend adjustments. Credits and dividend exclusions serve different functions.

Review Every Year Even If No Dividend Is Planned

A practical difficulty arises when income is included in the Japanese parent's return while cash remains in the subsidiary. Local capital spending or remittance restrictions may require separate Japanese tax funding.

Waiting until a dividend decision may therefore be too late. Each year, gather ownership information, accounts, local returns, income breakdowns, office and employee details, and local decision-making records. Previously exempt companies may change status after business contraction, asset sales, or increased investment activity.

Despite the “tax haven” name, the rules are not limited to particular countries. Control, actual activities, and income composition matter. Tax management starts by rejecting the assumptions that an overseas company or absence of dividends prevents Japanese tax.

Main bases: Act on Special Measures Concerning Taxation Articles 66-6 through 66-9, Related Administrative Guidance. This explanation focuses on ordinary operating corporations and omits special rules for liquidating companies, financial subsidiaries, and others. Treatment varies with ownership, fiscal year, and applicable exceptions.