Report of the OTO Advisory Council (April 12, 1993)

4-(1) Lowering the income tax rate on dividends paid by subsidiaries to its parent companies

1. Complainants: the European Business Council (EBC), the American Chamber of Commerce in Japan (ACCJ), Keidanren

2. Ministry concerned: Ministry of Finance

3. Complaint:

Under the "provision of lower tax rate on dividends," in effect until fiscal 1989, the corporate income tax rate on corporate earnings earmarked for dividends was set at 32%, while the basic tax rate at 42% on retained earnings. But this provision was abolished in fiscal 1990 when corporate income tax was cut, making all corporate income subject to a uniform tax rate of 37.5%. When a corporation pays dividends to another corporation in addition to the corporate tax refereed to above which is imported on income distributed as dividends, a 20% income tax is also deducted at the source. However, when Japanese subsidiaries of foreign companies pay dividends to their foreign parent companies, the rate of withholding tax charged by Japan is limited by the tax treaty (treaty to avoid double taxation on income) with the country in question; in the case of treaties with most industrialized countries, this ceiling rate is 10%. In tax treaties with Luxembourg, Norway and the Netherlands, which were concluded after the abolition of "provision of lower tax rate on income distributed as dividends", the ceiling tax rate was set at 5%, concordant with the 1977 OECD model treaty, because of such abolition.

The complainants have submitted the following complaints concerning the income tax rate on dividends paid by Japanese subsidiaries to foreign parent companies:

(1) After the "provision of lower tax rate on dividends" was abolished, foreign parent companies receive fewer dividends from their Japanese subsidiaries than prior to the abolition, because of increased corporate tax burden on foreign companies. This is contrary to the government's policy of encouraging direct investment into Japan and dampens foreign entities' interest in doing so. Since Japan has abolished the relatively low corporate income tax rate provided for in the "provision of lower tax rate on dividends," the relatively high tax rate of 10% set out in tax treaties with various countries on the assumption that this provision was in effect should be lowered to 5%, which is set out in the OECD model treaty, as in the tax treaties with Luxembourg, Norway and the Netherlands concluded after the provision was abolished.

(2) Taking into a comprehensive consideration the facts that revising tax treaties with individual countries will take a great deal of time, that supporting and strengthening the OECD model treaty is in Japan's long-term interest, and that there is a marked unbalance between direct investment by Europe and the U.S. into Japan and Japanese direct investment into those regions, Japan should advise the governments concerned that it will revise the tax treaties and do so independently, without waiting to negotiate the changes.

4. Results of deliberation:

Applying a lower tax rate on dividends paid by Japanese subsidiaries to their foreign parent companies has been done through bilateral tax treaties based on reciprocity. This is also an international rule. This tax rate cited in the reciprocal tax treaties is not one which can be lowered unilaterally by changing domestic laws. If this were done, a lower tax rate would apply not only to treaty partners but also to every other country in the world. This can hardly be considered a realistic approach, either in international terms or from the standpoint of Japanese tax policy. Accordingly, treaty provisions based on reciprocity should be handled in accordance with the usual international rules, i.e. through bilateral negotiations.

Tax treaties between Japan and many industrialized countries currently set the income tax rate on dividends paid by subsidiaries to parent companies is at 10%. However, this tax rate is predicated on the existence of the "provision of lower tax rate on dividends" that was applicable to corporate income tax in Japan. Because this provision has now been abolished, there is little reason for Japan to continue applying this tax rate. Therefore, bilateral tax treaties setting the tax rate at 10% should be changed as soon as possible to lower the rate to 5%, based on reciprocity and as set forth in the OECD model treaty. In fact, tax treaties concluded after the abolition of this provision, with Luxembourg, Norway and the Netherlands set the tax rate at 5% because of the abolition. The government should therefore adopt the same policy in its tax treaties with other industrialized countries. Since tax treaties regulate not only taxation on dividends between parent companies and their subsidiaries, but cover all other aspects of income taxation, it should be necessary to take into account overall balance of various matters and the conditions of treaty partner countries.

But, bearing in mind that Japan needs to take an initiative to make investing in Japan more attractive and to promote such investment, Japan should not wait for treaty partner countries to request that the tax rate be lowered. Japan should, instead take an initiative to propose to lower the tax rate and act promptly. The ministry or agency concerned have the above considerations in mind and take all possible actions in this direction, taking into consideration the various matters relating to income tax treaties.

Government decision (May 27, 1993)

In order to lower the income tax rate on dividends paid by subsidiaries to their parent companies, bilateral tax treaties should be concluded or revised based on the principle of reciprocity.