Japan Tax Bulletin
Navigating the New Horizons of Japan's Controlled Foreign Company Regime
April 2024
In the ever-evolving landscape of international taxation, theControlled Foreign Company (CFC) regime has emerged as a
critical tool for jurisdictions seeking to curb tax avoidance
through the strategic allocation of profits to subsidiaries in lowtax jurisdictions. This article aims to unpack the complexities ofthe CFC regime, with a focus on the recent amendments in Japan,
providing a comprehensive understanding for businesses and tax
professionals navigating these changes.

2. Recent Amendments to Japan's CFC Regime

1. Introduction to the Controlled Foreign Company (CFC) Regime

A)

Lowering of the Tax Burden Ratio:
The threshold for the tax burden ratio that exempts specificforeign subsidiaries from CFC taxation has been reduced
from 30% to 27%. This adjustment is aimed at broadening
the scope of foreign subsidiaries that fall under the CFC
regime, ensuring that more profits are taxed at the parent
company level in Japan.

B)

Relaxation of Documentation Requirements:
The amendment simplifies the documentation requirements
for certain foreign subsidiaries, easing the complianceburden for Japanese corporations.

C)

Definition and Scope of Foreign Related Companies:
The regime's application hinges on the classification offoreign subsidiaries based on direct or indirect ownershipexceeding 50% by Japanese entities or through substantialcontrol. The amendments clarify the criteria for determining
substantial control, refining the scope of what constitutes aforeign related company.

Japan, aligning with global tax reform trends, has introduced
significant amendments to its CFC regime as part of the fiscal
year 2023 tax reforms. These changes are primarily aimed at
simplifying the regime and adjusting it in response to the global
minimum tax initiatives under Pillar Two of the OECD/G20
Inclusive Framework on Base Erosion and Profit Shifting (BEPS).
Key amendments as below:(1) Scope and Types of Foreign Related Corporations
Under Japan's CFC regime, a Foreign Related Corporation(FRC) is identified based on the percentage of shares owned byJapanese residents or corporations, either directly or indirectly. Ifa Japanese resident or corporation owns more than 50% of aforeign corporation, or has de facto control over it, that foreign
corporation is considered an FRC and may be subject to Japan's
CFC rules.
(2) Taxation Principles
The key principle behind CFC taxation is the inclusion ofundistributed profits of FRCs in the taxable income of theJapanese parent company under certain conditions. Theseconditions are primarily focused on the tax rate applied to theFRC in its resident country and whether the FRC meets specificeconomic activity criteria.
A) Entity-Based Aggregation:
All income of the CFC is taxable to the Japaneseshareholder if the CFC does not engage in an 'active'
business as defined by law, or if it is considered a 'paper' or'cash box' company failing certain substance tests, and theforeign tax rate is below a specified 'trigger' rate.
B) Income-Based Aggregation:
Even if entity-based aggregation rules do not apply, certain'passive' income categories earned by the CFC are taxable to
the Japanese shareholder if the foreign tax rate is below the'trigger' rate.
(3) Tax Burden Ratio
The tax burden ratio, a critical factor in determining whether aforeign subsidiary falls under the CFC rules, is calculated basedon the taxes paid by the foreign corporation relative to its
income. The recent reform has adjusted this ratio, potentiallyaltering which FRCs are subject to CFC rules.

D) Taxation Methods and Exemptions:
The regime's application hinges on the classification offoreign The CFC regime employs both entity-based andincome-based aggregation methods to tax the income offoreign subsidiaries. Under the recent amendments, thecriteria for these methods have been adjusted, particularly
lowering the trigger rate for 'paper companies' to 27% forfiscal years beginning on or after 1 April 2024.
E)

Global Tax Reforms and Impact on Japanese Corporations:
The amendments also take into consideration the tax
reforms in other jurisdictions, such as the changes incorporate tax rates in the UK and the US, highlighting theneed for Japanese corporations to stay informed about
global tax developments.

3. Implications for Japanese Corporations
The amendments to Japan's CFC regime have several
implications for Japanese multinational corporations. Firstly, thelower tax burden threshold means that more foreign subsidiaries
may be subject to CFC rules, increasing the tax liabilities ofJapanese parent companies. Secondly, the simplifieddocumentation requirements aim to reduce the administrative
burden on companies, although they still necessitate careful
compliance efforts. Finally, the changes reflect Japan'scommitment to aligning its tax system with global standards,
necessitating that Japanese corporations pay close attention tointernational tax developments.
4. Immediate Action is Required
In the labyrinth of global tax reforms, the amendments toJapan's Controlled Foreign Company (CFC) regime stand as atestament to the dynamic nature of international taxation, achallenge that demands constant vigilance and adaptability frombusinesses. As the world moves closer to a consensus on theminimization of tax avoidance strategies, the recent updates to theCFC regime in Japan underscore the critical need formultinational corporations to stay abreast of changes, not justwithin their home jurisdictions but globally.
As we navigate through these complex waters, the message isclear: inaction is not an option. The convergence of global tax
reforms, including Japan's latest CFC amendments, is a clarion callto businesses and tax professionals worldwide to reassess their tax
strategies, ensuring compliance, efficiency, and foresight in theiroperations. Now is the moment to engage with tax professionals,
to delve deeper into the nuances of these changes, and tostrategize proactively. Remember, in the realm of international
taxation, being informed is not just about staying compliant; it'sabout securing a competitive edge. Let this be the nudge you needto take immediate action, seeking expert tax advice to navigate theevolving tax landscape effectively.

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