Friday, November 3, 2017

Japan Supreme Court reverses taxation on DENSO’s subsidiary in tax haven

On October 24 2017, the Japan Supreme Court reversed the taxation based on the Anti-Tax Haven (or Controlled Foreign Company: CFC) rules imposed on the income of DENSO’s subsidiary in Singapore.

Under the CFC rules, income arising from a foreign subsidiary located in the state or territory with significantly lower tax rates is deemed to arise as the income of the parent company under certain conditions, for example when its ‘principal business’ is holding shares or bonds, licensing industrial property rights etc. However, the CFC rules is not applied when the subsidiary is a substantial independent company and it is economically rational for the subsidiary to conduct business in the state or territory. More specifically, the CFC is not applied when it meets all of the following conditions;

  1. Its principal business is not holding shares or bonds, licensing industrial property rights or any other rights concerning technology etc. (Business)
  2. Having an office, store, factory or any other fixed facility that is considered to be necessary for conducting its principal business in the state or territory where its head office or principal office is located. (Substance)
  3. Taking charge of managing, controlling and operating the business by itself. (Control)
  4. When its principal business is wholesale business, banking business, trust business, securities business, insurance business, water transportation business or air transportation business, it conducts business mainly with a person other than a predefined related party. (Non-related party); When its principal business is not above-mentioned business, it conducts a business mainly in the state or territory where its head office or principal office is located. (Business location)

The Supreme Court ruled that the ‘principal business’ should be determined based on its concrete and objective business activities in the fiscal year. And when it conducts multiple businesses, it should be comprehensively examined based on its revenue or income obtained by each business activity, the number of employees required for the business activities, the situation of offices, shops, factories and other fixed facilities etc.

In this case, the DENSO’s Singapore subsidiary manages subsidiaries or affiliates in ASEAN and other territories, and its sales of service to improve logistics in the territories amounted to 85% of its revenue, while 80-90% of the pretax income is from dividend on the shares of the subsidiaries and affiliates. 

The Supreme Court stated that the Singapore subsidiary, with reasonable size and substance, conducts a broad range of businesses including finance and logistics with economically rational purpose of streamlining its ASEAN operations, and then judged the taxation based on the CFC rules illegal.

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