22/02/23

JAPAN: 2023 Tax Reform Starts to Implement Global Minimum Tax.

As published on bloombergtax.com, Wednesday 22 February, 2023.

On Feb. 3, the Japanese government submitted the 2023 tax reform package (in Japanese) to the Diet, the national legislature. The bill contains draft legislation to implement one of the three components of the OECD’s global minimum tax proposal in Japan.

The global minimum tax is an Organization for Economic Cooperation and Development project to introduce a mechanism, the Global Anti-Base Erosion rules—GloBE rules—in a critical mass of jurisdictions to ensure that multinational enterprise groups are taxed at an effective tax rate of at least 15%.

The GloBE rules allow relevant jurisdictions to impose an additional tax, or “top-up tax,” if the effective tax rate in the low-tax jurisdiction for any multinational enterprise group is less than 15%. The rules establish the following order regarding which relevant jurisdictions may impose the top-up tax amount.

First, the highest priority is given to top-up tax imposed by the low-tax jurisdiction itself, or the qualified domestic minimum top-up tax, QDMTT. In cases where a light taxing country has not introduced a QDMTT, the second priority is given to top-up taxation by the jurisdiction of the (ultimate) parent entity of the multinational enterprise group. This second-priority taxation has the unintuitive name of the income inclusion rule, IIR.

Finally, in cases where the effective tax rate is still less than 15% even after the QDMTT and IIR, other jurisdictions with constituent entities of the group may impose the top-up tax. This lowest-priority taxation is called the under-taxed profits rule (sometimes referred to as the under-taxed payments rule), UTPR.

The Japanese 2023 Tax Reform Bill only includes the IIR out of the three components of the GloBE rules. The other two—the QDMTT and UTPR—remain postponed for future legislation, as the ruling coalition had officially announced (in Japanese) that it would explore the possibility of including them in the 2024—or later—tax reform package. Japan seems to be taking a wait-and-see approach as long as possible, expecting the OECD to release additional guidance on the QDMTT and UTPR.

However, this doesn’t mean that Japan is passive in implementing the rules. In its announcement, the ruling coalition demanded that the Japanese government, as the host country of the G-7 summit this year, take the lead in implementing the outcome of international tax negotiations.

When implementing the GloBE Rules domestically, countries are supposed to align with the model rules and commentary published by the OECD/G-20 Inclusive Framework on BEPS. Therefore, conceptually, the proposed legislation for the Japanese IIR seems to follow the model rules closely.

The draft legislation isn’t a word-for-word translation of the model rules, but it rather restructures and restates them uniquely. This is presumably to conform to the standard format of Japanese tax code provisions. Accordingly, the fact that Japanese draft legislation looks quite different from the model rules on its face could be a matter of wording or formatting.

In addition, the proposed legislation only establishes the general principles and basic structure of the IIR. It leaves most of the substantive details of regulations to be issued by the government. Even for essential calculation elements, such as the numerator (tax) and denominator (income) used to determine the effective tax rate, the law only provides that they shall be calculated as provided by the regulations. Moreover, the law would provide non-exhaustive definitions for most of the terminology, and the forthcoming regulations would define it more precisely.

It is justifiable to provide substantive details in the form of regulations issued by the government, since the rules presumably will require frequent and flexible updates to keep up with the ongoing situation. For example, it has been reported that the OECD is preparing further guidance for the GloBE rules. Furthermore, the OECD’s public consultations about information return and dispute prevention and resolution mechanisms under GloBE rules haven’t reached conclusions yet.

The bill proposes to insert IIR-related provisions into the Corporate Tax Act. Additionally, one of these provisions clarifies that the taxation under the IIR would be classified as part of corporate income tax imposed on domestic corporations.

This classification is not only academically interesting but also may have practical implications; it creates a space where general rules that now apply to corporate income tax also may apply to the IIR. For example, the interplay between the anti-avoidance rules or doctrines in the traditional corporate tax area and the newly introduced IIR could require careful review.

Japanese IIR will be effective for fiscal years beginning on or after April 1, 2024. For a multinational enterprise group that has its fiscal year from January to December, the Japanese IIR won’t apply to this group for FY 2024; in other words, this group will be subject to the Japanese IIR from FY 2025 at the earliest. However, even in FY 2024, this group may be subject to GloBE rules in other jurisdictions. EU countries may apply their IIR to intermediate parent entities of the group. Furthermore, Korea will start its UTPR in 2024.

This implementation time frame has another implication. The 2024 tax reform package will likely pass before April 2024, assuming the annual routine of Japanese tax reform practice. Thus, Japan may utilize the 2024 tax reform package to reflect developments in the OECD in Japanese IIR legislation before its launch.

The bill is likely to pass the diet in late March, but it is just the first step for Japan in introducing a global minimum tax. Multinational enterprise groups operating in Japan will have to review the forthcoming regulations providing the substantive details of the IIR and keep a close eye on the progress of QDMTT and UTPR implementation in Japan.

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