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6. Cross-Border Business Restructurings and Outbound Transfer of Assets - Lessons from US Anti-Inversion Measures and EU Exit Charges -

Executive Summary

�T　Issue of Concern

　Against the background of the accelerating move in many major countries toward further clearance of impediments for cross-border business activities which might involve transfer of corporate assets, function, etc., especially to foreign affiliates in low tax countries, the problem of their tax base erasion caused by the inability to tax properly such migrating assets has become quite conspicuous latetly. Japan is no exception in this respect and the problem is likely to aggravate in the aftermath of recent tax reforms. Among those recent tax reforms, quite notable in this respect are; (�@) a cross-border triangular merger has become possible since 2007 owing to the enactment and implementation of the New Company Law, (�A) a foreign dividend exemption method was introduced by the 2009 tax reform, and (�B) Japanese CFC rule was reformed by the 2010 tax reform in such a way that the tax rate in a foreign country that triggers its application is now 20％ instead of 25％.
Certainly the Japanese tax system is equipped with the transfer pricing rule, the anti-corporate inversion measure, the earnings stripping rule, and so forth, but some might wonder and some others might apprehend that the counter-measures represented by those rules might not be effective enough to curb sufficiently the erosion of its tax base that is likely to become worse in the aftermath of the above-mentioned tax reforms and the majority of future tax reforms expected to be implemented mostly in the same direction. Such apprehension has prompted this paper and it aims at exploring some possible measures that could supplement the function of the current counter-measures. In exploring such measures, the paper mainly looks to some other major countries for their counter-measures and analyzes their potentials and limits. Through such analysis, lessons are drawn and attemps are made to propose ways by which they could be applied in restructuring Japan’s counter-measures.

�U　Chapter 1 ― Criteria for Corporate Residency and Exit Tax

　In many EU Member States,the concept of place of effective management or the real seat theory is adopted as the principal rule for determining a corporate residence. Such concept is more effective than the concept of place of incorporation or the incorporation theory in counteracting such a global tax planning as the management controlling from its country of presence a corporation registered in a foreign low tax country. In many cases, it also prevents the erosion of the countries’tax bases when a corporation transfers its management and control to a foreign country by deeming such transfer as liquidation. Lately, however, its preventive effect has diminished now that the European Council has adopted the Statute for a European company( Societas Europeae, SE ) that enables a company established in a Member State to opt for SE which can transfer its registered seat to another Member State without going into liquidation.
The ECJ has also expressed, in such cases as the Inspire Art case( C-167/01 ) a view that a company’s tax planning of differentiating a country of its principal business activity from a country of its registration is not necessarily abusive and could be an exercise of the right of freedom of establishment. This line of thinking is also observable in the ECJ’s view of exit taxes adopted in many EU Member States. Exit taxes have served for many years as effective means for protecting many countries’tax bases because, under the conventional exit tax regimes, capital gains of assets are deemed to be realized at the time of their departure from their home country. But they are now at stake because the ECJ has ruled in the Hughes de Lasteryie case ( C-9/02 ) that the French exit tax on individuals violate the freedom of establishment guaranteed by the EC Treaty.

�V　Chapter 2 ― EU States’ Moves toward Stronger Counter-Measures

　Now that the EU Commission has expressed a view that the above-mentioned Hughes de Lasteryie case has implications for exit taxes on companies as well, there is some suspicion that exit taxes on companies might also violate the principle of freedom of establishment. But, such suspicion was not substantiated in the Cartesio case( Case C-210/06 ) in which the ECJ ruled that the present EU law does not preclude a Member State’s legislation under which a company incorporated under the law of the Member State may not transfer its seat to another Member States whilist retaining its status as a company governed by the law of the Member State of incorporation. Taking advantage of such judgement etc., some countries such as Norway and Germany have moved in the direction of strengthening the function of their exit tax regime or extending the applicational scope of the “realization approach” incorporated in it.
The above-mentioned moves shown by such countries as Norway and Germany are in response to the apprehension of the tax authorities of those countries about the likelihood of their tax base erosion through the transfer of their domestic corporations’ intangibles and other valuables to foreign countries without those assets properly taxed under the conventional exit tax regimes. The OECD has also recognized the need for clarifying how the transfer pricing taxation regime should be applied to those valuables when they are transferred abroad in business restructurings and it added in 2010 Chapter IX to its Transfer Pricing Guideline. The Chapter provides some useful guidelines but it also reflects a fairly large difference of views which allow some of them to be interpreted in one’s own interest, making it difficult to see clearly enough how much the above-mentioned moves are in line with the Guideline.

�W　Chapter 3 ― US Counter-Measures and Their Potentials

　In the case of US, IRC§367 which is called “outbound toll charge”served for a long time as a means to curb the erosion of its tax base by imposing tax on capital gains of shares deemed to be realized in the otherwise tax-free cross-border corporate reorganization. However, it had come to be realized that it was not effective enough for the prevention of corporate inversions and IRC§7874 which incorporates both the “jurisdiction approach” and the“ realization approach”was introduced in 2004. Under the the jurisdiction approach adopted in IRC§7874, a foreign parent company newly formed through the corporate inversion is deemed a dometic corporation for income tax purpose, if it can be defined as a surrogate foreign corporation because its 80％ or more of the shares are held by the domestic corporation’s old shareholders and it is void of substantial business activity in the foreign country.
Underlying beneath the fact of IRC§7874 incorporating in it the “jurisdiction approach”is the strong recognition on the part of the Treasury and the IRS that the main problem with corporate inversions lies in the post-inversion earnings stripping of the domestic corporation by its foreign affiliates and this problem can not be coped with well enough under those measures which depend much on the “realization approach”. In fact,there were lately some moves to strengthen the function of the “jurisdiction approach” as in the case of the rewriting in 2009 of some of the treasury regulations on IRC§7874 and also repeated attempts by such Congress and Senate members as Mr. Lloyd Dogget and Mr. Carl Levin to introduce the place of effective management concept to make up for the limit inherent in the place of incorporation principle for the prevention of erosion of its tax base.

�X　Chapter 4 ― Options for Japan

　The analysis in the foregoing Chapters reveal that Japan’s anti-corporate inversion measure which is based on the “aggregation approach” and the“realization approach”could be fortified by extending the applicational scope of the aggregation approach or/and the realization approach but it could also be strengthened by incorporating in it the “jurisdiction approach”. In view of the difference in the approaches adopted in Japan and US, some propose that Japan’s anti-corporate inversion measure should also incorporate in it the “jurisdiction approach, while some others propose the extension of of applicational scope of the “aggregation approach” by questioning the reasoning behind the current system which fail to catch a cross-border triangular merger that involves a big domestic corporation.
It is true that the function of Japan’s anti-inversion measure could be strengthened by following the ways of reform expressed in the above proposals but they would entail some administrative difficulty and problem of international double taxation. Their effectivenss would also be reduced by the 2010 tax reform which lowered significantly the threshold tax rate that triggers Japan’s CFC rule. Therefore, the paper concludes that the “ realization approach” incorporated in exit charges offers much in contemplating options of possible couter-measures and such options might be recommendable now that some domestic court cases have revealed that Japan’s current tax system and administration should be particularly vulnerable to the outbound transfer of intangibles, etc. and there is much to learn from the legislative measures taken in such countries as US and Germany that are based much on the “realization approach”for the prevention of their tax base erosion.

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