Under the tax haven countermeasure rules, the final determinant of whether income is included is the tax burden ratio.If the tax burden ratioIt is.This one number can reverse the conclusion.

Three thresholds

Article 66-6(7) and (12) of the Act on Special Measures Concerning Taxation.

Only specified foreign related companies have the 27% threshold.The others use 20%. Confusing them reverses the determination.

Paragraph (12) also lists exemptions other than the tax burden ratio.

(ii) For each fiscal year's partial amount, the amount subject to application. or the amount subject to partial application for financial subsidiaries and similar entities is¥20 million or less.This satisfies the first exemption.

(iii) The proportion of the amount subject to partial application for the fiscal year in the amount prescribed by Cabinet Order as equivalent to income based on that year's financial statements isfive percent or less.This satisfies the first exemption.

partial inclusion also has an amount threshold of ¥20 million or less and a percentage threshold of 5% or less.Do not conclude “below 20%, therefore included” by looking only at the tax burden ratio.

The formula is simple; its components are not

Article 39-17-2(1) of the Order for Enforcement of the Act on Special Measures Concerning Taxation.

……The ratio calculated by dividing taxes imposed on the foreign related company's income for each fiscal year by the amount of that incomeThat is its role.

Tax is the numerator and income the denominator. The formula is a single fraction.The difficulty is that “income” in the denominator is neither accounting profit nor Japanese taxable income.

First determine whether the company falls under (a) or (b)

Paragraph (2)(i) of the same Article divides the denominator calculationinto two categories based on the company's location.

(b) Taxes imposed on corporate income,excluding the specified taxes,where no such tax exists in the country or region containing the foreign related company's head office or principal office

Subitem (a) coversforeign related companies other than those listed in (b).That is its scope.

A tax-free jurisdiction has no local taxable income to calculate.The calculation therefore starts from accounting income.Until this category is determined, neither the following adjustment table nor the treatment of loss years can be established.

Denominator under (a): add five items and subtract one from local-law income

Paragraph (2)(i)(a) of the same Article.

The starting point is “income calculated under the laws of the head-office jurisdiction.”This is income calculated under local tax law, not Japan's Corporation Tax Act.

That sentence contains three parenthetical qualifications.(1) For these purposes, foreign corporation from the relevant tax,taxes equivalent to a qualified domestic minimum top-up tax, QDMTT, are excluded.(2) Where local law containstwo or more sets of foreign corporation tax rules, use those for the principal foreign corporation tax.(3)Exclude group income taxation provisions, such as consolidated taxation and pass-through taxation,from the calculation.

Thenadd items (1) through (5) below.will do so.

And(6) Foreign corporation tax refunded, to the extent included in gross income,is subtracted. This corresponds to addition (3), foreign corporation tax paid.

The parenthesis in (1) matters.Income exempt locally is generally added back to the denominator,but dividends received are not added back.The structure prevents locally exempt foreign subsidiary dividends from reducing the tax burden ratio.

Item (2) matters in certain jurisdictions.Where dividends paid are deductible, that amount is added back.

Under (b), for tax-free jurisdictions, the items are arranged differently.Items (1) through (4) are additions, while (5) and (6) are subtractions.Identical numbers do not mean identical contents.Additions (1) through (4) under (b) correspond to (2) through (5) under (a): expensed dividends paid, expensed foreign corporation tax paid, and the two insurance reserve items.There is no equivalent to (a)(1) under (b).A tax-free jurisdiction has no concept of “income excluded from the tax base.” Subtraction (5) is the amount ofdividends and similar distributions receivedrecognized as revenue; subtraction (6) is the amount offoreign corporation tax refundedrecognized as revenue.Under (a), dividends are not added back because of the parenthesis in (1); under (b), they are subtracted under (5).Different structures reach the same result, so using the wrong table changes the figures.

Numerator: not only local tax

Paragraph (2)(ii) of the same Article.

... The amount offoreign corporation tax imposed in the head-office jurisdiction or another country or regionon the relevant income:the foreign corporation tax amountThat is its role.

Withholding tax imposed by third countries also enters the numerator.Counting only tax in the head-office jurisdiction understates the ratio.

The numerator also has adjustments for consolidated taxation and similar regimes.The parenthesis in item (ii) provides that where foreign corporation tax laws contain group income taxation provisions, use“the foreign corporation tax amount calculated as if those group income taxation provisions did not apply.”Both numerator and denominator are recalculated on a stand-alone basis.

Item (iii) adds two further adjustments.

• Include foreign corporation tax deemed paid.Amounts treated as paid and credited under local law are included in the numerator.
• Exclude certain foreign corporation tax.Foreign corporation tax on dividends received from corporations outside the head-office jurisdiction that are excluded from the denominator under item (i)(a)(1) is also excluded from the numerator.

Tax corresponding to income excluded from the denominator is excluded from the numerator too.The components are matched.

Years with no income or a loss

Paragraph (2)(v) of the same Article.

Where there is no income or there is a loss under the preceding paragraph,the ratio is ... the rate that would apply if income arose fromthe revenue of the principal business,namelya ratio equivalent to the foreign corporation tax rate in the head-office jurisdiction applicable to that income.That is its role.

A zero or negative denominator prevents calculation of the ratio.In that case,companies under (a), in jurisdictions with corporate income tax, use the applicable local tax rate,whilecompanies under (b), in tax-free jurisdictions, use zero.That is the rule.

For companies under (a), a loss does not mean a zero tax burden ratio.The local tax rate is used.

The “revenue” under (a) also has a parenthesis: if that revenue consists ofdividends excluded from income under item (i)(a)(1), use other revenue instead.For holding companies whose principal revenue is locally exempt dividends, the reference revenue therefore changes.

In progressive-rate jurisdictions, the highest rate may be used

Paragraph (2)(iv) of the same Article.

Where the head-office jurisdiction's foreign corporation taxrates increase with income,the foreign corporation tax amount under item (ii) may be calculated by treating those ratesas the highest of those rates,using the resulting foreign corporation tax amount.if the conditions for relief are met.。HoweverHowever, if application of the highest rateis not ordinarily expected,or the income category to which that highest rate appliesis extremely limited,or other circumstances makeuse of the main rule in this item manifestly inappropriate, this does not apply.。

The wording is “may.”It is an election, not a requirement.The proviso gives two examples of relevant circumstances:where the highest rate is not ordinarily expected to apply, and where the income category subject to it is extremely limited.What must be “manifestly inappropriate” is using the main rule in the item, not merely application of the highest rate itself.

Points that require care in practice

• Is a local corporation tax rate of 25% safe?For a specified foreign related company, it is below 27%. Also, the effective ratio does not necessarily equal the statutory rate.
• We have income exempt from local tax.It is added back under (1), except for dividends received.
• We pay withholding tax in a third country.It enters the numerator.
• How are loss years treated?Item (v) uses the applicable local rate.
• The company is in a jurisdiction with consolidated taxation.Calculate both numerator and denominator as though group income taxation provisions did not exist.
• We have a company in a tax-free jurisdiction.It falls under (b). The denominator starts with accounting income, and the ratio is zero in a loss year.
• Should we use 20% or 27%?It depends on the company category. Determine that category first.

The tax burden ratio is not determined simply by looking at a local tax rate table.It requires reconciling the local return and financial statements and identifying additions one by one. If you are concerned about CFC inclusion for a foreign subsidiary, consult us with its latest local tax return.

Legal basis

• Article 66-6(7)(i) and (ii) of the Act on Special Measures Concerning Taxation (Exemptions from Company-Wide Inclusion)
• Article 66-6(12)(i) through (iii) of the Act on Special Measures Concerning Taxation (Exemptions from Partial Inclusion)
• Article 66-6(14) of the Act on Special Measures Concerning Taxation (Attachments to Final Returns)
• Article 39-17-2(1) and (2) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Calculation of Foreign Related Companies' Tax Burden Ratios)
• Article 39-15(6) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Group Income Taxation Provisions)

This article does not cover details of insurance reserve additions or treatment of foreign financial subsidiaries and similar entities. Individual calculations require review of local tax returns and financial statements.