Japan To Tighten Tax Rules For Foreign Companies

by Mary Swire, Tax-News.com, Hong Kong

29 November 2005

The Japanese government is working on new proposals aimed at closing a loophole which allows foreign companies to avoid paying tax on corporate bonds issued to finance their Japanese operations, a finance ministry official has revealed to Reuters.

Under Japan's tax code, non-resident investors must pay tax on interest earned on bonds issued by Japanese firms, but not on debt issued by foreign companies to finance their Japanese offices.

They must pay tax on bonds issued by foreign firms under international tax treaties, but companies can bypass these rules by issuing bonds from countries with which Japan has not signed a tax agreement. As a result, foreign firms can avoid withholding taxes on interest paid on their corporate bonds, and their Japanese branches can reduce their income tax base by bearing the burden for interest payments on their corporate bonds.

The Japanese government is also concerned that foreign firms are using special purpose companies (SPCs) to avoid bond taxes by issuing debt to other SPCs registered offshore in countries not covered by Japan's tax treaty network.

According to the finance ministry official, the government is seeking to tighten up the tax rules in a bid to promote greater fairness in the tax system and to shore up its revenue base, which is coming under increasing strain from public spending demands.

"We will start various discussions on the issue so that we can implement steps to prevent their tax evasion within two or three years," the official told Reuters.

"We need to make the tax system fair to everyone as we face the challenges of fiscal reform and the need to raise tax revenues," the official added.

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