Western companies are sensitive to tax costs

Since elementary school, we have been taught that paying taxes is one of the three major obligations of citizens. Therefore, paying tax is a matter of course for everyone, and as long as taxes are levied fairly according to income, we do not have questions about it, and there is probably little awareness of or interest in taxation.

However, in Western countries in particular, there is a strong interest in taxation and a sense that one’s wealth is being taken away when one pays taxes.

Of course, we understand that public services, including infrastructure development, are provided by taxes paid by the public. Therefore, we will pay the amount of tax determined according to the rules, but we would like to keep it as low as possible.

In particular, since corporate income tax, for example, is seen as a cost of business management, keeping it low is rather an important management issue from the standpoint of economic rationality. Therefore, various schemes have been developed for this purpose, which have expanded from the category of tax saving to the form of tax avoidance.

However, when people have a strong sense that paying taxes is a natural obligation, they tend to think of schemes to lighten the tax burden as illegal acts such as tax evasion. However, tax avoidance is not the same as tax evasion, nor is it the same as tax saving.

Tax saving means taking advantage of laws or systems that allow tax reductions to reduce the amount of taxes paid. An example is the medical expense deduction. There is absolutely nothing wrong with using it, and the government expects you to reduce your tax burden by doing so.

In other words, the purpose of such systems is to provide for fair taxation.

However, using such laws and systems to reduce the tax burden in a way that is contrary to their purpose is called tax avoidance.

In other words, it is not tax evasion in the sense that it complies with the rules, but it is considered problematic when the law or system is used in a way that is unexpected or, in other words, abused.

For example, suppose a company with a parent company in Japan establishes a subsidiary overseas. In order to avoid being taxed in two different countries, the subsidiary is allowed to pay tax only in one country by setting a criteria for exemption from the Japanese tax system for its earnings.

In such a case, if the subsidiary is established in name only in a country with a very low corporate tax rate (tax haven), and the subsidiary earns profits through involvement in transactions with foreign companies, the corporate tax for such profits should be paid in that country.

This means that the corporate group as a whole can reduce its tax payments by transferring income from Japan, where corporate tax rate is high, to a subsidiary established in a country with a lower tax rate.

However, overlooking such tax avoidance is not only detrimental to Japan’s revenue, it is also problematic from the standpoint of fair taxation. Therefore, Anti-Tax Haven Rules were introduced in 1978, under which profits of subsidiaries in tax havens are treated as income of the parent company in Japan and taxed in Japan.

In other words, cases in which a subsidiary is established overseas for the purpose of unreasonably reducing taxes to be paid in Japan do not meet the criteria for exemption from the tax system for preventing double taxation. In fact, some companies have been punished for doing so.

On the other hand, some of these companies have challenged in court the application of the Anti-Tax Haven Rules on the grounds that their overseas subsidiaries are engaged in businesses that can only be conducted locally, that is, there is economic rationality in establishing subsidiaries.

In fact, it can be said that it is becoming more and more difficult to clarify whether there was an intention to avoid taxation in today’s diversified corporate business structures.

International tax systems are being constructed to prevent tax avoidance

It is true that some companies take advantage of gaps in laws and tax rates in various countries to avoid tax burdens. It is not easy to identify, especially since tax avoidance has become more sophisticated in today’s globalized economy and increasingly multinational corporations.

In the traditional view, the existence of a physical location (Permanent Establishment or PE), such as an office or production facility, was proof that the company was doing business in that country, and was also the basis for imposing corporate income tax.

However, multinational IT-related companies, such as GAFA companies, can do business in many countries without having a traditional PE.

For example, they can set up servers in tax havens and then provide digital services to users in various countries via the Internet.

As long as the Internet environment is in place, the company can generate revenue from fees paid by users or information outside the country where the company is headquartered, even without physical facilities such as a PE. Furthermore, the company does not have to pay corporate income tax in the country where the users reside.

In other words, the countries in which the users reside are unable to tax these companies under conventional tax laws, which means that the multinational companies that are making large profits are engaging in large-scale tax avoidance.

For this reason, there has recently been a movement to introduce a tax system that allows countries to tax these services according to actual facts, or a digital services tax that would tax revenues from digital services at a certain rate.

However, countries with a large number of IT companies are opposed to such a system as it targets their own companies, so we need to pay attention to how the tax system for such new economic transactions will take shape.

There is also a movement to unify the minimum corporate tax rate internationally, seeing tax avoidance through the use of tax havens as a problem. After some twists and turns, it is likely to be 15%.

From the perspective of tax havens, 15% is a high tax rate, but for developed countries such as Japan, where the maximum rate is about 30%, it is a low rate. However, it is necessary to create a global standard that includes agreement among low-tax countries, and cooperation among countries will be essential to avoid unfair tax competition.

In this sense, tax avoidance measures may be a catalyst for the establishment of an international tax system.

Having a sound knowledge of taxation is also in the interest of individuals

Tax saving and avoidance are not limited to corporations; they are also spreading to individuals. One of the most common inheritance tax schemes by wealthy individuals is the use of condominiums and other real estate.

In this scheme, a large amount of money is borrowed from a bank to purchase real estate. When filing inheritance tax returns, the property is valued based on the notice, and the amount borrowed from the bank is deducted from the property value to lower the amount of inheritance tax.

However, the taxation bureau issued a correction order to taxpayers who reported no inheritance tax under this scheme. The heirs filed a lawsuit against the taxation bureau, but in April 2022, the Supreme Court ruled in favor of the taxation bureau.

The court pointed out that the taxpayers had intended to significantly reduce the value of the real estate by using the valuation stipulated in the notice.

In fact, when the heirs borrowed money from the bank, it was noted on the approval form that the loan was “for inheritance planning purposes,” which was seen as an intentional attempt to avoid a large tax burden.

As mentioned earlier, in Western countries, people are highly aware of their rights to their personal property due to the way they pay taxes, and they want to protect their property from tax collection as much as possible, which is why they are also interested in how the taxes they pay are used.

On the other hand, in Japan, many taxpayers do not know how to pay taxes, but their companies take care of the procedures for them, so even though they know they are obligated to pay taxes, they do not have a high awareness of this. Recently, efforts have been made to enhance tax education, and I believe that such moves will become increasingly important in the future.

If such knowledge is cultivated, it will prevent people from paying more taxes than necessary and protect their own assets. Of course, this should not lead to excessive tax avoidance or illegal activities. In this sense, it is important to have the correct knowledge of taxation.

(I have tried to explain the above without using technical terms where possible, which makes some rough description.)

* The information contained herein is current as of march 2023.
* The contents of articles on Meiji.net are based on the personal ideas and opinions of the author and do not indicate the official opinion of Meiji University.
* I work to achieve SDGs related to the educational and research themes that I am currently engaged in.

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