5th Report of Market Access Ombudsman Council (March 17, 1998)

8-(2) Thorough implementation of the simplified certification of the system for exempting withholding tax at source for foreign banks

1. Complainant: Korean embassy

2. Ministry concerned: Ministry of Finance

3. Background:

(1) Obligation to withhold tax at the source when paying domestic taxable income to foreign companies

In principle, interest received by non-resident, foreign companies such as foreign banks, etc. is taxed by withholding at the source, in principle, when paid by Japanese borrowers, etc. (Income Tax Law, Article 212, Clause 1).

(2) Special tax measures concerning domestic taxable income of foreign banks with permanent domestic facilities

Regarding the interest on loans paid to foreign banks with domestic branches (permanent facilities), tax is paid on the income declared by the branch. If the branch presents a certificate (certificate of exemption from withholding tax at the source, hereafter, "certificate of exemption") issued by the head of the tax office with jurisdiction over the foreign bank to the borrower, the borrower (the party paying domestic taxable income) is not required to withhold at the source, as a special measure (Article 180 of the Income Tax Law, Article 42-2 of the Special Tax Measures Law). When the borrower, i.e. the party with the obligation to withhold at the source, pays interest, the certificate of exemption is necessary, to establish whether the interest 1) belongs to the branch (in which case it is exempt from withholding at the source), or whether it 2) belongs to the head office (in which case it is subject to withholding at the source).

In order to be exempt from withholding at the source on interest paid to them, foreign banks had formerly been required to submit the certificate of exemption to the borrower, but since March 1995, the system was simplified, while retaining the principle of exempting foreign banks from withholding at the source, and they are now merely required to show the certificate.

(3) The main requirements necessary for foreign banks to qualify for special tax measures are as follows:

* Present notification showing that the party has become an ordinary foreign company
* In cases where registration of the foreign company is necessary, present company registration papers
* That the domestic taxable income for which an exemption from withholding at the source is being sought be included in income which is subject to corporate tax, under ordinances of the Corporation Tax Law, etc.
* That the foreign company has not been unlawfully exempted from income or corporate tax in the past (Article 304 of the implementing ordinance to the Income Tax Law)

4. Complaint:

Although the certificate of exemption system has been changed from having to obtain a certificate to showing it, foreign banks with branches in Japan must still obtain a certificate of exemption from the tax office with jurisdiction over them, and in order to show it to the borrower, actually make a copy of the certificate, at the branch's discretion, and send it to the borrower; accordingly, the inconvenience the system presents for foreign banks has not been alleviated. Regarding the interest paid by parties which have borrowed funds from domestic branches of foreign banks, Article 180 of the Income Tax Law, which deals with exemption of the obligation to withhold income tax at the source, should be revised, and like domestic banks, foreign banks should not have to show the certificate of exemption to borrowers.

5. Results of deliberation:

The ministry concerned states that the branches and the head office of a foreign bank are legally one entity; this is done so that attribution of income for tax purposes can be made appropriately in relation to the expense involved. Accordingly, regarding interest income paid by domestic borrowers on operating funds lent by foreign bank branches, it is not possible for the borrower, who has the obligation to withhold tax at the source, to determine, by examining the loan contract, whether the interest is income belonging to the branch located in Japan or to the bank's head office abroad and this is an important justification for the requirement that foreign banks, etc. show their certificate of exemption. In other words, borrowers have no other way, except by seeing the certificate of exemption, of determining whether the interest they pay is income attributed to the bank's domestic branch or to its head office abroad, and without this system, borrowers may be unable to fulfill their obligation to withhold at the source.

Therefore, to make this system function effectively, all domestic businesses planning to borrow from foreign banks, etc. should be informed, either by having the foreign banks send notices to their borrowers, or through public announcements by the government, that the borrower incurs the obligation to withhold at the source when the bank does not show its certificate of exemption.

Although the certificate of exemption has a one-year validity period, considering that the said certificate is issued contingent on the bank meeting a number of conditions, in addition to having permanent facilities, in many cases these conditions will remain unchanged as long as the bank in question operates in Japan. Accordingly, some believe that there is little necessity for the certificate of exemption to be valid for one year only. But the ministry concerned states that if the validity period is extended, borrowers will have to bear a heavier burden from failing to withhold at the source (if the certificate of exemption is cancelled, etc. and the borrower incurs the obligation to withhold at the source, the borrower having to pay the tax withheld and claim it later from the foreign bank), and that this will also cause a problem as far as the period of limitation of the right to collect income tax withheld at the source is concerned.

An additional problem with the certificate of exemption is that, in cases where only one certificate of exemption is issued, it is difficult to deal efficiently with multiple borrowers.

Based on the above, the ministry concerned should take the following measures:

(1) "Tax-Answer" and the Internet should be used to enhance publicity regarding the system of exemption from withholding at source for interest on loans received by foreign banks, and the names, etc. of foreign banks which have received certificates of exemption from withholding at the source.

(2) In order to implement more thoroughly the simplification already made in FY1995, with the view to ease the clerical burden on foreign banks, i.e., requiring foreign banks to show the certificates rather than requesting them to submit the certificates to borrowers, a study on details of the system, including the number and validity periods of the certificates, will be initiated immediately, and from the viewpoint of the principle of non-discrimination between domestic and foreign entities in the financial sector and of ensuring appropriate taxation of foreign companies. A conclusion should be reached during FY 1998 and the necessary measures taken thereafter.

Government decision (March 23, 1998)

5-(2) Thorough implementation of the simplified certification of the system for exempting withholding tax at source for foreign banks

(1) "Tax-Answer" and the Internet will be used to enhance publicity regarding the system of exemption from withholding at source for interest on loans received by foreign banks, and the names, etc. of foreign banks which have received certificates of exemption from withholding at the source.

(2) In order to implement more thoroughly the simplification already made in FY1995, requiring foreign banks to show the certificates rather than requesting them with the view to ease the clerical burden on foreign banks, i.e., to submit the certificates to borrowers, a study on details of the system, including the number and validity periods of the certificates, will be initiated immediately, and from the viewpoint of the principle of non-discrimination between domestic and foreign entities in the financial sector and of ensuring appropriate taxation of foreign companies. A conclusion will be reached during FY 1998 and the necessary measures taken thereafter.