Satoshi Watanabe

Satoshi Watanabe

The Japanese government is strengthening the oversight of overseas patent transfers, especially those by companies aiming to reduce tax burdens by transferring licence revenues to a subsidiary – typically a shell company – established in a state or territory with lower tax rates. This report highlights a recent Supreme Court ruling which may help companies to judge whether anti-tax haven rules apply to their foreign IP management subsidiaries.

On October 24 2017 the Supreme Court reversed the taxation based on the controlled foreign company (CFC) rules (also referred to as anti-tax haven rules) that had been imposed on the income of a DENSO subsidiary in Singapore.

Under the CFC rules, income arising from a foreign subsidiary located in a state or territory with significantly lower tax rates is deemed to arise as the income of the parent company under certain conditions – for example, when its principal business is holding shares or bonds, or licensing IP rights. However, the CFC rules do not apply when the subsidiary is a substantial independent company and it makes rational economic sense for the subsidiary to conduct business in the state or territory. Specifically, the CFC rules do not apply to a subsidiary that meets all of the following criteria:

  • its principal business is something other than holding shares or bonds, licensing industrial property rights or any other rights concerning technology;
  • it has an office, store, factory or any other fixed facility that is considered necessary for conducting its principal business in the state or territory where its head office or principal office is located;
  • it manages, controls and operates the business itself; 
  • if its principal business is wholesale, banking, trust, securities, insurance, water transport or air transport, then it conducts business mainly with a person other than a pre-defined related party, and if its principal business is not one of these, then it conducts a business mainly in the state or territory where its head office or principal office is located.

The Supreme Court ruled that principal business should be determined by companies' concrete and objective business activities in a fiscal year. In order to determine the principal business of a company that conducts multiple businesses, the following aspects should be comprehensively examined:

  • total revenue (ie, income from each business activity);
  • number of employees required for each business activity; and
  • location of offices, shops, factories and any other fixed facilities.

DENSO’s Singapore subsidiary managed subsidiaries or affiliates in other territories, including member states of the Association of Southeast Asian Nations (ASEAN), and while the income from services to improve logistics in those territories represented 85% of its revenue, between 80% and 90% of its pre-tax income came from dividends on the shares of its subsidiaries and affiliates. 

The Supreme Court held that the Singapore subsidiary, with reasonable size and substance, had conducted a broad range of businesses – including finance and logistics – with the economically rational purpose of streamlining its ASEAN operations, and judged the taxation based on the CFC rules to be illegal.

In light of the Supreme Court's decision, companies with foreign IP management subsidiaries should ensure that all such subsidiaries with a reasonable number of employees are conducting concrete and objective business activities in addition to IP management, thereby avoiding the application of the CFC rules.

For further information please contact:

Satoshi Watanabe
Shobayashi International Patent & Trademark Office
www.sho-pat.com
Email: satoshi.watanabe@sho-pat.com
Tel: +813 6895 4600