Author:
Manami Yahata
Senior Tax Associate
Actus Tax Corporation
E: [email protected]
with contributions from:
Tetsunori (Ted) Chiba, LLM, MST
International Tax Partner
Actus Tax Corporation
E: [email protected]
Edited by:
Integra International Grant Gilmour, CPA (Canada, BC) CPA (USA, Arizona)
Integra Tax World Newsletter Editor
E: [email protected]
Understanding Japan’s Anti-Avoidance Rules and Tax Regulations
Japan has developed a robust system to prevent tax avoidance, particularly through the use of foreign subsidiaries or corporate structures that minimize tax liabilities. While Japan does not have a General Anti-Avoidance Rule (GAAR) like some other countries, it addresses tax avoidance using targeted, specific anti-avoidance rules. These rules focus on certain transactions or structures that appear to be primarily designed to reduce tax obligations, without substantial economic justification.
The Controlled Foreign Company (CFC) Rule
One key component of Japan’s anti-avoidance strategy is the Controlled Foreign Company (CFC) rule, which aims to prevent Japanese taxpayers from shifting profits to foreign countries to avoid taxes. A foreign company is considered a “foreign related company” if more than 50% of its shares or voting rights are controlled, either directly or indirectly, by individual residents in Japan and/or Japanese corporations in total.
When a Japanese taxpayer has a “Foreign Related Company (FRC)” in a jurisdiction with an effective tax rate below 20%, the taxpayer is required to include the FRC’s income in their own taxable income. However, this income may either be taxed at the entity level or, in some cases, only passive income is included.
If the effective tax rate of the FRC is below 20%, only passive income is subject to the CFC rule, provided the FRC meets the “Economic Activity Test”. This test examines whether the FRC has a real presence and manages its own operations. If the FRC does not meet this test, all of its income will be taxed at the entity level.
In cases where the tax rate is between 20% and 27%, and the FRC is classified as a paper company, cash box company, or is based in a blacklisted country¹, the company is classified as a “Specified Foreign Related Company”. In such cases, all of its income should be included in taxable income of its individual resident shareholders and/or Japanese corporate shareholders for Japanese tax purposes.
Family Corporations and Specific Anti-Avoidance Rules
Japan also targets specific tax avoidance behaviors with “Specific Anti-Avoidance Rules”, particularly in the areas of family corporations and corporate reorganizations.
A “family corporation” is defined as a domestic corporation where over 50% of its shares or voting rights are controlled by three or fewer shareholders and their related parties. If such a corporation engages in transactions that leads to an unreasonably low tax liability, the tax authorities have right to adjust the taxable income, regardless of the legal nature of such transaction.
This rule is not limited to corporate tax but extends to “individual income tax”, “inheritance tax” and “gift tax” for shareholders. If a shareholder’s tax liability is improperly reduced due to actions taken by the corporation, the shareholder’s income calculation can be adjusted, regardless of absence of taxpayer’s intention for a tax avoidance.
Corporate Reorganizations and Tax Avoidance
Japan’s tax code also includes anti-avoidance rules for “corporate reorganizations”, such as mergers, corporate splits, share transfers, and share exchanges. The tax authorities can adjust a taxpayer’s tax due if these transactions result in an unreasonable reduction of the tax burden. While this rule has been in place since 2001, there has been relatively little audit activity on corporate reorganizations in the past. However, recent trends suggest that there will be more scrutiny in this area moving forward.
Japan also has a special anti-tax avoidance rule specifically targeting group relief system and permanent entities, which is in addition to the standard regulations mentioned above.
Case Study: The Merging of Company B and Company C
Let me explain a famous court case to illustrate how these anti-avoidance rules apply. Company B was a wholly owned subsidiary of “Company A” and had significant tax loss carried forward. Company C saw an opportunity to merge with Company B to take advantage of its tax loss.
C had no prior capital relationship with B. Under Japanese tax law, C is required to have 100% parent-subsidiary relationship to assume B’s tax loss carried forward with its merger of B. To meet this requirement, C purchased all of B’s shares from A, making B a wholly owned subsidiary of C. C then merged with B.
Although the transaction satisfies the requirements provided by tax law for C to assume B’s loss carried forward, Japanese tax authorities found C’s purpose for the merger was mainly tax avoidance rather than genuine business strategy in economic substance and applied the anti-avoidance rule to bar C from deducting B’s loss carried forward from C’s taxable income.
Although Company C had literally satisfied the tax requirements for reorganization qualified for tax free with assuming loss carried forward, Japanese court ruled that tax authorities can disallow C to enjoy tax benefits for a tax qualified reorganization, if the main purpose was a tax avoidance.
Conclusion
Japan’s tax system includes various rules to combat tax avoidance, with a focus on specific actions that may result in unreasonable tax reductions. These include the CFC rule, anti-avoidance rules for family corporations, and regulations governing corporate reorganizations. While Japan does not have a broad GAAR, its targeted approach aims to address tax avoidance through close scrutiny of transactions that appear to have little economic substance beyond tax reduction.
© 2025 Integra International. All rights reserved. This Article is not intended to provide legal or other advice, and you should not take, or refrain from taking, action based on its content. Prior results do not guarantee a similar outcome.
¹Paper companies are business entities with no substance (like physical assets or employees) or without its own administration or management where the head office is. Cash box companies are business entities that meet both of two tests; first a passive income test that measures if the CFC has more passive income than assets, and second an asset test that measures if the CFCs total amount of securities, loan and receivables are higher than the total assets. In the case of financial subsidiaries, the formula is modified, and the CFC income inclusion is partially taken from the comparison between the larger of income generated from overcapitalization or the sum of leasing fees, royalties, capital gains, and abnormal income. The black or white list method is defined by BEPS Action 3 of the OECD.
About the Author:
Manami Yahata
Senior Tax Associate
Manami Yahata is a Senior Tax Associate at Actus Tax Corporation. She joined the firm’s international tax division after graduating from International Christian University (ICU) in 2022 and handles tax matters for both foreign-affiliated and domestic companies.
Tetsunori (Ted) Chiba, LLM, MST
International Tax Partner
Ted Chiba qualified as Certified Public Accountant and Certified Public Tax Accountant in 1985. He worked with Deloitte Touche Tohmatsu, Tokyo and Touche Ross, Detroit before he joined Actus as an international tax specialist. He has his master’s degree in taxation for US and Japan.
Ted offers tax and accounting consulting services primarily to foreign affiliated companies as well as to Japanese companies. He also focuses on advisory services to venture capital for listing of stocks.
He is a member of the International Taxation Committee of the Japanese Institute of Certified Public Accounts.
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