🏢 Japan’s Controlled Foreign Company (CFC) / Tax Haven Rules for Corporations

💡Basic Concept

The Controlled Foreign Company (CFC) Rules, also known as Tax Haven Rules, are designed to prevent Japanese corporations from avoiding taxation by establishing subsidiaries in countries or regions with low tax rates and accumulating profits there.

Under these rules, certain income earned by a foreign subsidiary controlled by a Japanese company may be included in the Japanese parent company’s taxable income.

⚙️When the Rules Apply

A foreign subsidiary’s income may be included in the Japanese parent company’s taxable income if all of the following conditions are met:
-The Japanese corporation owns 10% or more of the foreign subsidiary’s shares.
-Japanese residents (corporate or individual) collectively own more than 50% of the foreign subsidiary, including family members or related entities residing overseas.
-The foreign subsidiary’s effective tax rate is below 20%.

⚙️The subsidiary has little or no substantial business activity in its local jurisdiction (a paper company).

Even if the effective tax rate is 20% or higher, the rules may still apply to paper companies that lack real business substance.

⚖️Exclusion Criteria (Economic Activity Test)

If the foreign subsidiary is engaged in genuine business activities, it may be excluded from the CFC inclusion under the economic activity test. This generally applies when the subsidiary:
-Has its own office, employees, and business assets in the local jurisdiction, makes key management decisions locally, and
carries out actual business operations, such as providing goods or services.

However, even if the economic activity test is met, the CFC Rules may still apply to the portion of passive income earned by the subsidiary. Passive income includes:
-Interest income
-Dividends and royalties
-Lease income
Other income derived from investment or asset management without substantive business activity.

In such cases, the passive income portion is subject to inclusion and taxation in Japan.

🧾Taxation Mechanism

When the above conditions are satisfied the income of the foreign subsidiary is added to the Japanese parent company’s taxable income, even if no dividends are distributed.
In short, profits retained abroad cannot escape taxation in Japan.

🏝️Example

If Company A (Japan) establishes Subsidiary B in a jurisdiction with an effective tax rate of 15%, and B earns interest and dividend income in addition to operational revenue, the passive income portion of B’s profits may still be taxable in Japan, even if B has local employees or operations that satisfy the economic activity test.

💬 Final Note

The CFC (Tax Haven) Rules are highly complex, involving detailed tax, accounting, and factual assessments.
It is strongly recommended to consult a qualified tax professional for case-specific advice.