Statutory definition

Two provisions with different functions separately govern what happens to shareholders when a merger or split-type company split occurs. Article 24 of the Corporation Tax Act treats the amount of assets received in excess of the portion attributable to the shares as a dividend; Article 61-2 governs gains or losses on transfer of the shares themselves. We begin with Article 24.

Where a domestic corporation that is a shareholder, etc. of a corporation (excluding public-interest corporations, etc. and associations without legal personality, etc.; the same applies in this article) receives money or other assets due to any of the following events, and the sum of the money and value of non-monetary assets (for assets subject to a qualified distribution in kind, an amount equivalent to the distributing corporation’s book value immediately before delivery) exceeds the portion of that corporation’s stated capital, etc. corresponding to the shares or equity interests giving rise to the delivery, the excess shall, for purposes of this Act, be deemed an amount listed in Article 23, paragraph 1, item 1 or 2 (Exclusion of Dividends Received, etc. from Gross Income). 1. A merger (excluding a qualified merger). 2. A split-type company split (excluding a qualified split-type company split).

This provision applies when a domestic corporate shareholder receives money or other assets through a merger, split-type company split, or similar event. If the sum of money and the value of other assets received exceeds the portion of stated capital, etc. attributable to the shares, the excess is deemed a dividend. Qualified mergers and qualified split-type company splits are respectively excluded, so no deemed dividend arises in those cases.

This provision applies only to shareholders, etc. that are domestic corporations.

Overview

When Do Deemed Dividends Arise in Mergers and Split-Type Company Splits?

Article 2 of the Corporation Tax Act defines split-type company splits to include both splits where shares are delivered as consideration and splits without consideration.

A split with no assets delivered as consideration (hereinafter referred to in this and the following item as a “split without consideration”) where, immediately before the split, the successor corporation holds all the splitting corporation’s issued shares, etc., or the splitting corporation holds no shares in the successor corporation.

Even where no assets are delivered as consideration, a split is treated as a split-type company split if the successor holds all the splitting corporation’s issued shares, etc., or the splitting corporation holds no shares in the successor.

Article 24 also addresses mergers and split-type company splits without consideration as follows:

Even where the surviving or splitting corporation delivers no shares or other assets to the disappearing or splitting corporation’s shareholders, etc. in a merger or split-type company split, if the transaction is prescribed by Cabinet Order as one in which delivery of shares in the surviving or successor corporation is considered to have been omitted, paragraph 1 shall apply by deeming those shareholders, etc. to have received such shares as prescribed by Cabinet Order.

Under this provision, where issuance is considered to have been omitted, the absence of consideration does not itself prevent a deemed dividend: shareholders are deemed to have received shares. Qualified transactions are excluded from the triggering events and therefore produce no deemed dividend. Even a non-qualified transaction produces none if the total value of assets received does not exceed the share-attributable portion. For qualified split requirements, see Qualified Company Splits You can check with.

Why Do Mergers and Split-Type Company Splits Without Cash or Other Non-Share Consideration Produce No Share Transfer Gain or Loss?

Article 61-2 of the Corporation Tax Act governs gains and losses on transfer of the shares themselves. The general rule is as follows:

Where a domestic corporation transfers securities, the transfer gain (the excess of the amount in item 1 over that in item 2) or transfer loss (the excess of the amount in item 2 over that in item 1) shall be included in gross income or deductible expenses in calculating income for the business year containing the date the transfer contract was concluded (or, for a transfer resulting from a dividend of surplus or another event prescribed by Ministry of Finance Order, the effective date of the dividend or other date prescribed by that Order), except where Articles 62 through 62-5 (Transfers of Assets through Mergers, etc.) apply.

Receiving shares in a merger or split-type company split is treated as simultaneous disposal of old shares and acquisition of new shares. Under the general rule, the difference between consideration and cost is a transfer gain or loss. Article 61-2 provides a mechanism preventing that gain or loss where no cash or other non-share consideration is delivered. For split-type company splits, it states:

Where a domestic corporation receives shares in the successor corporation or other assets through a split-type company split by the issuer of shares it holds (hereinafter referred to in this paragraph as “held shares”), paragraph 1 shall apply as if it had transferred the portion of those held shares corresponding to the assets and liabilities transferred to the successor corporation through the split.

The shareholder is deemed to have transferred the portion corresponding to the transferred net assets. A split-type company split without cash or other non-share consideration means a split where no assets other than shares are delivered and those shares are distributed in proportion to each shareholder’s number or amount of shares in the splitting corporation relative to its total issued shares, etc. For such a transaction:

and, when shares in the successor or parent corporation are received through that split-type company split (limited to one without cash or other non-share consideration), each amount listed in paragraph 1 shall, for purposes of that paragraph, equal the book value of the held shares attributable to the net assets split off immediately before the split.

Both consideration and cost are thus the same book value attributable to the net assets split off. Since they are equal, no transfer gain or loss arises. Article 119-8 of the Enforcement Order prescribes the calculation of that book value.

The amount calculated as prescribed by Cabinet Order under Article 61-2, paragraph 4 of the Act (Inclusion of Gains or Losses on Transfers of Securities in Gross Income or Deductible Expenses) shall equal the book value of the held shares immediately before the split-type company split by their issuer, multiplied by the ratio prescribed in Article 23, paragraph 1, item 2 (Calculation of Stated Capital, etc. Corresponding to Held Shares) for that split.

A similar provision applies to mergers. A merger without cash or other non-share consideration is defined as follows:

Where shares are received through a merger by the issuer (limited to a merger in which its shareholders, etc. receive no assets other than shares in a single corporation that is either the surviving corporation or a corporation in a relationship prescribed by Cabinet Order involving direct or indirect ownership of all the surviving corporation’s issued shares or equity interests (excluding treasury shares; hereinafter “issued shares, etc.”); disregarding money or other assets delivered as dividends of surplus, etc. under Article 2, item 12-8 (Definitions), or as consideration pursuant to appraisal rights exercised by dissenting shareholders; hereinafter in this paragraph and paragraph 6 a “merger without cash or other non-share consideration”), or where old shares cease to be held due to a specified merger without consideration by their issuer (a merger delivering no surviving-corporation shares or other assets to shareholders, prescribed by Cabinet Order as one in which share delivery is considered omitted), the amount in item 1 of the preceding paragraph shall equal the book value of the old shares immediately before that merger.

Dividends of surplus, etc. and consideration paid pursuant to appraisal rights are disregarded as non-share assets. Consideration and cost both equal the old shares’ book value immediately before the merger, so no transfer gain or loss arises. For non-qualified mergers involving cash or other assets, see What Happens When a Merger Is Non-Qualified? You can check with.

How Are Deemed Dividends Excluded from Share Transfer Gains or Losses?

Where the assets received include money or other assets, both deemed dividends and share transfer gains or losses become relevant. The provision defining transfer consideration prevents duplication.

The consideration ordinarily receivable for a transfer of the securities for value at the time of transfer (where an amount is deemed under Article 24, paragraph 1 (Amounts Deemed to Be Dividends, etc.) to be an amount listed in Article 23, paragraph 1, item 1 or 2 (Exclusion of Dividends Received, etc. from Gross Income), the amount after deducting that deemed amount).

If Article 24 gives rise to a deemed dividend, that amount is deducted from the consideration ordinarily receivable on transfer of the securities. It is thus excluded from transfer consideration in advance.

If part of the assets received in a non-qualified merger or split-type company split constitutes a deemed dividend, first determine the deemed dividend under Article 24, then calculate the transfer gain or loss using the remainder as consideration. For its place within the broader regime, see Overview of Reorganization Taxation I am organizing with.

Points that require care in practice

• Individual shareholders are governed separately by the Income Tax Act and are outside this article’s scope.
• Whether share issuance is considered omitted in a merger or split-type company split without consideration must be checked against the Cabinet Order’s requirements.
• For a split-type company split without cash or other non-share consideration, check both that no non-share assets are delivered and that allocation is proportional. For a merger without cash or other non-share consideration, check that no non-share assets are delivered.
• The ratio used to calculate the book value attributable to the net assets split off is obtained from the splitting corporation’s notification.
• This article does not address whether the merger or split-type company split itself qualifies for tax-qualified treatment.

Legal basis

• Corporation Tax Act, Article 24, paragraph 1, opening provision (Amounts Deemed to Be Dividends, etc.) / Quoted wording: “Where a domestic corporate shareholder, etc. of a corporation (excluding public-interest corporations, etc. and associations without legal personality, etc.; the same applies in this article) receives money or other assets due to the following events, and the sum of the money and value of non-monetary assets (for a qualified distribution in kind, the distributing corporation’s book value immediately before delivery) exceeds the portion of that corporation’s stated capital, etc. corresponding to the shares or equity interests giving rise to delivery, the excess shall, for purposes of this Act, be deemed an amount listed in Article 23, paragraph 1, item 1 or 2 (Exclusion of Dividends Received, etc. from Gross Income).”
• Corporation Tax Act, Article 24, paragraph 1, item 1 (Amounts Deemed to Be Dividends, etc.) / Quoted wording: “A merger (excluding a qualified merger).”
• Corporation Tax Act, Article 24, paragraph 1, item 2 (Amounts Deemed to Be Dividends, etc.) / Quoted wording: “A split-type company split (excluding a qualified split-type company split).”
• Corporation Tax Act, Article 24, paragraph 3 (Amounts Deemed to Be Dividends, etc.) / Quoted wording: “Even where the surviving or splitting corporation delivers no shares or other assets to the disappearing or splitting corporation’s shareholders, etc. in a merger or split-type company split, if the transaction is prescribed by Cabinet Order as one in which delivery of shares in the surviving or successor corporation is considered omitted, paragraph 1 shall apply by deeming those shareholders, etc. to have received such shares as prescribed by Cabinet Order.”
• Corporation Tax Act, Article 2, item 12-9(b) (Definition of Split-Type Company Split: Splits Without Consideration) / Quoted wording: “Such a split without consideration where, immediately before the split, the successor corporation holds all the splitting corporation’s issued shares, etc., or the splitting corporation holds no shares in the successor corporation.”
• Corporation Tax Act, Article 61-2, paragraph 1, opening provision (Inclusion of Gains or Losses on Transfers of Securities in Gross Income or Deductible Expenses) / Quoted wording: “Where a domestic corporation transfers securities, the transfer gain (the excess of the amount in item 1 over that in item 2) or loss (the excess of the amount in item 2 over that in item 1) shall be included in gross income or deductible expenses for the business year containing the transfer contract date (or, for a dividend of surplus or another event prescribed by Ministry of Finance Order, the dividend’s effective date or other prescribed date), except where Articles 62 through 62-5 (Transfers of Assets through Mergers, etc.) apply.”
• Corporation Tax Act, Article 61-2, paragraph 1, item 1 (Inclusion of Gains or Losses on Transfers of Securities in Gross Income or Deductible Expenses) / Quoted wording: “The consideration ordinarily receivable for a transfer of the securities for value at the time of transfer (where an amount is deemed under Article 24, paragraph 1 (Amounts Deemed to Be Dividends, etc.) to be an amount listed in Article 23, paragraph 1, item 1 or 2 (Exclusion of Dividends Received, etc. from Gross Income), the amount after deducting that deemed amount).”
• Corporation Tax Act, Article 61-2, paragraph 2 (Inclusion of Gains or Losses on Transfers of Securities in Gross Income or Deductible Expenses) / Quoted wording: “Where a domestic corporation receives shares through a merger by the issuer of its old shares (meaning shares, including equity interests, previously held; the same applies in this article), limited to a merger delivering no assets other than shares in a single corporation that is either the survivor or a corporation in a relationship prescribed by Cabinet Order involving direct or indirect ownership of all the survivor’s issued shares or equity interests, excluding treasury shares (hereinafter ‘issued shares, etc.’), and disregarding money or other assets delivered as dividends of surplus, etc. under Article 2, item 12-8 (Definitions) or pursuant to appraisal rights of dissenting shareholders (hereinafter in this paragraph and paragraph 6 a ‘merger without cash or other non-share consideration’), or ceases to hold old shares through a specified merger without consideration by their issuer (a merger delivering no survivor shares or other assets to shareholders, prescribed by Cabinet Order as one in which share delivery is considered omitted; the same applies in this paragraph), the amount in item 1 of the preceding paragraph shall equal the book value of the old shares immediately before that merger.”
• Corporation Tax Act, Article 61-2, paragraph 4, first sentence (Inclusion of Gains or Losses on Transfers of Securities in Gross Income or Deductible Expenses) / Quoted wording: “Where a domestic corporation receives shares in the successor corporation or other assets through a split-type company split by the issuer of shares it holds (hereinafter ‘held shares’), paragraph 1 shall apply as if it transferred the portion of those held shares corresponding to the assets and liabilities transferred to the successor through the split.”
• Corporation Tax Act, Article 61-2, paragraph 4 (Inclusion of Gains or Losses on Transfers of Securities in Gross Income or Deductible Expenses: Split-Type Company Splits Without Cash or Other Non-Share Consideration) / Quoted wording: “Where successor shares or other assets are received through the split-type company split, excluding one delivering, as split consideration under Article 2, item 12-9(a), no assets other than shares in one corporation that is either the successor or a corporation in a relationship prescribed by Cabinet Order involving direct or indirect ownership of all its issued shares, etc. (hereinafter ‘parent corporation’), with shares allocated in proportion to each shareholder’s number or amount of splitting-corporation shares relative to its total issued shares, etc. (hereinafter a ‘split-type company split without cash or other non-share consideration’), the amount in paragraph 1, item 2 shall be calculated as prescribed by Cabinet Order based on the held shares’ book value immediately before the split (hereinafter ‘book value attributable to the net assets split off’). Where successor or parent shares are received in a split limited to one without cash or other non-share consideration, each amount listed in paragraph 1 shall equal that book value attributable to the net assets split off immediately before the split.”
• Order for Enforcement of the Corporation Tax Act, Article 119-8, paragraph 1 (Transfer Consideration and Cost in Split-Type Company Splits, etc.) / Quoted wording: “The amount calculated as prescribed by Cabinet Order under Article 61-2, paragraph 4 of the Act (Inclusion of Gains or Losses on Transfers of Securities in Gross Income or Deductible Expenses) shall equal the book value of the held shares immediately before the split-type company split by their issuer, multiplied by the ratio prescribed in Article 23, paragraph 1, item 2 (Calculation of Stated Capital, etc. Corresponding to Held Shares) for that split.”