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A comparative guide to hot button taxation issues in Japan and the Philippines

JAPAN

PHILIPPINES

Summary of selected taxation issues in Japan

When doing business in Japan, it is common to use financially opaque corporations, while using partnerships and other financially transparent entities is relatively less popular. This article focuses on corporate income tax (CIT). In addition to CIT, Japanese businesses are also subject to consumption tax (VAT). However, in principle, the VAT rate in Japan is relatively low at 10%, so in practice CIT tends to get more attention than VAT in Japan.

Implementing global minimum tax

Japan is one of the countries that have adopted the 15% global minimum tax proposed by the Organisation for Economic Co-operation and Development (OECD) through the Global Anti-Base Erosion Rules (GloBE). Japan has amended its relevant domestic CIT laws and regulations to incorporate most of the GloBE model rules and their substantial updates in the additional administrative guidance released by the OECD.

Japan has already adopted the “income inclusion rule” (IIR). This is a major element of the global minimum tax, which allows Japan to impose additional taxes on Japanese parent companies that have subsidiaries in jurisdictions with effective tax rates of below 15%.

The Japanese IIR is applied to fiscal years beginning on or after 1 April 2024. Japan has not yet taken legislative steps regarding the other two key elements of the GloBE model rules, commonly known as the QDMTT (qualified domestic minimum top-up tax, preventing Japanese companies from being under-taxed) and the UTPR (undertaxed profits rule, allowing Japan to tax Japanese entities within a multinational enterprise group that is under-taxed because of the absence of QDMTTs or IIR taxes levied by other jurisdictions).

The Japanese government has expressed interest in adopting both measures but has not provided a detailed road map for implementing them.

CFC legislation and high-tax policy

It is believed that Japanese multinationals were not actively engaged in tax planning, so the tax revenue from the global minimum tax is expected to be minimal. Japanese multinationals apparently consider that the main concern with the global minimum tax is the increasing compliance costs, rather than the higher tax burden.

Given the enormous compliance costs of the global minimum tax, Japanese multinationals now request that the government scale down the so-called controlled foreign company (CFC) legislation. However, the Ministry of Finance reportedly stated that the global minimum tax would not make the CFC legislation unnecessary or redundant. So far, the government has not announced any tax reform proposals that would respond to this request from Japanese multinationals.

There has been some debate as to why Japan needs CFC legislation. One explanation could be that Japan aims to remain a high-tax country. According to the Ministry of Finance, Japan’s effective CIT rate (including local taxes) is 29.74%. Meanwhile, under the Japanese hybrid international tax system (where capital gains from disposing of shares in foreign subsidiaries are fully taxable in Japan, but 95% of dividends from those foreign subsidiaries are exempt), Japan may not have opportunities to levy its taxes even if foreign subsidiaries are under-taxed abroad.

Thus, the Japanese international tax system may be vulnerable to international double non-taxation arising from income shifting to subsidiaries in low-tax jurisdictions. In other words, Japan could only maintain its high CIT if something were to be done about profit shifting.

In this way, the CFC legislation plays a key role in Japanese tax policy. It is notable that, even in the era of the global minimum tax, there may still be motivations to shift income from Japan to offshore jurisdictions, seeking a lower tax rate of 15% rather than Japan’s high CIT rate of 29.74%.

One would argue that the CFC legislation will remain irreplaceable to protect Japan’s tax base despite the 15% global minimum tax. Furthermore, while the global minimum tax applies to multinational enterprise groups with EUR750 million (USD818 million) or more in revenue, the CFC legislation covers even small and medium-sized enterprises, and individuals. In short, it is unclear whether Japan will overhaul its CFC legislation.

Net operating loss utilisation

Not only does Japan have a high (effective) CIT rate, but it also strictly restricts the amount of net operating losses (NOLs) that can be used to offset future profits. Japan has strict restrictions on loss carryforwards and carrybacks. In most cases, companies cannot claim a refund by loss carryback. NOLs can be carried forward for 10 years, but they can be offset only against up to 50% of the corporate income of each business year.

Japan allows domestic corporations to elect for the group tax relief regime, which allows the current losses of one group member to offset the current profits of another group member, but only when they are in a 100% direct or indirect shareholding relationship.

Japan is very different from jurisdictions, like the US, that allow consolidation even when there are minority shareholders. Furthermore, in recent years, there have been several tax disputes in which tax authorities have applied the anti-tax avoidance rule to deny the transfer of loss carryforwards between group companies through qualified reorganisations.

It will take several more years before the courts deliver their decisions in these cases, leaving legal uncertainty regarding corporate reorganisations that could facilitate utilising group losses.

Modest tax incentives

Another distinctive feature of Japanese CIT is that it provides only modest tax incentives. Japan has poor cost-recovery provisions for business investment in machinery and buildings. While the full expensing regime has recently become popular, as in the UK and the US, it does not seem to be part of Japanese tax policy. In addition, refundable or transferable tax credits are not common in Japan.

One of the major tax incentives for businesses in Japan would be the R&D tax credit. This tax credit is non-refundable, and the credit amount is determined based on a certain percentage of the R&D expenses. In principle, this percentage fluctuates between 1% and 14% depending on the year-on-year increase or decrease in R&D expenses. For example, if the current R&D expenses are the same as the previous year’s, the percentage will be 8.5%.

There is a ceiling on the R&D tax credit, which is 25% of the current CIT liability before tax credits are applied (this ceiling can be pushed up to 45% under certain conditions). It makes it unlikely that the R&D tax credit will result in a drastically low effective CIT rate in Japan. Any amounts above the ceiling will evaporate and will not be carried forward.

Accordingly, it is said that the companies that benefit the most from the R&D tax credit are large enterprises with stable profits and CIT liabilities. In contrast, startups with initial losses (and no current CIT liabilities) have fewer benefits.

The R&D tax credit accrued by one business line can also reduce the CIT liability on the profits of other business lines that may not require intensive R&D activities. Some may find it ironic that less-innovative companies with profitable businesses that do not involve much R&D would benefit the most from the R&D tax credit.

Japan will introduce a new tax incentive, known as the “Innovation Box” regime, from 1 April 2025. As the Innovation Box is also a modest tax incentive, it may be questionable whether it will be a real game changer. The Japanese Innovation Box provides a 30% deduction for qualified IP income. There is a ceiling for the deduction at 30% of current income (before the Innovation Box is applied) minus any unused loss carryforwards.

Assuming a typical effective tax rate of 29.74% in Japan, a 30% deduction would reduce the effective tax rate only to about 21%. Thus, the Innovation Box may not sound like a significant tax cut. It is way above the 15% global minimum tax rate.

The Innovation Box covers only patents and AI-related software programs. Income from licensing or domestic sale of such intellectual property is covered, but so-called embedded royalties are not. Income from related party transactions (including licensing to a foreign subsidiary) is excluded, even if the transactions are done at the arm’s length price.

Companies must apply to the Ministry of Economy, Trade and Industry to be eligible for the Innovation Box. The ministry is working on drafting guidelines for applications. In sum, it appears that further improvements are needed to make Japan’s tax system more competitive.

Nishimura & Asahi

Otemon Tower, 1-1-2 Otemachi

Chiyoda-ku, Tokyo 100-8124, Japan

Tel: +81 3 6250 6200

Fax: +81 3 6250 7200

Email: info@nishimura.com

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Philippines update: The VAT on digital services

Under a landmark law, the Philippine legislature has amended certain provisions of the national tax code to capture digital services coming into the country from abroad.

The upshot of these amendments is that the country’s 12% value-added tax (VAT) now clearly encompasses digital services provided by non-resident providers but which are consumed in the Philippines.

The law is Republic Act (RA) No.12023. It was signed by the president of the Philippines on 2 October 2024, and took effect on 18 October 2024, just 15 days after its publication.

The legislators who sponsored the bill that became RA No.12023 have made pronouncements that the reforms were not formulated in isolation and, in fact, were meant to align with international best practices. These legislators say the reforms bring Philippine VAT policy in line with global standards and also enhance revenue generation.

Legislative context

By way of background, services rendered abroad by non-resident service providers are generally out of reach of the Philippine VAT system. The critical determining factor for VAT taxability of services is place of performance.

RA No.12023 amends the tax code to make it clear that digital services rendered by non-resident service providers (DSPs) but consumed in the Philippines are within the coverage of the VAT.

The law states that “digital services delivered by non-resident digital service providers shall be considered performed or rendered in the Philippines if the digital services are consumed in the Philippines”.

The amendments

The new law expressly includes the provision of digital services as VAT-taxable transactions. It introduces a new section in the tax code that sets forth the liability of persons providing digital services, including non-resident DSPs.

Before discussing the key stipulations of the new law, here are some of the underlying definitions.

Digital service: The term “digital service” is broadly defined under RA No.12023 as any service that is supplied over the internet, or another electronic network with the use of information technology, and where the supply of the service is essentially automated.

It includes but is not limited to:

• Online search engines;
• Online marketplaces or e-marketplaces;
• Cloud services;
• Online media and advertising;
• Online platforms or digital goods.

Non-resident: The term “non-resident digital service provider” is defined under the new law as a digital service provider that has no physical presence in the Philippines.

Points of reform

RA No.12023 introduces an entirely new provision of the tax code that lays down the design contours of a VAT system that involves or impacts non-resident digital service providers, as follows:

• In a business-to-consumer (B2C) scenario: if the consumers are non-VAT registered, the non-resident DSP required to be registered for VAT shall be liable for the remittance of VAT on the digital services that are consumed in the Philippines.
• In a business-to-business (B2B) scenario: a reverse charge mechanism is introduced, and it applies if the Philippine consumers of non-resident DSPs are VAT-registered, in which case the VAT-registered consumers shall be liable to withhold and remit the VAT on their purchase of digital services from non-resident DSPs.
• In an online marketplace or e-marketplace scenario: A VAT-registered non-resident DSP classified as an online marketplace or e-marketplace shall also be liable to remit the VAT on transactions of non-resident DSPs that go through its platform, provided it controls key aspects of the supply and performs any of the following:

1. 1. It sets, either directly or indirectly, the terms and conditions under which the supply of goods is made; or
   2. It is involved in the ordering or delivery of goods, whether directly or indirectly.

Simplification

Registration, thresholds and exemptions: The law mandates the establishment of a simplified automated Bureau of Internal Revenue registration system for non-resident DSPs. VAT-registered non-resident DSPs are exempt from maintaining regular accounting records and subsidiary journals, although they are required to issue digital sales or commercial invoices for every transaction.

The threshold for VAT registration is the same for all DSPs, including non-resident DSPs. They are required to register, either electronically or manually, for VAT if:

• Their gross sales (excluding exempt sales) for the past 12 months exceeds the current VAT threshold of PHP3,000,000 (app. USD51,000); or
• There are reasonable grounds to believe that their gross sales for the next 12 months will exceed the threshold.

Note that the law reinforces traditional VAT exemptions. It excludes from the application of the VAT:

• Educational services, including online courses, online seminars and online trainings rendered by duly accredited private educational institutions and those rendered by government educational institutions.
• Sale of online subscription-based services to certain government agencies (Department of Education, Commission on Higher Education, Technical Education and Skills Development Authority) and educational institutions recognised by said government agencies.
• Services of bank, non-bank financial intermediaries performing quai-banking functions, and other non-bank intermediaries, including those rendered through different digital platforms.

Failure of a person to register with the Bureau of Internal Revenue as required can be met with extraordinary measures. The Commissioner of Internal Revenue has the power to temporarily close an establishment for a period of not less than five days, lifted only by compliance with requirements in the closure order.

The Commissioner’s power to suspend includes the authority to block digital services accessed in the Philippines, with the co-operation of the Department of Information and Communications Technology (DICT) through the National Telecommunications Commission.

Implementation

Rules and regulations: RA No.12023 mandates the Department of Finance, on the recommendation of the Bureau of Internal Revenue and in co-ordination with the DICT and the telecommunications commission, upon consultation with stakeholders, to issue rules and regulation no later than 90 days from the law’s effectivity.

Non-resident DSPs are to be immediately subject to VAT after a further 120 days from the effectivity of the implementing rules and regulations.

The Bureau of Internal Revenue has circulated the first draft of the implementing rules and regulations drafted by the technical working group that was formed by the commissioner immediately after the passage of the law.

Public consultation has also commenced, with the first hearing scheduled on 12 November 2024.

Refining the rules

Finer points that may need further clarification in the implementing rules include:

• The determination of customer location (would there be a hierarchy of information or indicators, presumptions or even fallback rules, for the DSP to make this determination?).
• The determination of the status of a customer (that would allow the DSP to quickly conclude that a B2B scenario exists).
• Whether guidance from the tax authorities would take into account the broader regulatory context including privacy laws.

The draft regulations are expected to undergo a number of iterations following the public consultations. It is hoped that the rules will be sufficiently simplified and remain aligned with international best practices that have been proven to increase voluntary compliance.

Taxpayers, on the other hand, will need to pay significant and sustained attention to the formulation and actual implementation of the rules, given the challenges in compliance, particularly for businesses faced with obligations in multiple jurisdictions.

OCAMPO AND SURALVO LAW OFFICES
6F Liberty Center Bldg, 104 HV Dela Costa St
Salcedo Village, Makati City
Metro Manila 1227, Philippines
Tel. +632 7625 0765
Email: info@ocamposuralvo.com

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