BEPS and Japan: How is Japan Implementing OECD/G20 Recommendations on International Tax Avoidance?

Japanese Attorney at Law - Bengoshi L.L.

• 7 min read

The early 21st century has witnessed a significant global movement to address international tax avoidance by multinational enterprises (MNEs). Spearheaded by the Organisation for Economic Co-operation and Development (OECD) and the G20 nations, the Base Erosion and Profit Shifting (BEPS) Project has aimed to equip governments with domestic and international instruments to tackle strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. Japan has been an active participant in this initiative. This article explores Japan's response to the BEPS Project and how key recommendations are being incorporated into its domestic tax laws and tax treaty policies.

1. Understanding the BEPS Project

The term "Base Erosion and Profit Shifting" (BEPS) refers to tax planning strategies used by MNEs that take advantage of inconsistencies in national tax laws and tax treaty provisions to minimize their overall corporate tax liability. This can result in MNEs paying little or no corporate tax globally, despite having significant economic activities. The BEPS Project, which delivered its final reports in 2015, outlined 15 Action Items designed to provide countries with a comprehensive framework to combat such avoidance, ensure profits are taxed where economic activities generating them occur and where value is created, and restore trust in the international tax system.

The core themes of the BEPS Project revolve around:

  • Ensuring coherence of corporate income taxation at the international level.
  • Realigning taxation with substance and value creation.
  • Promoting transparency and certainty.

2. Japan's Engagement and General Approach

Japan has been a strong proponent of the BEPS Project, actively contributing to the development of the action plans and committing to their implementation. The Japanese government has viewed BEPS as crucial for securing its corporate tax base and ensuring a level playing field between MNEs and domestic businesses.

While some perspectives suggest that Japanese MNEs have historically been less aggressive in engaging in the types of BEPS activities seen elsewhere, they are often subject to aggressive tax audits and transfer pricing adjustments in foreign jurisdictions. This context underscores Japan's interest in robust international tax rules and, importantly, effective dispute resolution mechanisms (BEPS Action 14) to prevent double taxation arising from BEPS-related adjustments.

Japan's implementation strategy has involved a combination of domestic legislative changes and active participation in multilateral efforts, such as the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the "Multilateral Instrument" or MLI).

3. Implementation of Key BEPS Actions in Japan

Japan has taken steps to implement various BEPS recommendations, particularly the minimum standards. Here's how some of the key BEPS Actions are reflected in Japanese tax law and policy:

A. Action 13: Transfer Pricing Documentation and Country-by-Country Reporting (CbCR)
Transparency in transfer pricing has been a central focus of BEPS. Action 13 introduced a standardized three-tiered approach to transfer pricing documentation:

  1. Master File: Providing a high-level overview of the MNE group’s global business, its transfer pricing policies, and its allocation of income and economic activity.
  2. Local File: Providing detailed information specific to the local taxpayer's transactions with foreign related parties, including a comparability analysis.
  3. Country-by-Country (CbC) Report: For MNE groups exceeding an annual consolidated group revenue threshold of €750 million, the CbC Report requires aggregate jurisdiction-level information on revenue, profit before tax, income tax paid and accrued, stated capital, accumulated earnings, number of employees, and tangible assets. It also requires a listing of all constituent entities by tax jurisdiction.

Japan has implemented these CbCR and documentation requirements into its Act on Special Measures Concerning Taxation (ASMT). This enhances the information available to the National Tax Agency (NTA) for transfer pricing risk assessment.

B. Action 3: Strengthening Controlled Foreign Corporation (CFC) Rules
BEPS Action 3 aimed to develop recommendations for the design of effective CFC rules that prevent the shifting of profits to low-tax foreign subsidiaries. Japan has had CFC rules (タックス・ヘイブン対策税制 - takkusu heibun taisaku zeisei) in place since 1978 (ASMT Art. 66-6). These rules attribute certain undistributed income of foreign subsidiaries in low-tax jurisdictions to their Japanese parent companies for current taxation.

While Japan's CFC rules predate the BEPS Project, their ongoing relevance and effectiveness are viewed in the BEPS context. The BEPS Project encourages robust CFC rules that target artificial profit shifting. Japan's system, with its "trigger tax rate" (currently less than 20%) and active business exemptions (though with a carve-out for certain passive income), aligns with the general spirit of BEPS Action 3 by seeking to tax passive or artificially diverted income held in low-tax environments. Discussions within the BEPS framework have also considered whether CFC rules should primarily target profit shifting from the parent country or also from third countries to low-tax jurisdictions, an issue relevant to the design of modern CFC regimes.

C. Action 4: Limiting Base Erosion via Interest Deductions and Other Financial Payments
BEPS Action 4 provided recommendations for rules to limit base erosion through interest expense deductions and other financial payments. Japan introduced earnings stripping rules (過大支払利子税制 - kadai shiharai rishi zeisei) in its 2012 tax reform (ASMT Art. 66-5-2), which limit a company's net interest deductions to related parties to 50% of its "adjusted taxable income" (akin to EBITDA). This fixed-ratio approach is generally consistent with the BEPS Action 4 recommendations. Japan also has thin capitalization rules (ASMT Art. 66-5) that predate BEPS but serve a similar anti-avoidance purpose for inbound investment.

D. Action 6: Preventing Treaty Abuse
BEPS Action 6 focused on preventing the granting of tax treaty benefits in inappropriate circumstances, particularly to tackle treaty shopping. This is a BEPS minimum standard. The recommendations include incorporating into tax treaties:

  1. A clear statement that the contracting states, when entering into a treaty, intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty-shopping arrangements.
  2. A specific anti-abuse rule, such as a Limitation on Benefits (LOB) clause (often detailed and more common in U.S. treaties), a Principal Purpose Test (PPT), or both.

Japan has long included LOB clauses in some of its key treaties (e.g., with the United States and the United Kingdom). Through the Multilateral Instrument (MLI, discussed under Action 15), Japan is in the process of adopting further anti-treaty abuse provisions, including the PPT, across a wider range of its tax treaty network.

E. Action 7: Preventing the Artificial Avoidance of Permanent Establishment (PE) Status
BEPS Action 7 aimed to counter common strategies used to artificially avoid having a taxable presence (PE) in a country, such as through commissionnaire arrangements or the fragmentation of business activities to qualify for specific activity exemptions in the PE definition. Japan's adoption of the Authorized OECD Approach (AOA) for PE profit attribution in its 2014 domestic law reforms already strengthened the principles for taxing PEs based on economic substance. The MLI is also being used by Japan to modify its treaties to incorporate certain BEPS recommendations designed to make it harder to artificially avoid PE status.

F. Action 2: Neutralizing the Effects of Hybrid Mismatch Arrangements
BEPS Action 2 developed recommendations to neutralize the tax effects of hybrid mismatch arrangements, which exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions, leading to double non-taxation or long-term deferral. Japan has taken steps in this area. For example, the 2015 tax reform amended the foreign subsidiary dividend exemption system (Corporation Tax Act Art. 23-2) to exclude dividends that are deductible for tax purposes in the paying subsidiary's country. This directly addresses a common type of hybrid mismatch outcome.

G. Action 14: Making Dispute Resolution Mechanisms More Effective
With increased international tax enforcement and the implementation of BEPS measures, the risk of tax disputes and double taxation can rise. BEPS Action 14, another minimum standard, aims to make dispute resolution mechanisms, particularly the Mutual Agreement Procedure (MAP) under tax treaties, more effective, efficient, and timely. Japan has committed to this minimum standard and has been working to improve its MAP processes. It has also adopted mandatory binding MAP arbitration in some of its newer treaties and through the MLI, providing greater certainty for taxpayers that disputes will be resolved.

H. Action 15: Developing a Multilateral Instrument (MLI)
To facilitate the swift implementation of the treaty-related BEPS measures (such as those for hybrid mismatches, treaty abuse, PE avoidance, and dispute resolution) across the vast global network of bilateral tax treaties, Action 15 led to the development of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the MLI). Japan is a signatory to the MLI and has submitted its provisional list of tax treaties to be covered and its choices regarding optional provisions. The MLI is a significant tool that allows Japan to efficiently update its treaties to incorporate BEPS standards without needing to renegotiate each treaty individually.

4. Broader Context: Harmful Tax Competition and Transparency

The BEPS Project builds upon earlier OECD work on harmful tax competition, which began in the late 1990s. The 1998 OECD report "Harmful Tax Competition: An Emerging Global Issue" identified criteria for harmful tax practices, initially focusing on no or nominal taxation, lack of effective exchange of information, lack of transparency, and absence of substantial activities. Over time, the focus increasingly shifted towards improving transparency and ensuring effective exchange of information for tax purposes, championed by the Global Forum on Transparency and Exchange of Information for Tax Purposes. These efforts laid crucial groundwork for the comprehensive approach taken by the BEPS Project.

5. Impact and Ongoing Efforts

Japan's implementation of BEPS measures has led to significant changes in its domestic tax laws and is reshaping its tax treaty network through the MLI. For MNEs operating in or with Japan, these changes mean:

  • Increased transparency and reporting requirements (e.g., CbCR, Master File/Local File).
  • Heightened scrutiny of international tax planning structures, especially those involving low-tax jurisdictions, hybrid arrangements, or aggressive transfer pricing.
  • More robust anti-abuse provisions in tax treaties.
  • Improved access to, and effectiveness of, dispute resolution mechanisms like MAP.

The BEPS Project is not a one-off initiative but an ongoing process, with continued monitoring of implementation and further work in certain areas. Japan remains committed to these international efforts to ensure a fairer and more coherent global tax system.

Conclusion

Japan has demonstrated a strong commitment to the OECD/G20 BEPS Project by actively participating in its development and moving forward with the implementation of its recommendations. Through domestic legislative reforms and the use of the Multilateral Instrument, Japan is reinforcing its tax system against base erosion and profit shifting strategies. For multinational enterprises, this means navigating a more complex but also a more internationally coordinated tax environment, where substance over form, transparency, and alignment of taxation with value creation are paramount principles. Staying abreast of these evolving rules and their practical application in Japan is crucial for international tax compliance and planning.