Japan adopts corporate, income and inheritance tax reforms – MNE Tax

By Takato Masuda, Nishimura & Asahi, Tokyo

Corporate tax, income tax and inheritance tax reforms in Japan, as well as new laws to remove barriers preventing Japanese asset management companies from appointing fund managers foreigners were adopted by the Diet on March 26 and promulgated on the same day.

The motivation for such reforms would be Japan’s ambition to overtake Hong Kong as a leading financial center in Asia, given the growing instability in Hong Kong linked to the enactment of the National Security Law in 2020.

Thus, Japan’s reforms appear to be an example of a country’s use of tax competition to strengthen its status as an international financial hub and attract investment. While there is a growing consensus that the race to the bottom on corporate tax rate cuts should be softened, as in the OECD’s Pillar 2 (GloBE) proposal, other types tax competition seem to persist.

Under the new tax law, performance compensation paid by a portfolio management company to executives is now deductible from corporation tax under certain conditions.

Under previous legislation, performance pay paid to executives by unlisted companies – which asset management companies often are – was not deductible. It was felt that this rule should be changed as it was incompatible with the typical compensation package for executives of investment management companies, which is primarily performance based compensation.

Regarding inheritance tax, if a non-Japanese fund manager resided in Japan for more than 10 years, a heavy inheritance tax of up to 55% was imposed not only on the domestic assets of the manager but also on foreign assets, even if the heir resided outside the country.

This has made Japan a less attractive place to work than other countries without inheritance tax, such as Singapore. Thus, under the new rules, some foreign nationals who reside in Japan for work purposes will not be subject to inheritance tax on their foreign assets, regardless of the length of stay in Japan.

Regarding income tax for fund managers, the Japan Financial Services Agency and the National Tax Agency have issued guidance to clarify the tax-advantaged treatment of so-called “the deferred interest ”(a common form of remuneration for fund managers based on a share of profits).

In general, if the deferred interest received by a resident natural person is considered as remuneration for services, it is taxed at a progressive rate of up to 55%. However, it is believed that this discourages foreign professionals from entering the Japanese financial sector. As a result, under the new guidelines, certain deferred interest will be taxed separately from other income at a flat rate of 20% as financial income rather than in consideration for services.

The reforms also extend the scope of the tax exemption for those who invest in Japan from overseas through limited liability companies that have (or are deemed to have) a permanent establishment in Japan.

If a foreign investor is a limited partner of such a limited partnership, the income tax attributable to the permanent establishment is exempt under certain conditions, for example when the foreign investor holds less than 25% of interest in the partnership.

Likewise, in previous law, if the limited partner was not a natural person but a “fund of funds”, the participation held by the fund of funds had to be less than 25%. After the revision, in the case of a participation held by a fund of funds, the 25% threshold applies to the participation substantially held by the respective investors in the fund of funds.

Takato Masuda is a lawyer and partner at Nishimura & Asahi, Tokyo.

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