At the end of 2010, the Japanese Government announced its tax reform plans for 2011. As previously pointed out in this column, Japan has one of highest corporate tax rates in the world, with an effective rate of around 42 percent.
It remains possible that some significant changes may be made prior to the 2011 proposals being implemented, however the main thrust appears to be as follows. On the plus side for companies, there would be a reduction in the top corporate tax rate from 42 percent to 35 percent. In addition, there would be an extension of the loss carry forward period from seven years to nine years.
However, there are also some significant negatives, which are in part designed to make up for the expected loss of revenue resulting from the lower tax rate. Currently, a company that incurs a loss is able to fully utilize that loss against future profits. Under the proposals, a company would only be able to utilize 80 percent of past losses. According to Paul Previtera, who heads the International Tax Education Program (ITEP) at Temple University’s Tokyo campus, “Such a change could have a deep impact on businesses that have high cyclicality in their profits. This would include investment banks and pharmaceutical companies since these companies tend to show significant losses in some years which they need to offset against profits in good years.”
In addition, the proposals call for the research and development (R&D) tax credit to be reduced from 30 percent to 20 percent. At a time when there is considerable global competition to host R&D, the reduction may undermine the economics of undertaking such activities in Japan.
Although the reduction in corporate tax rates is to be applauded, it seems that Japan’s tax system will continue to cause a number of problems. Most importantly, the corporate tax rate will remain substantially out of line with rates offered by some of Japan’s near neighbors, in particular Singapore and Hong Kong. This is a serious issue when combined with the ability of many industries to relocate with comparatively little effort.
Also, the reforms do little to reduce the impetus for entrepreneurs to set up business outside Japan. Japan’s high tax rates on corporate income and dividends stand in sharp contrast to its Asian neighbors. In addition, many of the jurisdictions with which Japan now competes for entrepreneurial talent do not impose capital gains tax when an entrepreneur sells the business.
Again, according to Temple University’s Paul Previtera, “We are definitely seeing an acceleration in the rate of companies shifting operations to Singapore and Hong Kong. We do not expect the 2011 initiatives to affect this.”
The real need is to stimulate new entrepreneurial economic activity in Japan. This would create employment and additional tax revenues that could be used to address Japan’s burgeoning public debt.
Japan needs to consider reducing or even eliminating capital gains tax when entrepreneurial ventures are sold. In addition, individual tax rates need to be addressed. A vast amount of economic activity is undertaken by SMEs where corporate tax is often not the issue since profits get paid out to employees and owners.
In summary, the proposed measures represent a positive step in that they indicate recognition by the Japanese government that taxes are an impediment to economic growth. However, Japan needs to be doing more in order to compete with its fast-growing neighbors.
Dean Page is CEO of Accounting Asia. He is qualified as both an attorney and as a CPA and was formerly a partner with Ernst & Young. Dean.Page@Accounting.Asia
Brandon Boyle is a manager at Accounting Asia where his work focuses on investment into Asian jurisdictions including Hong Kong and Singapore. He is a qualified attorney and formerly worked with Ernst & Young in Tokyo. Brandon.Boyle@Accounting.Asia