Under the most recent tax reform, approved by the Diet in March,
Japan has changed its general tax rules applicable to a foreign
corporation having a permanent establishment in Japan
("FCPE"). Under the current Japanese domestic tax law,
which adopts the "force of attraction" principle, all
income arising from sources within Japan is fully taxable
regardless of whether such income is attributable to the FCPE.
Under the revised Japanese domestic tax law (the "New Domestic
Rules"), (i) income attributable to an FCPE will be taxable
regardless of the source; and (ii) income attributed to an FCPE
will be calculated in line with the Authorized OECD Approach (the
"AOA"). Please note that the concept of an FCPE under the
Japanese domestic tax law will remain unchanged. FCPEs are
generally divided into the following three categories: (i) a
branch, or any other fixed place where business in Japan is
conducted; (ii) a construction site or installation project; and
(iii) an agent PE. The concept of PE under Japanese domestic law is
slightly broader than that under the OECD Model Tax
Convention.
Under the New Domestic Rules, (i) internal dealings within a
single entity will be recognized (e.g., internal royalty, internal
interest, internal service fees (including appropriate mark-ups),
etc., will need to be charged to calculate Japanese corporation
tax); (ii) a mere purchase by an FCPE of goods for its head office
will generate profits; (iii) prices of internal dealings not in
line with the arm's-length principle will trigger the taxation
equivalent of transfer pricing taxation; and (iv) an FCPE may claim
a foreign tax credit on its Japanese corporation tax return.
Reasonable cost allocation from a head office to an FCPE, such as
the allocation of overhead expenses related to administrative
functions performed by the head office for the benefit of the FCPE,
without any mark-ups, will continue to be deductible. In addition,
some documentation requirements (including documentation similar to
transfer pricing documentation) will be imposed on FCPEs.
Note: The New Domestic Rules explicitly provide that if an
income tax treaty not incorporating the AOA is applicable, internal
interest for non-financial enterprises and internal royalties will
not be recognized, and a mere purchase of goods will not generate
profits for Japanese corporation tax purposes.
The New Domestic Rules will apply to the corporation tax for a
fiscal year commencing on or after April 1, 2016.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
