This article outlines the reorganizations, assets, and periods covered by the specified-asset loss restriction and its principal exceptions. Individual asset classifications and deductible-amount calculations require examination of the relevant Cabinet Order and transaction facts together.

Statutory definition

Article 2 of the Corporation Tax Act defines a controlling relationship as follows:

A relationship prescribed by Cabinet Order in which one person directly or indirectly owns more than fifty percent by number or amount of a corporation’s issued shares or equity interests, excluding its treasury holdings (hereinafter in this article “issued shares, etc.”; such relationship is hereinafter in this item a “controlling relationship between parties”), or the mutual relationship between corporations under the controlling relationship of the same person.

“Controlling relationship” includes direct or indirect ownership of more than fifty percent of issued shares, etc. and relationships between corporations linked through the same controlling person. Article 62-7 defines the reorganizations covered as follows:

A specified qualified reorganization, etc. (a qualified merger or a non-qualified merger subject to Article 61-11, paragraph 1 (Gains and Losses on Transactions Between Wholly Controlled Corporations), qualified split, qualified contribution in kind, or qualified distribution in kind that is not prescribed by Cabinet Order as a qualified reorganization for a joint business under Article 57, paragraph 4 (Carryforward of Losses); the same applies in this article).

A specified qualified reorganization, etc. means a qualified merger or equivalent merger, qualified split, qualified contribution in kind, or qualified distribution in kind that does not meet the prescribed joint-business reorganization conditions under Article 57. Deemed Joint Business Requirements Reorganizations satisfying these requirements are excluded; losses on transfers, etc. of specified assets arising in other covered reorganizations are non-deductible for a specified period.

Overview

How Do Specified Inherited Assets Differ from Specified Held Assets?

Article 62-7 separates the assets generating non-deductible specified-asset losses into two categories. The first consists of assets received from a corporation in a controlling relationship.

The total losses prescribed by Cabinet Order from transfers, revaluations, bad debts, retirements, or other events relating to assets received by the domestic corporation in the preceding paragraph from the related corporation through a specified qualified reorganization, etc. (excluding inventory, assets with low book value on the transaction date, and other prescribed assets), held by that related corporation before the start of the business year containing the most recent commencement of the controlling relationship (the “control commencement date” in the following item), including prescribed equivalent assets (hereinafter “specified inherited assets”), less the total gains prescribed by Cabinet Order from transfers, revaluations, or other events relating to those assets.

Specified inherited assets are transferred assets that the related corporation held before the start of the business year containing the control commencement date. The second category comprises assets the domestic corporation itself held before the reorganization.

The total losses prescribed by Cabinet Order from transfers, revaluations, bad debts, retirements, or other events relating to assets held by the domestic corporation in the preceding paragraph (excluding inventory, assets with low book value at the start of the business year containing the specified qualified reorganization, etc., and other prescribed assets), held before the start of the business year containing the control commencement date, including prescribed equivalent assets (hereinafter “specified held assets”), less the total gains prescribed by Cabinet Order from transfers, revaluations, or other events relating to those assets.

The distinction is whether assets were received or already held, but both categories concern assets existing before control arose. The combined net losses after deducting gains in these two categories constitute non-deductible losses on transfers, etc. of specified assets.

How Long Does Non-Deductibility Apply?

Article 62-7 defines the covered period as follows:

The period from the start of the domestic corporation’s specified-reorganization business year until three years have elapsed from that date (or, if later than the date five years after the most recent commencement of control with the related corporation, until that five-year date); where Article 62-9, paragraph 1 (Fair-Value Gains and Losses of Subsidiary Assets in Non-Qualified Share Exchanges, etc.), Article 64-11, paragraph 1 (Upon Commencement of the Group Tax Sharing System), Article 64-12, paragraph 1 (Upon Joining That System), or Article 64-13, paragraph 1, limited to item 1 (Upon Leaving That System, etc.) applies in a business year ending during that period, the period ends at the close of that business year (referred to in paragraph 6 as the “covered period”).

The general period runs for three years from the start of the business year containing the specified qualified reorganization. If that endpoint would fall after five years from the control commencement date, it is shortened to the five-year endpoint. This upper limit corresponds to the years used for Transfer of Tax Loss Carryforwards and Restrictions. However, the non-deductibility rule itself does not apply where control has continued for a prescribed period. Article 123-8 of the Enforcement Order provides:

The cases prescribed by Cabinet Order under Article 62-7, paragraph 1 (Non-Deductibility of Losses on Transfers, etc. of Specified Assets) shall be any of the following. 1. Where a controlling relationship between the domestic and related corporations specified in that paragraph has continued from five years before the start of the specified-reorganization business year (referred to in the following item as the “five-years-prior date”).

The restriction does not apply if control has continued from five years before the start of the specified-reorganization business year.

Which Assets Are Excluded?

The definitions of specified inherited and held assets contain a parenthetical exclusion for inventory, low-book-value assets on the specified qualified reorganization date, and other assets prescribed by Cabinet Order. Article 123-8 specifies the latter as follows:

The other assets prescribed by Cabinet Order under Article 62-7, paragraph 2, item 1 shall be the following. 1. Inventory (excluding land, including rights over land; referred to in paragraph 5, item 3 as “land, etc.”).

Inventory other than land, etc. is excluded. Other exclusions include short-term trading commodities, trading securities, assets below ¥10 million, assets worth at least their book value (only where value and book-value details are attached to the final return, etc. and valuation support is retained), and assets other than gain-or-loss adjustment assets transferred in a non-qualified merger. Article 123-9 prescribes reductions in specified-asset losses relating to specified inherited assets as follows:

For business years containing days within the covered period, specified-asset transfer losses under Article 62-7, paragraph 2 relating to specified inherited assets during that period may be reduced by the amounts prescribed for the following cases. 1. If the related corporation’s fair-value net assets at the end of the business year preceding the control business year (the year containing the most recent commencement of control) equal or exceed book-value net assets, an amount equal to the covered-period specified-asset losses on those inherited assets. Fair-value net assets mean total asset values less total liability values, including obligations relating to share acquisition rights and share subscription rights; book-value net assets mean total asset book values less total liability book values. 2. If fair-value net assets at that time are below book-value net assets, the portion of the current business year’s covered-period specified-asset losses exceeding that shortfall after deducting the combined amounts in (a) and (b).

If fair-value net assets at the end of the pre-control business year equal or exceed book-value net assets, the full covered-period loss may be offset, reducing the restricted amount to zero. If fair-value net assets are lower, only losses exceeding that shortfall, after specified adjustments, may be offset; losses up to the shortfall remain non-deductible. The reduction requires attachment and retention of supporting documents with final returns, etc.

Points that require care in practice

• The identified control commencement date—the most recent date control arose—affects which assets are specified inherited or held assets.
• Whether the reorganization meets the prescribed joint-business conditions under Article 57 is a prerequisite determining whether this regime applies.
• Article 123-8 also separately provides exceptions where either corporation was incorporated after the five-years-prior date.
• The reduction under Article 123-9 requires retention of documents supporting fair-value net assets, so documentation readiness must be checked.
• Article 62-7 also applies, with necessary substitutions, to specified qualified reorganizations in which disappearing corporations, etc. establish a corporation.

Legal basis

• Corporation Tax Act, Article 2, Item 12-7-5 (Controlling Relationship)
• Corporation Tax Act, Article 62-7, Paragraph 1 (Non-Deductibility of Losses on Transfers, etc. of Specified Assets)
• Corporation Tax Act, Article 62-7, Paragraph 2, Item 1 (Specified Inherited Assets)
• Corporation Tax Act, Article 62-7, Paragraph 2, Item 2 (Specified Held Assets)
• Order for Enforcement of the Corporation Tax Act, Article 123-8, Paragraph 1, Item 1 (Non-Deductibility of Losses on Transfers, etc. of Specified Assets)
• Order for Enforcement of the Corporation Tax Act, Article 123-8, Paragraph 2, Item 1 (Non-Deductibility of Losses on Transfers, etc. of Specified Assets)
• Order for Enforcement of the Corporation Tax Act, Article 123-9, Paragraph 1, Items 1 and 2 (Amounts Deductible from Specified-Asset Transfer Losses, etc.)