This article distinguishes distributions in kind, qualified distributions in kind, share distributions, and qualified share distributions, and explains Article 62-5’s effects. Detailed Cabinet Order requirements for qualified share distributions are outside its scope.

Statutory definition

All four terms are defined in Article 2 of the Corporation Tax Act. We begin with distributions in kind and the definitions of the distributing and recipient corporations.

The corporation transferring assets through a distribution in kind (delivery by a corporation, excluding public-interest corporations, etc. and associations without legal personality, etc., of non-monetary assets to its shareholders, etc. due to the following events; the same applies in this article): (a) dividends of surplus relating to shares or equity interests, or dividends of profits, excluding those through split-type splits, or distributions of surplus relating to equity interests; (b) distributions of residual assets upon dissolution; (c) events in Article 24, paragraph 1, items 5 through 7 (Amounts Deemed to Be Dividends, etc.).

The provision defines the distributing corporation, with the definition of distribution in kind embedded in parentheses. A distribution in kind is delivery of non-monetary assets by a corporation, excluding public-interest corporations and associations without legal personality, to shareholders through dividends of surplus or profits, distributions of surplus on equity interests, residual-asset distributions upon dissolution, or deemed-dividend events. The corporation transferring assets through that delivery is the distributing corporation.

The corporation receiving assets from the distributing corporation through a distribution in kind.

The recipient corporation receives the assets. Unlike an ordinary cash sale, a distribution in kind transfers non-monetary assets directly in a shareholder distribution. These party names are also used in the definitions of qualified distributions in kind, share distributions, and qualified share distributions below.

Overview

What Are the Requirements for a Qualified Distribution in Kind?

Article 2 defines a qualified distribution in kind as follows:

A distribution in kind by a domestic corporation in which all recipients of assets are domestic corporations (limited to ordinary corporations or cooperatives, etc.) in a wholly controlling relationship with it immediately before the distribution.

Three points follow. First, the distributor must be domestic. Second, every recipient must be a domestic corporation in a wholly controlling relationship with it immediately before the distribution. Third, recipients are limited to ordinary corporations or cooperatives, etc. If there are several shareholders receiving assets, all must meet those conditions. Wholly owned control is a common foundation of reorganization taxation. For an overview centered on that concept, see Overview of Reorganization Taxation I am organizing with.

How Do Share Distributions and Qualified Share Distributions Differ?

Article 2 defines a share distribution as follows:

A distribution in kind, limited to dividends of surplus or profits, transferring all issued shares, etc. in a corporation wholly owned by the distributor immediately beforehand (the “wholly owned subsidiary” in the following item), excluding distributions where all recipients were in a wholly controlling relationship with the distributor immediately beforehand.

A share distribution transfers all shares in a wholly owned subsidiary to shareholders as a dividend of surplus or profits. However, the parenthetical exclusion removes cases where every recipient had a wholly controlling relationship with the distributor immediately beforehand. Transfers solely among wholly related group persons therefore fall outside the share-distribution concept itself.

A qualified share distribution is defined as follows:

A share distribution transferring only shares in the wholly owned subsidiary, prescribed by Cabinet Order for that subsidiary and the distributor to conduct business independently, limited to distributions allocating the shares in proportion to each shareholder’s number of distributor shares (or amount of equity interests) relative to the distributor’s total issued shares, etc.

A qualified share distribution is one prescribed by Cabinet Order for the subsidiary and distributor to operate independently, with shares allocated proportionately to the distributor’s shareholders. Detailed conditions are in the Enforcement Order. Share distributions, like company splits, can separate businesses from a group. For comparison with qualified-split requirements, see Qualified Company Splits You can check with.

What Effects Does Article 62-5 Prescribe?

Article 62-5 addresses asset transfers through distribution or delivery of all residual assets, excluding qualified distributions in kind, as follows:

Where a domestic corporation transfers assets to a recipient corporation or another person through distribution or delivery of all residual assets (excluding a qualified distribution in kind; the same applies in the following paragraph), its income for each business year shall be calculated as if those assets were transferred at their value when residual assets are determined.

A non-qualified distribution or delivery of all residual assets is treated as a transfer at their value when residual assets are determined. The resulting gain or loss enters gross income or deductible expenses in the business year containing that determination date.

For qualified distributions in kind or qualified share distributions, the provision instead states:

Where a domestic corporation transfers assets to a recipient corporation or other shareholders through a qualified distribution in kind or qualified share distribution, its income for each business year shall be calculated as if those assets were transferred at their book values immediately beforehand (or, for a qualified distribution of all residual assets, when those residual assets are determined).

Qualified distributions use immediately preceding book values rather than fair values; distributions of all residual assets use book values at determination. On the recipient side, the following rule also applies:

Income arising when a domestic corporation receives assets through a qualified distribution in kind shall not be included in gross income in calculating its income for each business year.

The recipient’s income from a qualified distribution in kind is excluded from gross income. Combined with book-value transfer treatment, this prevents taxation of transfer gains or losses or receipt gains for either party. Shareholder taxation must be considered from a separate perspective; see Reorganizations and Shareholder Taxation We are dealing with that.

Points that require care in practice

• The point immediately before the distribution at which wholly owned control is tested must be confirmed against the actual transaction structure.
• Detailed Cabinet Order conditions for qualified share distributions are in the Enforcement Order and must be checked directly.
• A share distribution excludes cases where every recipient is wholly related to the distributor. Whether the transfer stays within the group or includes outside shareholders therefore affects its classification.
• Article 62-5 distinguishes fair-value from book-value transfers according to whether the residual-asset distribution is qualified. Qualified status must therefore be established first.
• Article 62-5 delegates the recipient’s acquisition costs and other necessary matters to Cabinet Order. Detailed calculations require consulting that Order.

Legal basis

• Corporation Tax Act, Article 2, Item 12-5-2 (Distributing Corporation)
• Corporation Tax Act, Article 2, Item 12-5-3 (Recipient Corporation)
• Corporation Tax Act, Article 2, Item 12-15 (Qualified Distribution in Kind)
• Corporation Tax Act, Article 2, Item 12-15-2 (Share Distribution)
• Corporation Tax Act, Article 2, Item 12-15-3 (Qualified Share Distribution)
• Corporation Tax Act, Article 62-5, Paragraph 1 (Asset Transfers through Distributions in Kind)
• Corporation Tax Act, Article 62-5, Paragraph 2 (Asset Transfers through Distributions in Kind)
• Corporation Tax Act, Article 62-5, Paragraph 3 (Asset Transfers through Distributions in Kind)
• Corporation Tax Act, Article 62-5, Paragraph 4 (Asset Transfers through Distributions in Kind)
• Corporation Tax Act, Article 62-5, Paragraph 6 (Asset Transfers through Distributions in Kind)