This article distinguishes the transfer of losses from a disappearing corporation and its restrictions from restrictions on using the surviving corporation’s own losses. It does not cover the detailed joint-business requirements or individual calculations of restricted amounts.

Statutory definition

A loss-making company’s tax loss carryforwards do not transfer automatically in a reorganization. The prerequisite is whether the merger is qualified. Article 2 of the Corporation Tax Act defines this as follows:

A merger falling under any of the following categories in which shareholders, etc. of the disappearing corporation receive no assets other than shares or equity interests in one corporation that is either the surviving corporation or its parent (a corporation in a relationship prescribed by Cabinet Order involving direct or indirect ownership of all the survivor’s issued shares, etc.), disregarding money or other assets delivered as dividends of surplus, etc. (dividends of surplus, dividends of profits, or distributions of surplus relating to shares or equity interests), consideration pursuant to appraisal rights of dissenting shareholders, and money or other assets delivered to shareholders other than the survivor where the survivor holds at least two-thirds of the disappearing corporation’s issued shares or equity interests by number or amount immediately before the merger.

The provision sets out three categories, (a), (b), and (c), and requires one to be satisfied. For details, see Requirements for a Qualified Merger You can check with.

Overview

What Happens to the Disappearing Corporation’s Losses in a Qualified Merger?

Article 57 of the Corporation Tax Act provides as follows for qualified mergers, etc.:

Where a qualified merger makes the domestic corporation in the preceding paragraph the survivor, or residual assets are determined for another domestic corporation in which it holds all or part of the issued shares or equity interests and with which it has a wholly controlling relationship (limited to control by that domestic corporation or the mutual relationship in Article 2, item 12-7-6 (Definitions)), and the disappearing or other corporation (hereinafter the “disappearing corporation, etc.”) has losses arising in business years beginning within ten years before the merger date or the day after residual assets are determined (hereinafter in this paragraph, the following paragraph, and paragraph 7, item 1 the “preceding-ten-year business years”), limited to losses satisfying Cabinet Order requirements including filing final returns for the relevant years, including losses deemed its own under this paragraph but excluding those deemed nonexistent under paragraphs 4–6, 8, or 9 or Article 58, paragraph 1 (Special Treatment of Losses in Business Years Without Blue Returns), and excluding losses already deducted under the preceding paragraph or used to calculate refunds under Article 80 (hereinafter “unused losses”), those unused losses shall, for applying the preceding paragraph from the merger business year or the year containing the day after residual assets are determined (hereinafter the “merger, etc. business year”), be deemed losses of the domestic corporation’s respective business years containing the start dates of the years in which they arose. Where the other corporation has two or more shareholders, the amount is prorated by the domestic corporation’s shares or interests over total issued shares or interests excluding treasury holdings. Losses arising in preceding-ten-year business years of the disappearing corporation, etc. beginning on or after the domestic corporation’s merger, etc. business-year start are deemed to arise in the preceding business year of the domestic corporation.

Unused losses arising in the disappearing corporation’s preceding-ten-year business years may be carried forward as the surviving corporation’s own losses. Only losses meeting Cabinet Order requirements, including filing final tax returns, qualify.

Are Transfers Restricted When the Controlling Relationship Is Recent?

A relatively recent relationship with the disappearing corporation, etc. can restrict the transfer. Article 57 provides:

The unused losses under the preceding paragraph of the disappearing corporation in a qualified merger (limited to one in a controlling relationship with the domestic corporation in that paragraph, or another disappearing corporation where the domestic corporation is newly established by the merger) or the other domestic corporation whose residual assets are determined (hereinafter the “disappearing corporation, etc.”) shall exclude the following losses unless either the merger is prescribed by Cabinet Order as being for a joint business, or a controlling relationship has continued as prescribed by Cabinet Order from the latest of: five years before the start of the domestic corporation’s business year containing the merger date (or the merger date for an incorporation-type merger), or five years before the start of the business year containing the day after residual assets are determined; the disappearing corporation’s incorporation date; or the domestic corporation’s incorporation date.

Certain losses are excluded unless the qualified merger is prescribed by Cabinet Order as being for a joint business or falls within the prescribed continuous-control cases. The former requirements are discussed in Deemed Joint Business Requirements You can check with.

Excluded amounts are losses from before the controlling-relationship business year (the year containing the most recent commencement of control), plus the following portion of subsequent losses:

The amount prescribed by Cabinet Order as the portion of losses arising in preceding-ten-year business years from the controlling-relationship business year onward that consists of an amount equivalent to losses on transfers, etc. of specified assets under Article 62-7, paragraph 2 (Non-Deductibility of Losses on Transfers, etc. of Specified Assets).

The portion corresponding to losses on transfers, etc. of specified assets is excluded from unused losses. For details, see Losses on Transfers, etc. of Specified Assets You can check with.

Are the Surviving Corporation’s Own Losses Also Restricted?

Restrictions also apply to losses the surviving corporation already held. Article 57 provides:

Where the domestic corporation in paragraph 1 and a corporation in a controlling relationship with it undertake a qualified merger, a non-qualified merger subject to Article 61-11, paragraph 1 (Gains and Losses on Transactions Between Wholly Controlled Corporations), a qualified split, qualified contribution in kind, or qualified distribution in kind making the domestic corporation the surviving, successor, or recipient corporation (hereinafter a “qualified reorganization, etc.”), excluding cases prescribed by Cabinet Order involving continuous control from the latest of five years before the start of the business year containing the transaction date (or the day after residual assets are determined for a distribution of all residual assets; hereinafter the “reorganization business year”), the domestic corporation’s incorporation date, or the related corporation’s incorporation date, and the transaction is not prescribed by Cabinet Order as a qualified reorganization for a joint business, the following losses shall be deemed nonexistent for purposes of paragraph 1 from the reorganization business year onward, out of the domestic corporation’s losses under that paragraph, including losses deemed its own under paragraph 2 but excluding those deemed nonexistent under this paragraph through paragraph 6, paragraphs 8 or 9, or Article 58, paragraph 1.

If the reorganization does not qualify as a prescribed joint-business reorganization and does not meet the prescribed continuous-control exception, certain losses, including pre-control losses, are deemed nonexistent.

Can Control Be Acquired Solely to Access Tax Losses?

Article 57-2 applies to domestic corporations entering a specified controlling relationship as follows:

A domestic corporation that comes under another person’s specified controlling relationship (direct or indirect ownership by that person of more than fifty percent of its issued shares or equity interests by number or amount, excluding treasury holdings, or another relationship prescribed by Cabinet Order, excluding relationships arising from prescribed events; the same applies in this paragraph).

Specified control includes direct or indirect ownership of more than 50 percent of issued shares, etc. A loss corporation is a domestic corporation with losses arising before the business year containing the date specified control arose (the control date and specified-control business year), or assets with unrealized losses at the start of that year. If, in specified circumstances such as no business immediately before control, discontinuance of the old business, or acquisition of specified claims, it undergoes a triggering event such as a qualified merger as the disappearing corporation by the day before five years have elapsed from the control date, Article 57 ceases to apply to pre-application-year losses from the business year containing the triggering date (the day before the merger for a qualified merger) onward.

Points that require care in practice

• Whether control has continued from “five years earlier” depends on the starting point, which must be verified.
• The requirements for a merger prescribed by Cabinet Order as being for a joint business are in the Enforcement Order and are outside this article’s scope.
• Article 57 separately restricts losses inherited from the disappearing corporation and the surviving corporation’s own losses. The targets differ.
• Article 57-2 has multiple triggering events beyond the qualified-merger example discussed here.

Legal basis

• Corporation Tax Act, Article 2, Item 12-8 (Qualified Merger)
• Corporation Tax Act, Article 57, Paragraph 2 (Carryforward of Losses)
• Corporation Tax Act, Article 57, Paragraph 3 (Carryforward of Losses)
• Corporation Tax Act, Article 57, Paragraph 3, Item 2 (Carryforward of Losses)
• Corporation Tax Act, Article 57, Paragraph 4 (Carryforward of Losses)
• Corporation Tax Act, Article 57-2, Paragraph 1 (Disapplication of Loss Carryforwards for Loss Corporations Controlled by Specified Shareholders, etc.)