Global minimum tax to be introduced under 2023 tax reform, along with easing of CFC rules
Japan’s fiscal year 2023 tax reform proposals announced on 16 December 2022 include the introduction of the Pillar Two rules under the BEPS 2.0 project, as well as changes to the domestic controlled foreign company (CFC) rules to mitigate the administrative burden on multinational entities (MNEs) that will be subject to the global minimum tax. More than 800 MNEs are anticipated to be subject to the minimum tax in Japan.
The parliament (Diet) is expected to approve the tax reform in March although it is possible that the proposals may be revised during Diet deliberations.
Introduction of a global minimum tax
The OECD/G20 Inclusive Framework on Base Erosion and Profit Sharing (BEPS) 2.0 includes the allocation of new taxing rights to market jurisdictions (Pillar One) and the introduction of a global minimum tax (Pillar Two). The Japanese government has decided to move forward with the implementation of Pillar Two. Pillar Two establishes a 15% global minimum tax rate through the introduction of two interlocking rules: an income inclusion rule (IIR) and an undertaxed payments rule (UTPR), collectively referred to as the Global anti-Base Erosion Rules (GloBE Rules). Under the IIR, the ultimate parent entity is primarily liable for all “top-up tax” that is applied to profits if the effective tax rate in any jurisdiction is below the minimum 15% rate and, as a “backstop,” the UTPR requires a UTPR taxpayer to make an adjustment for any top-up tax allocated to it from a low-taxed constituent entity in the same MNE group where low-taxed income is not brought to charge under the IIR. There is also a subject-to-tax rule (STTR) that allows source country jurisdictions to impose a top-up withholding tax on certain types of outbound payments made between related parties that are not subject to a minimum tax rate.
Japan’s 2023 tax reform proposals include legislation for the IIR that is broadly in alignment with the OECD measures, but the UTPR and the qualified domestic top-up tax (QDMTT) will not be considered for legislation until the 2024 tax reform at the earliest.
The IIR will apply to MNEs headquartered in Japan and Japanese subsidiaries of foreign-headquartered MNEs where the worldwide gross revenue of the ultimate parent entity in two or more of the four preceding fiscal years is EUR 750 million or higher. The IIR will apply to fiscal years beginning on or after 1 April 2024. Under the Japanese IIR, the global minimum tax relates to national taxes only (domestic taxes such as corporate business tax and corporate inhabitant tax will not be included) and thus, a global minimum corporate tax and a global minimum local corporate tax will be imposed on MNEs that satisfy the conditions.
The global minimum taxable amount is basically equivalent to GloBE income as explained in Chapter 3 of the GloBE Model Rules (i.e., “Computation of GloBE Income or Loss”). The global minimum corporate tax is computed by multiplying the global minimum taxable amount by the tax rate of 90.7/100 for each relevant fiscal year. The global minimum local corporate tax is calculated by multiplying the global minimum corporate tax liability by the tax rate of 93/907.
The corporate tax return filing and payment due dates under the global minimum tax will be 15 months (or 18 months in certain circumstances) from the day following the last day of the MNE’s fiscal year. If the MNE does not have a global minimum tax base during the fiscal year, no tax filing will be required. Information return filing also will be introduced, with the filing due date being the same as for the corporate tax return.
Revision of CFC rules
The CFC rules would be revised to ease the additional administrative burden on Japanese MNEs that would have to comply with the new rules relating to Pillar Two and to address any overlap between the Pillar Two rules and Japan’s CFC regime:
- Currently, if the tax rate of a foreign subsidiary of a Japanese parent is 30% or higher, the foreign subsidiary is exempt from the application of individual entity-basis income inclusion under the Japanese CFC rules. The tax reform proposal would reduce this threshold rate by 3%, i.e., down to 27%.
- The requirement to submit to the Japanese tax authorities certain documents related to a foreign subsidiary that is partially subject to the Japanese CFC regime, along with the MNE’s corporate tax returns, would be eliminated. Going forward, the taxpayer would be required to keep the documents but would not have to submit them to the authorities.
The revisions to the CFC rules would be effective from fiscal years starting on or after 1 April 2024 to coincide with the implementation of the global minimum tax rules in Japan.