The economic activity tests: This is the fourth test.The applicable test varies by industry.For wholesale businesses, it concerns counterparties, the unrelated-party test; for other businesses, it concerns where business is conducted, the local business test.Only one of the two applies.
Provision
Article 66-6(2)(iii)(c) of the Act on Special Measures Concerning Taxation.
For each fiscal year, depending onwhich of the following categories the principal business falls within,the corresponding condition must be met.
（1） Wholesale, banking, trust business, financial instruments business, insurance, water transport, air transport, or goods leasing,（limited to businesses principally engaged in aircraft leasing:that businessLeasing of fixed assetsmust be conducted with persons other than foreign related companies those related to the relevant company,resident domestic corporations, and other persons prescribed by Cabinet Order as equivalent,in the cases prescribed by Cabinet Order.
（2） Businesses other than those listed in (1):the business must be conductedprimarily in the head-office jurisdiction,including, in relation to that jurisdiction,waters prescribed by Cabinet Order.。）The business must be carried on there.in the cases prescribed by Cabinet Order.
Subitem (1) is the unrelated-party test; subitem (2) is the local business test.
| Industries covered | What is examined | |
|---|---|---|
| Unrelated-party test（1） | Wholesale / banking / trust business / financial instruments business / insurance / water transport / air transport /goods leasing, limited to businesses principally engaged in aircraft leasing | Whether the counterpartiesare unrelated parties |
| Local business test（2） | Other businesses | Whether the businessunder the laws of the head-office jurisdiction,is carried on in the relevant jurisdiction |
The goods leasing category is limited.It does not cover goods leasing generally, but only the specified type.limited to businesses principally engaged in aircraft leasing:Other goods leasing businesses fall under the local business test in (2).
The modified wording in subitem (b), referring to headquarters functions for qualifying headquarters companies and management functions for foreign financial holding companies and similar entities,also applies to subitem (c)through the parenthesis in (b), “the same applies in (c).”
Unrelated-party test: the denominator differs by industry
Article 39-14-3(28) of the Special Measures Order prescribesa different fraction for each industry.The “more than 50%” threshold is common, butthe denominator differs by item.
| Item | Industry | Test |
|---|---|---|
| Number 1 | Wholesale | Sales transaction amount:more than 50% must be unrelated-party transactionsor Purchase transaction amountmore than 50% must be unrelated-party transactions |
| No. 2 | Banking | Interest received:more than 50% must be received from unrelated partiesor Interest paid:more than 50% must be paid to unrelated parties |
| Number 3 | Trust business | Trust feesmore than 50% must be received from unrelated parties |
| Item (iv) | Financial instruments business | Fees received,（including gains on securities sales,of which more than 50% must be received from unrelated parties |
| Item (v) | Insurance | Premium income:the specified amounts in total must exceed 50% |
| Item (vi) | Water transport and air transport | Ships and aircraft:revenue from operation and leasing,of which more than 50% must be received from unrelated parties |
| Item (vii) | Goods leasing(principally aircraft leasing) | Revenue from aircraft leasingof which more than 50% must be received from unrelated parties |
Items (i) and (ii) provide two fractions joined by “or.”For wholesale, either sales or purchases exceeding 50% is sufficient. Item (iii) onward has only one fraction each.Using “more than 50% of sales from unrelated parties” for every industry would be incorrect.
For wholesale, both “sales transaction amount” and “purchase transaction amount” includethe value of sales transactions giving rise to agency or brokerage commissions, under the parenthesis in item (i).It is the transaction value, not the commission amount.The same parenthesis appears on both the sales and purchase sides.
“Related parties” are broadly defined in six items
Article 39-14-3(27) of the Special Measures Order includes, in addition to domestic corporations under Article 66-6(1) and residents under Article 40-4(1),the followingpersons as related parties.
| Item | Who is covered |
|---|---|
| Number 1 | Where a domestic corporationWhere the domestic corporation is a group relief corporation,in that case,other group relief corporations |
| No. 2 | Persons holdingmore than 50% of that domestic corporation's issued shares or similar interests:those holders |
| Number 3 | For the group relief parent corporation,more than 50% of that domestic corporation's issued shares or similar interests:those holders |
| Item (iv) | a resident under the items of Article 40-4(1) or a domestic corporation under the items of Article 66-6(1),in relation to that person,a controlled foreign corporation foreign corporationmeaning a foreign corporation under de facto control, excluding those falling under items (ii) and (iii) |
| Item (v) | Entities interposed in a chain of indirect holdings:other foreign corporations and equity-related foreign corporations |
| Item (vi) | The foreign related company itself,the residents and domestic corporations above, and the persons in items (i) through (v), together with persons having with themspecial relationships prescribed by Cabinet Order under Article 66-6(1)(iv) |
Shareholders of the parent company are also related parties.Item (ii) covers “persons holding more than 50% of the domestic corporation's issued shares or similar interests.”Transactions with someone controlling the Japanese parent do not count as unrelated-party transactions.
Deeming rules address routed transactions
Article 39-14-3(29) of the Special Measures Order.Two patterns are deemed related-party transactions.
(i) Where, in a transaction between a foreign related company andan unrelated party,called the “subject transaction,” assets, services, or other items transferred or provided to that unrelated partyare predetermined by contract or otherwise, at the time of the subject transaction, to be transferred or provided to a related party of the foreign related company,the subject transaction is covered.
Even with an unrelated party interposed, the transaction is related-party if it was predetermined that the ultimate recipient would be a related party.Item (ii) covers the reverse pattern: related party → unrelated party → foreign related company.
The requirement is that the onward transaction be “predetermined.”Merely happening that way afterward does not meet the statutory wording. This is a question of factual findings.
A reverse exception for wholesale headquarters companies
Article 39-14-3(30) of the Special Measures Order.This provision narrows the scope of related parties.
excluding a foreign related companyA business listed in paragraph (28)(i),meaning wholesale,limited to a company with that principal business,where that companyqualifies as a headquarters company,for purposes of the preceding two paragraphs,related parties under that item and the preceding paragraph do not include foreign corporations managed by that foreign related company.。
For a headquarters company principally engaged in wholesale, transactions with managed companies that are foreign corporations count as unrelated-party transactions.Without this rule, a regional headquarters company's wholesale transactions could be mostly intragroup, causing it to fail the unrelated-party test.
Note that headquarters companies have two routes.
| Type of headquarters company | Test under subitem (c) |
|---|---|
| Holding shares and similar interests:a headquarters company principally engaged in this activity, under item (iii)(a)(1) | Under the modified wording in subitem (b), its principal business becomesheadquarters functions.Because headquarters functions are not among the industries listed in (1),the local business test in (2)applies under the opening text and item (iv) of Article 39-14-3(32), testing whether the headquarters functions are performed primarily in the head-office jurisdiction. |
| WholesaleA headquarters company principally engaged in wholesale | Its principal businessremains wholesale.It is tested under the unrelated-party test in paragraph (28)(i),with managed foreign corporations excluded from related parties under paragraph (30). |
It is not accurate to say that all headquarters companies are tested by their headquarters functions.Wholesale headquarters companies follow this route.
Local business test: also specified separately by industry
Article 39-14-3(32) of the Special Measures Order.
| Item | Industry | Test |
|---|---|---|
| Number 1 | Real estate business | Leasing of fixed assetsReal estate located in the head-office jurisdiction:sales, leasing, agency, brokerage, or management of that property |
| No. 2 | Goods leasing(excluding businesses principally engaged in aircraft leasing) | Leasing of fixed assetsGoods used in the head-office jurisdiction:leasing of those goods |
| Number 3 | Manufacturing | Leasing of fixed assetsManufacture of products in the head-office jurisdiction,includingcases prescribed by Ministry of Finance Order where the company is recognized as playing a substantive role in manufacturing through important manufacturing functions） |
| Item (iv) | Other businesses | Leasing of fixed assetsLeasing by a company that, in its head-office jurisdiction,The business is conducted there. |
The parenthesis in item (iii) is significant in practice.Even without its own factory, a company using supplied-material processing or contract manufacturing may qualify if it“plays a substantive role in manufacturing through important manufacturing functions.”That can satisfy the local business test.However, details are delegated to Ministry of Finance Order.The Cabinet Order's wording alone is insufficient for a determination.
The parenthesis concerning watersin statutory item (iii)(c)(2) is defined by Article 39-14-3(31) of the Special Measures Order as the head-office jurisdiction's“internal waters and territorial sea, and waters equivalent to its exclusive economic zone or continental shelf.”This matters for activities such as offshore resource development.
Points that require care in practice
- For wholesale, is the test based on sales or purchases?Either exceeding 50% is sufficient under item (i).
- We manufacture but have no factory.Check the parenthesis in item (iii) and the Ministry of Finance Order.
- Which test applies to aircraft leasing?The unrelated-party test in (1). Other goods leasing falls under (2).
- Is a transaction through a trading company an unrelated-party transaction?Check whether the deeming rule in paragraph (29)(i) applies.
- What about transactions with a major shareholder of the parent?That person is related under paragraph (27)(ii).
- What is examined for a headquarters company?For shareholding headquarters companies, the business is read as headquarters functions. For wholesale headquarters companies, it remains wholesale, with managed foreign corporations excluded from related parties under paragraph (30).
The unrelated-party test starts with a list of counterparties.Because the statutory scope of related parties is broad, a general impression that “most are unrelated” may not match the figures. If you are concerned about a foreign subsidiary's transaction mix, consult us with the latest year's sales and purchases broken down by counterparty.
Legal basis
- Article 66-6(2)(iii)(c) of the Act on Special Measures Concerning Taxation (Unrelated-Party and Local Business Tests), and subitem (b) (Modified Meaning of Principal Business)
- Article 39-14-3(27) of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Scope of Related Parties), paragraph (28) (Unrelated-Party Test), paragraph (29) (Transactions Deemed Related-Party Transactions),paragraph (30) (Special Related-Party Rules for Headquarters Companies Principally Engaged in Wholesale),paragraph (31) (Waters), and paragraph (32) (Local Business Test)
- Article 40-4(1), each item, of the Act on Special Measures Concerning Taxation (Rules for Residents)
This article does not cover the details of insurance-related item (v) or the Ministry of Finance Order provisions concerning manufacturing. Individual determinations require confirmation of counterparties and actual business activities.
This article is a general explanation based on laws and regulations as of September 6, 2026. Please consult us about your individual circumstances before taking action.
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