Tax credit on dividends received by a foreign corporation

Summary of the old rule

If a Japanese domestic corporation is subject to withholding tax on dividends, the withholding tax is treated as an advanced payment of corporate tax and is creditable against corporate tax when the tax return is filed. On the other hand, a foreign corporation cannot credit withholding tax on dividends against corporate tax even if the dividend income is included in the taxable income of the permanent establishment of the corporation in Japan.

Summary of the new rule

Under the new rule, if a foreign corporation has a branch or other permanent establishment in Japan, withholding tax paid on dividends can be credited, the same as with Japanese domestic corporations. In this case, the dividends must be attributable to the business income in Japan and be included in the income statement to be attached to the tax return. As before, the existing rule that, for corporations, allows the exclusion of dividends in calculation of corporate taxable income will also apply to foreign corporations. As the result, regarding dividends, there are no rules that discriminate against foreign corporations in the present tax law. The new rule is effective from the fiscal year of a foreign corporation starting on or after April 1, 1998.

Withholding tax refund for a tax-loss corporation

There is one more change in the rules regarding withholding tax credit: the rule that suspended the tax refund to a tax-loss corporation has been abolished. Before the tax reform, even if a corporation paid withholding tax on interest or dividends, it could not claim a tax refund on the portion in excess of its corporate tax liability. The excess withholding tax could be offset against the corporate tax in the following four years, then the rest was refunded in the fourth year.

This rule was disadvantageous to corporations that continuously had no taxable income. Because such corporations were required to wait for their refund for four years from the payment year. Under the new rule, however, a tax-loss corporation is also eligible to obtain a full withholding tax refund on the tax return for the year which the dividend was paid. The new rule is effective for the withholding tax paid during the fiscal year ending on or after April 1, 1998.

The new rule is also applicable to foreign corporations with a permanent establishment in Japan. Therefore, after the effective date of new rules, if a foreign corporation with a permanent establishment in Japan is subject to withholding tax of 20% on dividends in a year, the withholding tax may be fully refunded even if the corporation has no taxable income.

For more specific information regarding these articles, please do not hesitate to contact Yuko Ban of Showa Ota Ernst & Young, Tokyo at 03-3506-2434 (telephone) or at 03-3506-2412 (fax)

Special Tax Treatment of Corporate Investment Trust for Securities Investment Companies and Investors

"Corporate Investment Trust" means an investment scheme in which investors invest in a securities investment company (the Company), established for the purpose of investing in securities. The investors receive dividend income from the Company. The investment securities issued by the Company are recognized as marketable securities under Securities Exchange Law. The investors are stockholders of the Company and can attend a general meeting of stockholders of the Company. The Corporate Investment Trust is made available as an important part of "Financial Big Bang", based on the "Law concerning adjustment of regulations in relation to financial system reforms (the Law)", which was passed on June 6 and promulgated on June 15, 1998. As a set of the Law, special tax treatment was provided in the Special Taxation Measures Law and the Registration Tax Law. The special tax treatment is summarized as follows.

Taxation for the Company

(1) Corporate income tax

The dividends paid by the Company to the investors are deductible expense for corporate income tax purposes. The upper limit of the deduction is the taxable income for the business year. This special treatment can be applied if the following conditions are all satisfied.

  • 1 The Company should be registered by the Prime Minister.
  • 2 The total value of stock issued at the establishment of the Company should be Y100,000,000 or more, and the issued stocks should be held by 50 or more stockholders or only by qualified institutional investors at the end of the business year.
  • 3 The Company's business should be investment in securities.
  • 4 The employment of the assets should be entrusted to a securities investment trust consignor and the management of the assets should be entrusted to a trust bank.
  • 5 The Company should not be categorized as a family corporation defined in Japanese corporate tax law at the end of the business year.
  • 6 The Company should pay dividends to the stockholders in an amount of 90% or more of the surplus available for dividends for the business year.
  • 7 Other conditions provided in the enforcement order should be satisfied.

(2) Withholding income tax

Interest and dividend income earned by the Company derived from investments in government and corporate bonds, joint investment trust, stock, etc., and paid in Japan is not subject to Japanese withholding income tax.

(3) Registration tax

The registration tax for establishment of the Company is Y30,000

Taxation for investors

  • (1) Individual investors - Dividends from the Company are subject to 15% withholding tax at the time of payment, without further levy of other individual income tax. This treatment is available to both resident and non-resident investors in Japan. For resident investors, 5% local inhabitants tax should be withheld in addition to the above 15% withholding tax.
  • (2) Corporate investors - Dividends from the Company are subject to 15% withholding tax at the time of payment. This treatment is available to both Japanese and foreign corporate investors in Japan. For Japanese corporate investors, 5% local inhabitants tax should be withheld in addition to the above 15% withholding tax. For the dividends from the Company, a rule of Dividends Received Deduction is not applied.

The above special tax treatment of corporate investment trust will be enforced effectively from December 1, 1998.

For any specific questions regarding this article, please do not hesitate to contact Yoshihiro Ninagawa of Showa Ota Ernst & Young at 03-3506-2438 (telephone) or at 03-3506-2412(fax).

Keeping accounting books and documents on electronic data


A bill for "the law on the special treatment of keeping method of accounting books and documents prepared by the computer system" passed the Diet and was implemented on July 1, 1998. The taxpayer will be able to keep accounting books and documents on magnetic records (electronic data), recorded on magnetic tape, CD-ROM and other recording media in place of paper, effective January 1999. In order to adopt this regulation, the tax office's prior approval is required.

Background for the enforcement

The taxpayer is required to keep accounting books such as general ledgers, financial statements such as profit and loss statements, balance sheets, copies of order sheets, and invoices and receipts issued to clients, for five or seven years under the Corporate Tax Law and the Individual Income Tax Law now in force.

As a result, the printing costs of accounting books and documents, and related storage costs were very high. In particular, there were tremendous amounts of copies of register paper in retail stores, and trade records of ATM machines in banking agencies.

To reduce these costs, the retention of certain records on electronic data is permitted if the records are maintained in a way that facilitates future audits by the tax authorities.

Brief summary of this regulation

(1)Accounting books and documents which may be kept on electronic data include
  • Accounting books such as journal ledgers, general ledgers and sub-ledgers which the taxpayer prepares using a computer system.
  • Financial statements which the taxpayer prepares using a computer system.
  • Accounting documents such as copies of invoices for clients which the taxpayer prepares using a computer system. This regulation applies to accounting books and documents that the taxpayer prepares exclusively by computer, from the first step through to the last step. The following is not permitted:
  • Disposal of the original paper invoices and receipts from suppliers after converting them to electronic data. Disposal of the handwritten accounting books after inputting the same entries in a lump sum into the computer system at the settling term.

(2) Specific requirements in the case of keeping accounting books and documents on electronic data
  • "audit trail" The computer system must be able to confirm the facts and details of changes when the original electronic data is revised, deleted or otherwise changed.
  • "cross-reference" It must be possible to follow up the link between the accounting books kept on electronic media and the related books.
  • "searching possibility" It must be possible to refer to the details of the electronic data by using brief recorded items found in the accounting books and documents.
  • "visibility" The system must include a display, printer, etc., in order to output the electronic data to the screen and on paper.
  • The specifications of the computer system.

Taxpayers have to include some structure for retaining an "audit trail" in the computer system for the tax audit, since the electronic data characteristically can be revised, deleted or added to without leaving marks. It is not required to retain the "audit trail" within one week after original input date under the directive.

  • "Cross-reference", "searching possibility" and "visibility" demand that the taxpayer be able to refer to and produce books and documents immediately at the tax audit. Therefore, the taxpayer has to be able to deal with the old system's data after changing the computer system.

(3)Application due date

Taxpayers have to file an application form with the tax office three months (five months in the first implementation year) before the starting date of fiscal year. Since this regulation was implemented on July 1, 1998, the earliest a taxpayer can adopt it is effective January 1999 (in the case of a corporation whose fiscal year ends in December which files the application in July 1998). Individual taxpayers also have to file the application in July 1998 in order to adopt this regulation effective for the calendar year 1999.

(4) Other details
  • 1. Taxpayers can select the recording media such as CD-ROM, floppy disks and MO Disk, etc.
  • 2. Taxpayers can keep a part of books and sub-books in electronic data, and can keep the rest on paper as usual.
  • 3. Taxpayers can keep books and documents on electronic data in each division or each branch. This seems to take the fact into consideration, that recently many enterprises, especially the large ones, adopt the "self-support accounting" divisional system, that is to say, the "company" system.
  • 4. Even if the director of the tax office repeals the approval of keeping records on electronic data, this does not automatically cause the revocation of approval to file blue return. In this case, the taxpayer has to output all the electronic data concerning the repealed accounting books or documents, as of the repealed day, onto paper.

Other regulation

(1) Keeping in COM regulation

With regard to the accounting books and documents prepared by the computer system, the taxpayer can keep them on COM (computer output microfilm). Accounting books and documents that are permitted under this regulation are almost same as the above electronic data regulation. Please take note that this COM regulation is different from the regulation of keeping records on "shooting type" microfilm. (As to the "paper" accounting books and documents, which have already been kept for three or five years, the taxpayer can keep them on "shooting type" microfilm for the rest of the term.)

(2) Keeping trading information for the electronic transactions

Those who have to keep the accounting books and documents under the corporate tax law or the individual income tax law, have an obligation also to keep the electronic trading information, which is transmitted or received by the EDI or Internet transactions, on electronic data, COM, or paper documents effective July 1, 1998. The trading information required to be kept includes the items usually mentioned in the order sheet or proposal letter. This regulation was provided with regard to the new trading transactions.

For any specific information regarding this article, please feel free to contact Taiji Yamamoto of Showa Ota Ernst & Young at 03-3288-3641(telephone) or at 03-3288-2459 (fax).

Retirement of Shares by use of Capital Surplus

The Law for the Partial Amendments to the Law for Special Exceptions to the Commercial Code Concerning Procedures for Retirement of Shares (Revised Law) which allows public companies to purchase and retire their own stock by the use of capital surplus was enacted on March 30, 1998 and enforced on the same day. The law is a two-year passing measure effective through March 31, 2000.

Outline of the Law

When shares are retired by the use of capital surplus, the company must provide in the Articles of Incorporation that the company may purchase and retire its own stock by the use of capital surplus, as well as the total number of shares and the total acquisition value of shares that the company may purchase and retire by resolution of the Board of Directors meeting. The total acquisition value may not exceed the total of capital surplus and legal reserve, minus the amount equal to 1/4 of stated capital. There are no restrictions on the number of shares that may be purchased as in the case of retirement of shares by the use of profits.

The resolution of the Board of Directors meeting must specify the class and number of shares that the company will purchase and retire by use of capital surplus as well as the total acquisition value.

The company may not purchase the shares if the net asset value on the company's most recent balance sheet is below the total of the amount in each item of Article 293-5-? of the Commercial Code and the amount of interim dividend.

After the resolution of the Board of Directors meeting, the company must notify its creditors by public and individual notices to allow them the opportunity to lodge any objection. When the company has purchased its own stock, the company must, without delay, carry out procedures to cancel the shares as soon as the procedures for protection of creditors have been completed.

Advantages to the company retiring shares

The use of capital surplus has heretofore been restricted to either transfer to capital or for covering losses. The revised law has expanded this to the extent that public companies may use the funds for purchase and retirement of their own stock. The revised law is aimed at increasing the share prices in the sluggish stock market.

Special provisions for tax treatment of constructive dividends

The Special Tax Measures Law was partially revised in accordance with Article 6 of the regulations to the revised law.

  • 1. Taxation of shareholders who consented to retirement of shares - When the company purchases its shares by tender offer and retires by use of capital surplus, both corporate and individual shareholders will be taxed on the amount in excess of acquisition cost not as constructive dividends but as capital gains from the sale of stock (individual shareholders may elect taxation by withholding of tax at source).
  • 2. Taxation of shareholders who did not consent to retirement of shares - The issue of constructive dividends will not arise as shares will be retired by the use of capital surplus and not profits.

For further information on this subject please contact Chieko Shimizu of Showa Ota Ernst & Young, Tokyo at 03- 3506-2650(telephone) or 03- 3506-2655(fax)