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    consolidate-tax

  1. Introduction
  2. In the Act for Partial Revision of the Income Tax Act and Other Acts (Act No. 8 of 2020) promulgated in March 2020, the consolidated tax payment system underwent a review and was shifted to the group aggregation system. This transition will be effective for fiscal years beginning on or after April 1, 2022. The consolidated tax payment system, which preceded the group aggregation system, was established in 2002 and had the advantage of reducing tax payments by aggregating profits and losses of an entire group. However, only about 20% of the companies submitting their annual securities reports have adopted the system due to its complicated structure and heavy administrative burden. Taking this into consideration, the revision aims to simplify the system by shifting to a group aggregation system, while maintaining the purpose of aggregating profits and losses in consolidated tax payments.

    As this system will be applied starting next year, let us reiterate the points to keep in mind regarding the group aggregation system.

  3. About the Group Aggregation System
  4. Groups that currently apply the consolidated tax payment system will be automatically transferred to the group aggregation system from the fiscal year beginning in April 2022. Any group that would like to opt out of this automatic transfer will need to submit a notification.

    For groups that are considering applying for the group aggregation system in the future, they are required to submit a notification three months prior to the start of the fiscal year in which you wish to apply the system.

    (If the parent company reports a loss, it would have been more beneficial to apply the consolidated tax payment system and then switch to the group aggregation system. However, the end of December 2020 (for corporations with a fiscal year ending in March) and the end of September 2021 (for corporations with a fiscal year ending in December) were the last deadlines for advance applications for the consolidated tax payment system.

    The following is an overview of the group aggregation system compared to the consolidated taxation system.

    Consolidated Tax Payment System Group Aggregation System
    Applicable Corporations Where a domestic corporation and other domestic corporation(s) in which the former domestic corporation has full controlling interest
    (Certain corporations are excluded.)
    Where a domestic corporation and other domestic corporation(s) in which the former domestic corporation has full controlling interest
    (Certain corporations are excluded.)
    Tax-paying Entity The parent corporation consolidates the tax payments
    *The subsidiary is jointly and severally liable for payment.
    The parent corporation and each subsidiary are responsible for tax payment.
    *The parent corporation and each subsidiary are jointly and severally liable for payment.
    Business Year Business year of the parent company Business year of the parent company
    (Part of the deemed business year varies with that under the consolidated business tax payment system)
    Determining SMEs Based on the capital of the parent company If any corporation in the group is a non-SME, all corporations in the group are not considered SMEs.
    Fair Value and Loss Carried Forward Upon Start or Joining For parent corporation: No fair value valuation and no writing-off of losses carried forward
    For subsidiary: Valuation of assets at market value for non-consolidated subsidiaries, and losses carried forward are written-off
    Restrictions on the treatment of fair value valuation and of losses carried forward are similar to those in the Corporate Reorganization Taxation System (restrictions also apply to the parent corporation).
    Aggregation of Profits and Losses Calculate consolidated income by adding up individual income or losses The total loss amount of corporation with losses is divided proportionally by profit ratio of the corporation with profits, and the corporation with profit includes it in its deductible expenses, while the corporation with losses includes it in their income
    Adjustment of Investment Book Value The value of the change in the amount of profit reserve of the exiting subsidiary during the during the consolidation period is the book value of the investment. The net book value of assets of the exiting subsidiary shall be the book value of the equity investment.

    In the following sections, we shall discuss in detail some points that one must pay special attention to.

    tax-entity

  5. The Tax-paying Entity
  6. First, let’s talk about who the tax-paying entity is. Under the current consolidated tax payment system, the though the burden of tax payment is on the subsidiary corporations, since it’s the parent company that consolidates payments and is the one that remits it, the parent company ends up bearing a significant portion of the tax payment burden.

    Under the group aggregation system, the administrative burden is reduced to a certain extent due to the individual filing method; however, the parent corporation still needs to manage its corporate tax-related applications.

    Additionally, though many companies that adopt the consolidated tax payment system transfer the amount equivalent to the tax effect resulting from profit and loss sharing, in many cases, the parent corporation will be responsible for the calculation, notification, and receipt of tax payments under the current system.

    On the other hand, the staff that handle each subsidiary’s accounting and taxation matters will need to understand the system, as each subsidiary will file its own individual tax return, which is expected to require some training costs.

  7. Fair Value and Loss Carried Forward Upon Start or Joining
  8. Under the consolidated tax payment system, the assets held by the subsidiaries were in principle assessed at market value and losses carried forward were discarded because the tax-paying entity essentially changed its tax status when it joined the consolidated tax group (with exceptions for subsidiaries with long-term continuous holdings, etc.). The group aggregation system has a similar framework, but the number of corporations subject to market value assessment has grown more limited.

    ① Fair Valuation

    1. Upon Start
      At the time of commencement, if the parent company is expected to retain complete control of the subsidiary, both entities will not be subject to mark-to-market valuation. In other words, unless the subsidiary is expected to be sold or otherwise divested, all corporations in a relationship of complete control can participate in the group aggregation system without having to be subject to mark-to-market valuation.
    2. Upon Joining
      If any of the following applies, the company is not subject to the mark-to-market valuation upon joining:
      1. If it is a newly established corporation within the aggregate group
      2. If it is a wholly-owned subsidiary in a share exchange, etc. that has joined through a qualified share exchange, etc.
      3. If it meets the same requirements for a qualified corporate reorganization

    ② Writing-off Losses Carried Forward

    Loss carryforwards of corporations subject to mark-to-market valuation as indicated above will be written-off. Whether or not a company not subject to mark-to-market valuation can also write off its losses carried forward can determined using the chart below:

    tax-entity

  9. Aggregation of Profits and Losses
  10. The most significant change from the current consolidated tax payment system is the method of aggregating profit and loss.

    In the past, the amount of consolidated income was calculated by combining the amounts of income calculated separately, but under the new system, losses are allocated according to the amount of income of the income-generating corporation.

    Please refer to the table with more specific, numerical examples below to better understand.

    【Case: Profit for the Entire Group】

    Parent Company P Subsidiary
    A
    Subsidiary
    B
    Subsidiary
    C
    Total
    Profit or loss prior to aggregation 300 90 60 -120 330
    Allocation of profit and loss -80 -24 -16 120
    Profit (Loss) 220 66 44 0 330
    Aggregated profit amount 120 (Total income (450) is more than total loss (120))
    Profit/loss allocated to Parent
    Company P
    -80 (120 x 300 / 450 = 80)
    Profit/loss allocated to Subsidiary B -24 (120 x 90 / 450 = 24)

    【Case: Loss for the Entire Group】

    Parent Company P Subsidiary
    A
    Subsidiary
    B
    Subsidiary
    C
    Total
    Profit or loss prior to aggregation 120 80 -60 -240 -100
    Allocation of profit and loss -120 -80 40 160
    Profit (Loss) 0 0 -20 -80 -100
    Aggregated profit amount 200 (Total income (200) is less than total loss (300))
    Profit/loss allocated to Parent
    Company P
    -120 (200 x 120 / 200 = 120)
    Profit/loss allocated to Subsidiary B 40 (200 x 60 / 300 = 40)
  11. Adjustment of Investment Book Value
  12. The current consolidated tax payment system allows for adjusting the book value of investments to prevent double taxation within a consolidated group. With the group aggregation system, however, the calculation method has been changed.

    When an event such as the transfer of a subsidiary’s stock occurs, the book value of the investment is adjusted by adding or subtracting the amount of profit reserve from the book value of the stock. The National Tax Agency’s website also provides the following numerical examples.

    Investment-Book

    (Source: National Tax Agency homepage)

    In addition, after the transition to the group aggregation system, the book value of shares of the relevant subsidiary will be adjusted to an amount equivalent to the net book value of assets, as shown below. The same numerical examples are available on the National Tax Agency’s website, and the calculation results will be the same.

    Case: If Company P, the consolidating parent corporation, establishes Company S with an investment of 100, and Company S later leaves the consolidated group after the next fiscal year following Company P’s transfer of all its Company S shares, which has 400 in cash and 100 in debt, for 300, the calculation method for the adjustment of the investment book value is shown below.

    Investment-Book

    (Source: National Tax Agency homepage)

    While this isn’t a problem for a corporation established within a group, as you can see in this example, if a company is acquired as a subsidiary from outside the group with the expectation of goodwill value, the transfer gains may be less favorable than if the group aggregation system were not adopted.

    In the following example, the book value of the investment in Company S is 300 because the shares of Company S purchased at 400 must be adjusted to the book value equivalent to the net asset value at the time of the transfer of Company S. If the shares are transferred at 500, a gain of 200 is generated.

    Purchasing Company S for 500 (100%) Purchasing Company S for 500 (100%)
    Company S’s BS as of purchase Company S’s BS as of transfer
    Assets 800 Liabilitties 400
    Capital 400
    Profit Reserve 200
    Assets 800 Liabilitties 500
    Capital 200
    Profit Reserve 100
    S Company’s adjustment of investment book value:
    (800 – 500) x 100% = 300
  13. Conclusion
  14. Companies that choose not to adopt the consolidated tax payment system because of its complexity and cost, including administrative burden, are now considering the adopting the new group aggregation system.

    Although the system has been simplified, a certain level of knowledge is still required to understand and navigate the system. It is important to consider the cost of training personnel as well as improving existing workflows (in many cases, additional functions will be added for a fee).