What was decided, when, and by whom

The Outline of the FY2005 Tax Reform was published by the Ministry of Finance on December 19, 2004. Immediately below the original title, it simply states “December 19, 2004, Ministry of Finance.”

The Outline sets out the tax reforms planned for the fiscal year, item by item. The FY2005 Outline has seven chapters, each describing the changes with wording such as “reduce as follows” and “take the following measures.”

The introduction describes the aims of this year's reforms as follows.

In light of current economic and fiscal conditions, the following tax reforms will be implemented to build an appropriate tax system that sustainably revitalizes the economy and society. The fixed-rate tax reduction will be scaled back in anticipation of the review of national and local personal income taxation to be undertaken in the FY2006 tax reforms, and appropriate measures will be taken in housing taxation, financial and securities taxation, international taxation, taxation of SMEs, and other areas.

The reduction of the fixed-rate tax cut comes first, followed by housing taxation, financial and securities taxation, international taxation, and taxation of SMEs. In this series examining each year's Outline in the same format, the most recent fiscal year is Key points of the FY2026 tax system revision outline summarizing in

Main pillars of the outline

The Fixed-Rate Tax Reduction Is Halved

The most significant change this year is the scaling back of the fixed-rate income tax reduction. This mechanism deducts a fixed percentage from calculated income tax. The Outline compares the existing and proposed rules as follows.

Both the percentage deducted and the ceiling are halved. The Outline states that this change applies to income tax for 2006 onward.

Corresponding changes will be made to the payroll withholding tax tables and the fixed-rate reduction deducted from income tax withheld on public pensions and similar payments. These apply to salaries and public pensions payable on or after January 1, 2006, changing the amount withheld each month from that date.

Housing Tax Relief Expands around Earthquake Resistance

The housing taxation chapter expands the range of existing homes eligible for four programs. The additions are certain existing homes that meet technical standards for structural methods necessary for earthquake safety, or equivalent standards.

• They will be included among existing homes eligible for the special income tax credit for housing loans, commonly called the mortgage tax credit.
• Under the special rules for long-term capital gains on replacement or exchange of specified residential property, certain fire-resistant buildings meeting the same standards will be added to the eligible replacement assets.
• They will be included among existing homes eligible for the special settlement-at-inheritance taxation rules for funds used to acquire housing.
• They will become eligible for reduced registration and license tax on registration of preservation or transfer of ownership of residential buildings and registration of mortgages securing housing acquisition loans. The application period will also be extended by two years.

Effective dates differ by program. The mortgage tax credit, reduced registration and license tax, and special settlement-at-inheritance taxation rules cover existing homes acquired on or after April 1, 2005. The residential property replacement relief covers cases where the original property is transferred on or after January 1, 2005 and the replacement property is acquired on or after April 1 that year.

Financial and Securities Taxation Makes Specified Accounts More Flexible

Personally Held Shares Can Be Transferred into Specified Accounts

From April 1, 2005 through May 31, 2009 only, personally held listed shares and similar securities may, subject to conditions, be transferred into a specified account using their actual acquisition dates and costs. When shares lent to a securities firm are returned, shares of the same issue may also be accepted using the acquisition cost recorded at the time of lending. Japan Post will be added to the institutions permitted to operate specified accounts.

Losses on Worthless Shares Are Treated as Losses on Transfer

A “specified management account” will be introduced to hold shares in domestic corporations transferred out of specified accounts after they cease to qualify as listed shares or similar securities. If an event such as completion of liquidation of the issuing company occurs while the shares continue to be held there, the shares will be deemed transferred. An amount calculated using a prescribed method will be deemed a loss on transfer, allowing the special taxation rules for capital gains and other income from shares and similar securities to apply.

In addition, business income and miscellaneous income from cash settlement and similar settlement of exchange-traded financial futures transactions entered into on or after July 1, 2005 will be included in the special taxation rules for miscellaneous income and similar income from futures trading. Certain gains on foreign-currency deposits will also become subject to separate taxation and related rules for financial-equivalent products.

International Taxation Extends to Foreign Subsidiaries and Partnerships

Several changes will be made to the controlled foreign company rules, described in the Outline as the special taxation rules for income relating to specified foreign subsidiaries and similar entities of domestic corporations and others. Where a specified foreign subsidiary fails the country-of-location test or unrelated-party test but meets the business, substance, and management and control tests, its taxable retained income will be its undistributed income less 10% of certain personnel costs. The lookback period for previously taxed retained income deductible upon receipt of dividends and similar distributions will increase from five years to ten years before the start of the fiscal year. The carryforward period for losses deducted when calculating undistributed income will increase from five years to seven years.

The scope of taxation of nonresidents and foreign corporations will also expand. Income from transfers of certain shares and similar interests issued by corporations whose Japanese real estate accounts for at least 50% of total assets will become Japanese-source income subject to tax return filing and payment.

For investment through partnerships, profit distributions receivable by nonresident or foreign corporate partners in Civil Code partnerships and similar arrangements will be subject to 20% withholding tax. Foreign partners with a permanent establishment in Japan for business other than the partnership business are exempt from this withholding, subject to conditions. The transfer pricing rules will expand the definition of foreign related parties to include foreign corporations connected through chains of effective control and shareholding relationships.

SME Tax Measures Are Restructured to Match New Legislation

SME tax measures will be restructured in anticipation of the Act on the Promotion of New Business Activities by Small and Medium-sized Enterprises (provisional title). The Outline states that enactment of this law will abolish measures under the SME Business Innovation Support Act, the Act on Facilitating the Creation of New Business, and related legislation.

The tax incentives for strengthening the business foundations of SMEs and similar businesses will be expanded to cover machinery and equipment acquired by SMEs under business innovation plans or plans for developing new business fields through cross-sector collaboration (provisional title) under the new law, as well as machinery and equipment acquired by certain SMEs within five years of establishment. The capital-size criterion for the acquisition tax credit will not apply to these measures.

Additional fiscal years will qualify for the exemption from the special tax rate on family companies for SMEs and similar entities. These include fiscal years within ten years of establishment for family companies qualifying as SMEs under the new law, and fiscal years in which SMEs with approved business innovation plans under that law conduct business for such innovation. The angel tax incentive, formally the special taxation rules for capital gains and similar income on shares issued by specified small and medium-sized companies, will be extended by two years.

The Transfer of Tax Revenue Sources from Income Tax to Individual Inhabitant Tax Begins

The chapter on promoting decentralization addresses the allocation of financial resources between national and local government. The Outline states the following on the transfer of tax revenue sources.

As part of the Trinity Reforms, a full transfer of tax revenue sources from income tax to individual inhabitant tax will be implemented under the FY2006 tax reforms.

The full transfer is scheduled for the FY2006 tax reforms, with interim measures in FY2005. Their details and allocation criteria are as follows.

In FY2005, as an interim measure, JPY1.1159 trillion in tax revenue sources will be transferred through the income transfer tax. Taking into account reforms to national subsidies and contributions and other factors, three-fifths will be allocated to prefectures and two-fifths to municipalities. Allocations among local governments will be based on population for both the prefectural and municipal portions.

The income transfer tax is a mechanism for transferring financial resources from national to local government; it does not require procedures by taxpayers. The FY2006 Outline mentioned here is covered in our article on the FY2006 Tax Reform Outline.

To determine if it relates to you

• If you receive salaries or public pensions, see the scaling back of the fixed-rate tax reduction in “I. Personal Income Taxation.” It affects income tax for 2006 onward and withholding on salaries and similar payments payable on or after January 1 of that year.
• If you are considering buying a pre-owned home or using the mortgage tax credit, see “II. Housing Taxation.”
• If you use a specified account or hold share certificates yourself, see the section on transfers into specified accounts in “III. Financial and Securities Taxation.” Transfers are permitted only during a specified period.
• If your shares have ceased to qualify as listed shares or similar securities, see the specified management account section in the same chapter.
• Companies with overseas subsidiaries or transactions with nonresidents or foreign corporations should see “IV. International Taxation.”
• SMEs planning capital investment and family companies established within the past ten years should see “V. Taxation of SMEs.”
• Corporations increasing employee education and training expenditure and individuals donating to certified NPOs should see “VII. Other Measures.” It includes the introduction of a special tax credit for increased education and training expenditure and a higher limit on eligible donation deductions.

Source

• Ministry of Finance, “Outline of FY2005 Tax Reforms” (December 19, 2004)