UK corporation tax rate reduction - Japanese CFC impact

A combination of changes published in the latest Japanese tax reform on 8 December 2016, and the upcoming decrease in UK corporate tax rate to 19% could mean the Japanese Controlled Foreign Company (JCFC) rule would be triggered for many Japanese groups. Companies needs to review their JCFC position before 31 March 2017 to identify whether any UK income would be subject to a JCFC charge, and what action they can take.

  • No change to JCFC effective tax rate trigger of "less than 20%" before UK corporation tax rate reduction to 19% from 1 April 2017.
  • Definition of "passive income" expanded, and new measures targeting companies with insufficient substance from 1 April 2018.
  • From 1 April 2017, all UK subsidiaries of Japanese groups potentially subject to JCFC taxation at 30%.
  • Each company should review the availability of an entity level exemption, identify what passive income will be picked up and consider mitigating actions.
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Video transcript

Presenters

  • Chair: Richard Johnston, Japanese Business Network Tax Leader
  • Speaker 1: Basim Khattab, Japanese Business Network Tax Senior Manager
  • Speaker 2: Hideki Shiota, Japanese Business Network Tax Manager
  • Speaker 3: Kohei Kobayashi, Japanese Business Network Tax Senior Manager

Richard: Hello, my name is Richard Johnston and I lead our inbound Japanese tax practice. Today we’ll be discussing the impact on Japanese groups of the 2017 UK corporation tax rate reduction and the 2018 reform of the Japanese CFC rules.

I’m joined today by my colleagues Basim Khattab, Hideki Shiota, and Kohei Kobayashi who are all specialists in the Japanese CFC rules.

Basim, the Japanese CFC rules have been around for quite some time now. Why should companies be particularly concerned about them now?

Basim: Well the Japanese CFC rules are only triggered if a subsidiary’s effective tax rate falls below a certain level. 

Up until now, the UK statutory rate has always been at least equal to that level. From 1 April 2017, the UK statutory rate falls below the trigger rate which is 20%. So potentially all UK subsidiaries of Japanese parents will be Japanese CFCs. 

However, there are some exemptions from the Japanese CFC regime that are in the regime. One of those is an active business exemption, and the other is an exemption for regional head quarter corporations. So potentially UK companies could benefit from one or the other of those exemptions.

If those exemptions apply, then effectively all of their income is excluded from the Japanese CFC apportionment, except to the extent that they have any passive income.

Richard: So Hideki, are there any business models that we expect to be particularly impacted by the UK tax reduction.

Hideki: Yes, I think there are three types of particular business, which have a potential impact on Japanese CFC rules.

So the first is a holding type of business. I think there are a lot of regional head quarter in the UK for Japanese businesses. But in some cases, there are a few employees or few business substance. In this case, all of the income like interest income and Royalty income also might be caught by JCFC (Japanese CFC) charge. And then, even if they have substance, there are some certain particular passive income, like minority shareholder dividend might be caught.

And the second (point) is the treasury company. I also understand there are a lot of group finance companies in the UK. But again, if there are no substance, no control activity in the UK, they cannot pass an active exemption.

The third (point) is a group trading company. In some certain business like wholesale or retailer, if the company who might have a lot of transactions with related company might not be able to pass an active business exemption.

Richard: Ok, so it’s not an exhaustive list, but there are three good examples there. Holding companies, finance companies and intra-group trading companies.

And Kohei, I think there are further changes coming in 2018. Can you tell us a bit more about that?

Kohei: yes, it will be mainly two changes.

One is the trigger rate. There will be two types of trigger rates. One is the current 20%, and the new 30%. It will apply if the company is treated as a paper company, cash box, and any companies in blacklisted countries. The other thing is expansion of passive income. Now interest will be all passive income. But each income will have (its) each cave-out so UK companies will need to review income in nature. And it will need to communicate with the Japanese headquarters more closely.

Richard: Ok, so two trigger rates. 20% and the 30%, and an expansion of passive income.

I know Kohei you work with a lot of groups in the FS sector. Are there any particular points that the FS groups need to be aware of?

Kohei: Even if the banking group, it will need to review each group entity if there is a paper company or a cash box - this is the one thing. The other thing is scope of passive income. For the FS sector, there will be a different scope of passive income – it will also need to be reviewed.

Richard: Basim, are there any particular actions that need to be taken by Japanese groups before 31 March 2017?

Basim: I think it’s really important that UK groups look to see and review all the UK entities to see if they will benefit from the active business exemption or the regional headquarters exemption.

And on top of that, also to do some diligence to work out whether either exemptions apply, then whether there is any passive income that could still be subject to tax on the Japanese parent.

Richard: Thanks everyone for your time.

Well clearly there is a lot for Japanese groups to thinking about before 31 March when it comes to the Japanese CFC rules. For more information and a handy diagnostic tool, please check out the My Taxpartner website.

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Basim Khattab

Basim Khattab

Japanese Business Network Tax Senior Manager, PwC United Kingdom

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