Taxation of M&A of Japanese companies (share acquisition) by foreign corporations and non-residents
Against a backdrop of a weak yen and a lack of successors (business succession), acquisitions of Japanese companies by overseas funds and wealthy individuals are increasing. There are broadly two ways to buy a Japanese company: share acquisition (buying the whole company) and business transfer (buying only the business). This article organizes the taxation that is specific to cases where the buyer is a foreign corporation or non-resident — that capital gains on Japanese shares are in principle tax-exempt but with important exceptions, withholding on dividends, permanent establishments (PE), and tax treaties — based on primary sources from the National Tax Agency.
・The treatment of consumption tax, off-balance-sheet liabilities, and loss carryforwards differs between share acquisition and business transfer
・Capital gains on shares of a Japanese corporation held by non-residents and foreign corporations are, in principle, tax-exempt in Japan. However, shares similar to a business transfer (deemed business-transfer shares) and real-estate-rich company shares are taxable
・Dividends after the acquisition are subject to withholding (in principle 20.42%). This may be reduced or exempted under a tax treaty
First, the premise: share acquisition or business transfer?
The buyer's taxation changes greatly depending on which scheme is used.
| Aspect | Share acquisition (the whole company) | Business transfer (only the business) |
|---|---|---|
| Object acquired | The company's shares (succession of the entire legal entity) | Specific businesses and assets (the legal entity remains) |
| Off-balance-sheet liabilities | In principle inherited (due diligence is important) | Not inherited (only the chosen assets and liabilities) |
| Consumption tax | Transfer of shares is exempt (no consumption tax) | 10% consumption tax applies to the transfer of taxable assets |
| Licenses and permits | The licenses held by the company are in principle maintained | Often need to be re-obtained |
| The seller's tax | Capital gains tax on the shareholders | Capital gains (corporate tax) on the company |
For acquisitions of mid-sized and small companies by overseas buyers, share acquisition, whose procedures are comparatively simple, is often chosen. Below we explain mainly share acquisition.
The core: capital gains on "Japanese shares" of non-residents and foreign corporations are in principle tax-exempt, but with exceptions
Capital gains earned by a non-resident or foreign corporation from selling shares of a Japanese corporation are in principle not taxed in Japan (because they do not fall under domestic-source income). However, in cases such as the following, they are exceptionally taxed in Japan[NTA No.2878 (in Japanese)]. This is an issue that comes into play at a future sale (exit) after the acquisition.
| Main cases where tax applies | Points |
|---|---|
| Shares similar to a business transfer (deemed business-transfer shares) | Where a shareholder group holding 25% or more of the issued shares transfers 5% or more in that year. It is regarded as effectively transferring the company and is taxed |
| Real-estate-rich company shares | Where shares of a corporation (a real-estate-related corporation) whose 50% or more of total assets is Japanese real estate are held above a certain ratio and transferred |
| Japanese golf-membership-type shares | Transfer of shares relating to the use of a golf course |
| Transfer after buying up / transfer while staying in Japan | Transfer after cornering the same issue, or a transfer made while staying in Japan |
In a typical M&A acquiring a majority to 100%, the holding of 25% or more and a sale of 5% or more are almost certainly met, so the capital gain on a future sale is likely to be taxed in Japan as shares similar to a business transfer (deemed business-transfer shares). Also, note that a company holding a lot of Japanese real estate (real-estate-rich company shares) tends to be taxable regardless of the ratio. It is important not to simply assume "because they are shares, they are tax-exempt in Japan."
A tax treaty can change the conclusion
The above concerns Japan's domestic law; if there is a tax treaty between the buyer's country of residence and Japan, the conclusion can change. Many treaties assign the taxing right over capital gains on shares to "the transferor's country of residence only," while at the same time providing that shares similar to a business transfer (the 25%/5% criteria) and real-estate-rich company shares can also be taxed in Japan (e.g., Article 13 of the Japan–Singapore tax treaty). Whether tax applies is split by the presence and content of a treaty, so confirmation according to the buyer's nationality and place of residence is essential[MOF Tax Treaties (in Japanese)].
"Dividends" after the acquisition are subject to withholding
When paying dividends from the acquired Japanese company to overseas shareholders (non-residents and foreign corporations), withholding is required. Under domestic law it is in principle 20.42% (dividends on listed shares, etc. are 15.315%), but it is often reduced to 0%, 5%, 10%, 15%, and so on under a tax treaty. To receive the reduction, you must file an "Application Form for Income Tax Convention" before payment[NTA No.2888 (in Japanese)]. There are also treaties that exempt dividends between parent and subsidiary companies (at a certain shareholding ratio), which affects the design of the capital structure.
Watch out for the "permanent establishment (PE)"
If a foreign corporation carries on business in Japan through a permanent establishment (PE) such as a branch or office, the income attributable to that PE becomes subject to Japan's corporate tax[NTA No.5281 (in Japanese)]. Whether you create a Japanese corporation (SPC) as the acquisition vehicle or the foreign corporation holds it directly, and where you place the management function, change PE recognition and the scope of taxation. It is safest to involve an international tax specialist from the early stages of structuring.
You also inherit the taxes of the company you bought
In a share acquisition, the target company is succeeded together with its legal entity, so that company's corporate tax, consumption tax, and local tax obligations and tax positions are inherited as they are. In particular, there is a provision that restricts the use of loss carryforwards when the shareholders change substantially, which affects tax saving after the acquisition. Tax due diligence before the acquisition (checking past filings and off-balance-sheet risks) is important. For the overall picture of the company's own taxes, see the Guide to corporate tax filing; for the pricing (fair value) of unlisted shares, see Acquisition and valuation of unlisted shares. A comparison with directly holding real estate is explained in Foreigners' acquisition of Japanese real estate and taxes.
Summary
FAQ
If an overseas company buys shares of a Japanese company and later sells them at a profit, is it taxed in Japan?
In principle, capital gains on shares of a Japanese corporation held by non-residents and foreign corporations are tax-exempt in Japan, but there are exceptions. "Shares similar to a business transfer (deemed business-transfer shares)," where a group holding 25% or more of the issued shares sells 5% or more in that year, and "real-estate-rich company shares," of a company whose 50% or more of total assets is Japanese real estate, are taxed in Japan. Consider that a typical M&A acquiring a majority tends to be taxable at the exit. The treatment also changes under a tax treaty.
How does the tax differ between share acquisition and business transfer?
The big differences are consumption tax and the scope of succession. In a share acquisition, no consumption tax is charged on the share transfer itself, and you inherit the company's assets, liabilities, licenses, and tax positions in their entirety (off-balance-sheet liabilities are inherited too). A business transfer inherits only the chosen assets and liabilities, but 10% consumption tax applies to the transfer of taxable assets, and licenses often have to be re-obtained.
If you pay dividends from the acquired Japanese company to the overseas parent, is tax withheld?
Yes. Dividends to non-residents and foreign corporations are subject to withholding of, in principle, 20.42% (listed shares, etc. 15.315%). However, they are often reduced to 0%, 5%, 10%, 15%, and so on under a tax treaty, and by filing an "Application Form for Income Tax Convention" before payment, the reduced rate applies.
If you hold a Japanese company while remaining a foreign corporation, is corporate tax charged in Japan?
If you merely hold the shares, the taxation centers on the dividends and capital gains. However, if a foreign corporation carries on business in Japan through a permanent establishment (PE) such as a branch or office, the income attributable to that PE becomes subject to Japan's corporate tax. Because the taxation changes depending on whether the vehicle is a Japanese corporation or a foreign corporation, and on where you place the management function, consult a specialist at the design stage.
Reference links (sources)
This article is based on the following official materials (neutral, primary sources).
- National Tax Agency — Tax Answer No.2878 Where shares are acquired, etc. from a non-resident / domestic-source income (in Japanese)
- National Tax Agency — Tax Answer No.2888 Applications relating to tax treaties (dividends, etc.) (in Japanese)
- National Tax Agency — Tax Answer No.5281 The scope of a permanent establishment (PE) (in Japanese)
- Ministry of Finance — Tax treaties (Japan's tax treaty network) (in Japanese)
* This article is general information, not tax advice. The requirements, ratios, and criteria for taxation and the content of tax treaties differ by individual circumstances and country, and may be revised. Because M&A taxation is complex, always confirm with a tax accountant, attorney, or other professional well versed in international taxation and M&A.