This article explains the definition, exclusions, and tax effects of qualified contributions in kind. Detailed joint-business requirements and acquisition-cost calculations are distinguished as matters requiring consultation of the relevant Cabinet Order.

Statutory definition

An overview of reorganization taxation is provided in Overview of Reorganization Taxation. Here, we examine the statutory definition of contributions in kind treated as tax-qualified and the effects of qualification.

Article 2 of the Corporation Tax Act defines the parties to a contribution in kind. First, the transferor:

The corporation transferring its assets, or its assets together with liabilities, through a contribution in kind.

This defines the contributing corporation and includes transfers of liabilities alongside assets. Next, the recipient:

The corporation receiving assets, or assets together with liabilities, from the contributing corporation through a contribution in kind.

This is the recipient corporation. Only contributions between these parties meeting specified conditions are treated as qualified. Article 2 provides:

A contribution in kind falling within any of the following categories, excluding: transfers to a recipient foreign corporation of Japanese real property or other prescribed assets (“domestic real property, etc.”), assets or liabilities relating to a business conducted through a domestic establishment (for a domestic corporation, the head office, etc. under Article 69, paragraph 4, item 1 (Foreign Tax Credit); for a foreign corporation, a permanent establishment), excluding shares in a foreign corporation where the holding represents at least twenty-five percent of its issued shares, etc. by number or amount (“domestic assets, etc.”), or a domestic corporation’s industrial property rights, copyrights, or other prescribed assets (“intangible assets, etc.”), except prescribed transfers under which all these assets or liabilities become attributable to the recipient foreign corporation’s permanent-establishment business; transfers by a foreign corporation to a domestic or another foreign corporation of assets, excluding domestic real property, etc., or liabilities relating to its business through the head office, etc. under Article 138, paragraph 1, item 1 (Domestic Source Income) (“foreign corporation’s overseas assets, etc.”), with transfers to another foreign corporation excluded only where all or part becomes attributable to that other corporation’s permanent-establishment business; transfers by a domestic corporation to a foreign corporation of assets or liabilities relating to business through an overseas establishment under Article 69, paragraph 4, item 1 (“domestic corporation’s overseas assets, etc.”), where all or part becomes attributable to the foreign corporation’s head-office business and the transfer is prescribed as equivalent to a domestic-asset transfer; and delivery of bonds with share acquisition rights upon exercise of those rights; and limited to contributions for which only recipient-corporation shares are delivered to the contributing corporation.

(a)

A contribution in kind where the contributing and recipient corporations have a wholly controlling relationship through either corporation, or another relationship prescribed by Cabinet Order.

(b)

A contribution in kind where the contributing and recipient corporations have a controlling relationship through either corporation, or another prescribed relationship, and all the following requirements are met.

（1）

Principal assets and liabilities relating to the contributed business (the contributing corporation’s pre-contribution business to be conducted by the recipient afterward; the same applies in (b)) are transferred to the recipient.

（2）

Approximately eighty percent or more of the employees engaged in the contributed business immediately beforehand are expected to work afterward for the recipient, a corporation in a wholly controlling relationship with it, or, where the business is expected to pass through a subsequent qualified merger, the survivor or a corporation in a wholly controlling relationship with that survivor.

（3）

The contributed business is expected to continue afterward in the recipient, a corporation in a wholly controlling relationship with it, or, where it is expected to pass through a subsequent qualified merger, the survivor or a corporation in a wholly controlling relationship with that survivor.

(c)

A contribution in kind prescribed by Cabinet Order for conducting business jointly between the contributing and recipient corporations (or, for a contribution establishing a corporation, between the contributing corporation and another contributing corporation).

The parenthetical definition excludes certain transfers involving foreign corporations and delivery of bonds with share acquisition rights. However, there is an exception to the exclusion for certain cases where domestic assets, etc. remain in the recipient foreign corporation’s Japanese permanent establishment. Check transferor, recipient, and asset attribution separately. The categories are summarized below. Consideration is limited to recipient-corporation shares.

Qualification falls into three categories, (a), (b), and (c), according to the strength of the relationship between contributor and recipient. This classification is also shared by Qualified Company Splits.

Overview

Which Transactions Does the Parenthetical Definition Exclude?

Foreign-corporation involvement does not automatically disqualify a contribution. The parentheses in Article 2, item 12-14 distinguish the following transactions.

For example, even when domestic assets are transferred to a foreign corporation, the result depends on the permanent-establishment exception above. First establish that no exclusion applies, then assess the shares-only consideration requirement and the conditions in (a), (b), and (c).

What Is the Effect of a Transfer at Book Value?

Article 62-4 prescribes the effects of a qualified contribution in kind.

Where a domestic corporation transfers assets, or assets together with liabilities, to the recipient through a qualified contribution in kind, its income for each business year shall be calculated as if those assets and liabilities were transferred at their book values immediately before the contribution.

2

The recipient’s acquisition costs for assets and liabilities and other matters necessary to apply the preceding paragraph shall be prescribed by Cabinet Order.

Article 62-4 requires income to be calculated as though transferred assets and liabilities were transferred at their immediately preceding book values. Accordingly, the qualified contribution itself produces no transfer gain or loss. For losses on subsequent disposals of assets whose book values were carried over, see Losses on Transfers, etc. of Specified Assets We are dealing with that.

What Constitutes a Contribution in Kind for a Joint Business?

Where contributor and recipient have neither a wholly controlling nor a controlling relationship, qualification is available only for contributions outside (a) and (b) that satisfy the joint-business conditions prescribed by Cabinet Order. The Enforcement Order sets out detailed criteria, including business relatedness and size, transfer of principal assets and liabilities, employee continuity, business continuation, and continued share ownership. Eligibility must be checked against each case’s facts.

Points that require care in practice

• Consideration is limited to recipient shares, so delivering cash or other assets may disqualify the contribution.
• Where the recipient is foreign, distinguish domestic real property, domestic assets, and intangible assets when applying the rules.
• The number of requirements to check differs between wholly controlled and merely controlled cases.
• Joint-business contribution requirements are detailed in Cabinet Order, which must be read alongside the statute.
• Expected employee continuity and business continuation should be assessed for how firmly they can be established before execution.
• Acquisition costs and other matters necessary for book-value treatment are delegated to Cabinet Order.

Legal basis

• Corporation Tax Act, Article 2, Item 12-4 (Definition of Contributing Corporation)
• Corporation Tax Act, Article 2, Item 12-5 (Definition of Recipient Corporation)
• Corporation Tax Act, Article 2, Item 12-14, Opening Provision (Scope and Consideration Restriction for Qualified Contributions in Kind)
• Corporation Tax Act, Article 2, Item 12-14(a) (Wholly Controlled Cases)
• Corporation Tax Act, Article 2, Item 12-14(b) (Requirements in Controlled Cases)
• Corporation Tax Act, Article 2, Item 12-14(c) (Contributions in Kind for Joint Businesses)
• Corporation Tax Act, Article 62-4, Paragraph 1 (Transfers of Assets, etc. at Book Value through Qualified Contributions in Kind)
• Corporation Tax Act, Article 62-4, Paragraph 2 (Delegation of Acquisition Costs, etc. to Cabinet Order)
• Order for Enforcement of the Corporation Tax Act, Article 4-3, Paragraph 15, Opening Provision (Requirements for Contributions in Kind for Joint Businesses)