NECESSITY OF AMENDMENT
Currently, a non-resident or a foreign entity who receives interest on a certain corporate bond issued outside Japan is exempted from income tax on such interest if paid outside Japan. However, the recent amendment of the Foreign Exchange and Foreign Trade Control Law enables a resident to freely open an account abroad. Thus a resident could receive interest illegally without withholding tax deduction, by using an offshore account and pretending to be a non-resident. To avoid tax evasion, the Ministry of Finance of Japan proposed to amend certain provisions of the Japanese tax code and related orders, which will apply only to bonds issued from April 1, 1998 to March 31, 2000. The new tax code is about to be approved by the Japanese Diet.
EXEMPTION OF TAX
After April 1, 1998, a non-resident or a foreign entity who receives interest on a corporate bond must pay income tax on such interest unless certain conditions are satisfied. Correspondingly, the issuer of a bond must withhold 15% of the amount of such interest to be paid as withholding tax. There are three exceptions. In order to fall under any of the three exceptions, a corporate bond must be issued outside Japan by a Japanese entity and the interest on the bond must be paid outside Japan.
The first exception is not very useful because, under such exception, a non-resident or a foreign entity must file a tax return with the competent tax authority through the issuer entity each time interest is paid.
The second exception, which will supposedly be utilized by non-resident eurobond holders, requires financial institutions who hold bonds in custody for bondholders ("Custodians") to confirm and notify the bond issuer information on whether the payees are residents or non-residents, and requires the bond issuer to file certain documents describing such information prior to the respective dates on which the Custodians receive interest payments. In order for a bond to fall under the second exception, the underwriting agreement must prevent the underwriters from selling the bonds to residents or domestic entities. Also, a description of the tax obligation of Japanese residents or entities must be provided on the certificates and the prospectus of bonds.
The third exception only applies to Swiss franc bonds. For this exception to be applied, a bond must be issued in Switzerland and the repayment of principal and the payment of interest must be made in Switzerland in Swiss Francs. As with the second exception, the underwriting agreement must prevent the underwriters from selling the bonds to residents or domestic entities. If it otherwise falls under the third exception and the underwriters file with the competent tax authority the documents describing, among others, that they have not sold the bonds to residents or domestic entities, income tax will not be imposed.
NOTIFICATION AND FILING OF HOLDERS' INFORMATION
In order for eurobond holders to be exempted from income tax, financial institutions who hold bonds in custody for bondholders ("Custodians") must confirm and notify the bond issuer information on whether the payees are residents or non-residents, and the bond issuer must file certain documents describing such information prior to the respective dates on which the Custodians received interest payments.
The notification must include the following information: whether all the payees are non-residents or foreign entities; if not, the amount of interest to be paid to non-residents and foreign entities; identification of bond certificates; the date of interest payment; and information on the Custodian.
The Custodians need not wait until the initial interest payment date to notify. They may make such notification from 40 days after issuance, on which definitive bonds are usually delivered to clearing organizations or non-resident financial institutions, if the initial interest payment date is later than such date.
In the event that the first notification states that all payees are non-residents or foreign-entities, the Custodian does not need to make subsequent notifications if it confirms that all the payees are non-residents or foreign-entities, subject to the issuer's prior consent. If an issuer does not receive notification from a Custodian by one day before the interest payment date, the issuer is deemed to have received the notification that all the payees are non-residents or foreign-entities.
The draft Cabinet Order provides that a non-resident payee shall be so confirmed by presenting to its Custodian documents evidencing that it is a non-resident or by so proving a similar way. What suffices for this requirement is unclear.
Because of the generality of this article, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
(c) Komatsu, Koma & Nishikawa 1997
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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.