On 14 December 2018, Japan’s ruling coalition party has approved a package of tax reform proposals for 2019. The proposal includes amendments to Japan’s controlled foreign company (CFC), interest expense limitation, and general transfer pricing rules, among others. It is expected that most of the items contained in the 2019 Tax Proposals will be passed into law in March 2019. The revisions would thus apply to fiscal years beginning or after 1 April 2020.

Some of the main measures are summarized as follows:

CFC Rules:

The CFC rules are to be amended to provide certain exclusions in relation to paper companies, which are CFCs that fail to meet substance or administration and control tests and are subject to full-inclusion and subject to tax rate below 30%. The new tax reform also proposed to amends the CFC rules by expanding the definition of a “cash box” entity, while narrowing the definition of a “paper company”, among other changes.

Interest Limitation rules:

The earnings stripping rules are to be amended, which includes:

  • An extension of the scope of the rules to interest payments to related parties and third parties;
  • A reduction in the deductible interest payments cap from 50% of adjusted taxable income to 20% of adjusted taxable income;
  • Changes in how adjusted taxable income is determined for the purpose of the rules; and
  • Changes in the de minimis exemptions from the rules, including:
  • An increase in the net interest payment exemption from JPY 10 million to JPY 20 million; and
  • The replacement of the exemption where related-party interest / total interest is less than or equal to 50%, with an exemption where total interest expense of a Japanese company and its related Japanese companies (Japanese group) / total adjusted taxable income of the Japanese group is less than or equal to 20%.

 Transfer Pricing Rules:

The transfer pricing rules are to be amended in line with OECD guidelines (BEPS Action 8-10), which includes:

  • A new definition of intangible assets subject to transfer pricing rules, meaning assets, other than physical assets or financial assets and investments, for which consideration would be paid for a transfer or lease of the assets if the transfer or lease was between independent parties under normal terms and conditions;
  • The introduction of the discounted cash flow method as an allowed method for calculating arm’s length prices for intangibles where comparable transactions cannot be identified;
  • The Japanese tax authority will be allowed to make pricing adjustments where the results of transactions of hard-to-value intangibles are different from initial projections by more than 20%; and
  • The extension of the statute of limitations for transfer pricing purposes from six years to seven years.