Carryover Basis and Donee's Costs: The Japanese Supreme Court on Golf Club Membership Gifts and Acquisition Cost

Japanese Attorney at Law - Bengoshi L.L.

31 May 2025 • 11 min read

Case: Supreme Court, Third Petty Bench, Judgment of February 1, 2005 (Heisei 13 (Gyo-Hi) No. 276: Action for Rescission of Income Tax Reassessment Disposition) – Commonly known as the "Golf Club Membership Gift Case"

Introduction

On February 1, 2005, the Third Petty Bench of the Supreme Court of Japan delivered a significant judgment concerning the calculation of acquisition cost for capital gains tax purposes when an asset is acquired by gift and the "carryover basis" rule under Article 60, Paragraph 1 of the Income Tax Act applies. This rule generally dictates that the donee (recipient of the gift) takes over the donor's original acquisition cost and holding period. The case specifically addressed whether incidental expenses incurred by the donee at the time of receiving the gift, such as a name transfer fee for a golf club membership, could be added to the carried-over acquisition cost. The Supreme Court's decision clarified that such expenses paid by the donee are indeed includable, aiming to ensure that the tax deferral mechanism inherent in Article 60 does not lead to an overstatement of the donee's taxable gain.

The dispute involved X, who received a golf club membership as a gift from his father, A. X paid a name transfer fee and later sold the membership. The tax authority, Y, disallowed the inclusion of this fee in the acquisition cost, leading to a higher taxable gain for X.

Facts of the Case

The Gift and Initial Acquisition: On July 1, 1993, X (the appellant) received a golf club membership ("the Membership") of a golf club operated by B Company as a gift from his father, A. Upon receiving the gift, X paid a name transfer fee (名義書換手数料, meigi kakikae tesūryō) of 824,000 yen ("the Fee"). The Membership had originally been acquired by A on November 18, 1988, for a price of 12 million yen ("the Original Price").
Subsequent Sale by Donee: On April 3, 1997, X sold the Membership to C Company for 1 million yen.
Tax Filing and Dispute: In his income tax return for the 1997 tax year, X calculated his capital gain from this sale. He treated the sum of the Original Price paid by his father A (12 million yen) and the Fee he himself paid (824,000 yen) – totaling 12,824,000 yen – as the acquisition cost of the Membership. Since the sale price was 1 million yen, this resulted in a capital loss of 11,824,000 yen, which he reported as a long-term capital loss under Article 33, Paragraph 3, Item 2 of the Income Tax Act.
The director of the competent tax office (the appellee, hereinafter Y) disagreed with X's calculation. Y disallowed the inclusion of the 824,000 yen Fee in the acquisition cost, thereby reducing the recognized capital loss to 11 million yen. This led to an upward reassessment of X's total income and an accompanying underpayment penalty (collectively, "the Disposition").
X contested the Disposition through administrative appeals and, upon their rejection, filed a lawsuit in the Tokyo District Court seeking its cancellation.
Lower Court Rulings:
- The Tokyo District Court dismissed X's claim. It reasoned that "the 'amount expended to acquire assets' under Article 38 is the purchase price constituting the objective value of the asset at the time of acquisition and incidental expenses for acquiring that asset". Furthermore, under Article 60, Paragraph 1, "it is deemed that the donor continued to own the said asset throughout the period before and after the gift". Based on this, the court concluded that the Fee paid by X could not be included in the acquisition cost. It also found that the Fee was an expense for acquisition and thus not a deductible transfer expense for the subsequent sale.
- X appealed to the Tokyo High Court, which also dismissed his appeal. The High Court held that when Article 60, Paragraph 1 applies, the capital gains amount is "the difference between the value of the asset at the time the donor acquired it and its value at the time the donee transfers it". It stated that "the 'amount expended to acquire assets' should be interpreted as the purchase price constituting the objective value of the asset at the time of the donor's acquisition and incidental expenses for acquiring the said asset [by the donor]". The High Court primarily reasoned that the Fee paid by the donee could not be part of this donor-centric acquisition cost. It also agreed with the District Court that the Fee was not a transfer expense for X's sale of the membership.
  X then filed a petition for acceptance of final appeal with the Supreme Court.

The Supreme Court's Decision

The Supreme Court overturned the judgments of the High Court and the First Instance Court, ruling in favor of X. The Court held that the Fee paid by X should be included in the acquisition cost.

I. General Principles of Capital Gains Taxation and Acquisition Cost

The Court began by reiterating established principles:

"Regarding the amount of capital gains, the Income Tax Act (hereinafter 'Act') stipulates that it is calculated by deducting the acquisition cost of the asset and the expenses incurred for its transfer from the gross revenue amount (Article 33, Paragraph 3)".
"The aforementioned acquisition cost of the asset, unless otherwise provided, is the sum total of the amount expended to acquire that asset, as well as expenses for equipment and improvements (Article 38, Paragraph 1)".
"This taxation of capital gains is for the purpose of taxing, as income, the increase in value that has accrued to the owner of an asset, taking the opportunity of the asset's transfer from the owner's control to another to liquidate and tax this gain (see Supreme Court, Third Petty Bench, December 26, 1972, Minshu Vol. 26, No. 10, p. 2083 ; Supreme Court, Third Petty Bench, May 27, 1975, Minshu Vol. 29, No. 5, p. 641 )". This is the "liquidation taxation theory."
"And, it is understood that the aforementioned 'amount expended to acquire assets' includes, in addition to the purchase price that should constitute the objective value of the said asset, the amount of incidental expenses for acquiring the said asset (see Supreme Court, Third Petty Bench, July 14, 1992, Minshu Vol. 46, No. 5, p. 492 )".

II. Purpose and Mechanism of Article 60, Paragraph 1 (Carryover Basis for Gifts, etc.)

The Court then explained the rationale behind the carryover basis rule in Article 60, Paragraph 1:

"From the perspective of the aforementioned purpose of capital gains taxation, even in the case of a gift, inheritance, or bequest, capital gains tax should ideally be imposed by deeming a transfer to have occurred at a value equivalent to the fair market value of the said asset at that time (see Act Article 59, Paragraph 1)". (Article 59(1) generally applies to transfers to corporations or certain other cases, deeming a sale at fair market value).
"However, for gifts, etc., as stipulated in Article 60, Paragraph 1, Item 1 (e.g., gifts between individuals, certain inheritances/bequests), the increase in the asset's value is not concretely realized at that point in time. Therefore, imposing capital gains tax at that juncture might be difficult for the taxpayer to accept".
"Consequently, [Article 60(1)(1)] defers this taxation, opting to liquidate and tax the gain when the donee, etc., subsequently transfers the asset, thereby concretely realizing the increased value".
"Due to the provisions of this paragraph, in calculating the donee's capital gains, the expenses incurred by the donor to acquire the said asset are carried over, and the donee is taxed on the donor's accrued gain (which was tax-deferred) along with any further gain accrued during the donee's ownership. Furthermore, the donor's acquisition date is also carried over, resulting in the tacking of holding periods for the asset (see Act Article 33, Paragraph 3, Items 1 and 2) for the purpose of distinguishing between long-term and short-term gains".

III. Interpreting Acquisition Cost under Article 60(1) with Respect to Donee's Incidental Expenses

This was the core of the Court's new interpretation:

"Thus, since the main purpose of the provisions of Article 60, Paragraph 1 is the deferral of tax on the increased value, it should be said that this provision does not envisage capturing as income, in the calculation of the donee's capital gains, an amount exceeding the sum of the increased value accrued during the donee's holding period and the increased value accrued during the donor's holding period".
"And, the amount of incidental expenses incurred by the donee to acquire the asset from the donor is, by its nature, something that should be deducted from the revenue amount as 'amount expended to acquire assets' (Article 38, Paragraph 1) when calculating the increased value accrued during the donee's holding period".
"Therefore, the said amount of incidental expenses [paid by the donee] should be interpreted as falling under 'amount expended to acquire assets' in the calculation of capital gains made pursuant to Article 60, Paragraph 1".

Application to X's Case

Applying this interpretation to the facts:

"According to the aforementioned facts, the Fee in this case constitutes an incidental expense for the appellant (X) to acquire the Membership". "It is, by its nature, something that should be deducted from the revenue amount as 'amount expended to acquire assets' when calculating the increased value accrued during the appellant's holding period of the Membership".
"Consequently, the capital gains amount in this case should be calculated by treating the Fee as falling under 'amount expended to acquire assets'".
The Court then recalculated X's capital loss using the Original Price (12 million yen) plus the Fee (824,000 yen) as the total acquisition cost (12,824,000 yen). Against the sale price of 1 million yen, this resulted in a long-term capital loss of 11,824,000 yen.
Therefore, the tax office's reassessment, which disallowed the Fee and calculated a smaller loss (11 million yen) leading to a higher total income, was illegal to the extent it exceeded the income calculated with the Fee included. The Court ordered the cancellation of the excessive part of the reassessment and the entire underpayment penalty.

Commentary Insights

This 2005 Supreme Court decision is a key ruling for understanding the calculation of acquisition costs in situations involving gifted assets where a carryover basis applies.

Premise: The Meaning and Scope of Acquisition Cost

The commentary begins by referencing the "liquidation taxation theory," under which capital gains tax targets the "increase in value that has accrued to the owner of an asset". While one might initially think that acquisition cost should only include expenditures reflecting the asset's objective value (an "objective value theory"), the commentary points out that "a Supreme Court judgment of July 14, 1992 (Minshu Vol. 46, No. 5, p. 492 – Case 46 in this series) allowed the inclusion of loan interest incurred before the asset was put to use as part of the acquisition cost, citing the deductibility of transfer expenses". "Transfer expenses can include items like transportation costs, the amount of which can vary based on subjective circumstances of the transfer". "To that extent, it can be said that the calculation of capital gains already aimed to approximate the actual gain enjoyed by the asset owner". "Therefore, acquisition cost would also likely include expenses whose amount or incurrence is influenced by subjective aspects of the acquisition method, as long as they can be understood as 'expended to acquire the asset'".
Furthermore, "a Supreme Court judgment of April 20, 2006 (Hanrei Jihō No. 1933, p. 76) stated that [deductibility of transfer expenses] should be judged based on whether the expense was objectively necessary to realize the transfer, given how the transfer was actually conducted," thereby "confirming that subjective circumstances of the transfer can affect the amount of capital gains". The legal landscape concerning the deductibility of registration taxes and real property acquisition taxes for gifted or inherited property used in a business also underwent changes around the time of this ruling.

Significance and Interpretation of Article 60(1)

Article 60, Paragraph 1 of the Income Tax Act mandates a carryover basis for assets acquired through gift or inheritance, meaning the recipient is "deemed to have...continuously owned" the asset. However, "the statutes do not provide specific details on how exactly the acquisition cost, etc., should be calculated" in such cases. The tax authority's argument in this case effectively was that "the donee and donor should be treated as completely identical, and thus facts surrounding the gift itself should be disregarded in calculating capital gains".
The Supreme Court "rejected this, focusing on the legislative history, noting that the scope of Article 60(1) expanded as the scope of Article 59(1) (which deems transfers at fair market value) was narrowed". The core purpose of Article 60(1) "is to tax the donor's untaxed accrued gain in the hands of the donee by carrying over the donor's basis (requiring the donee to accept a 'transferred basis')". It "is not intended to tax the donee's own accrued gain in a manner inconsistent with general capital gains principles or to overstate it".
The commentary finds the Supreme Court's logic that the donee's gain is "grafted" onto the donor's, while also having a separate holding period consideration for the donee's expenses, to be "somewhat lacking in persuasiveness". "However," it continues, "it is undeniably true that denying the donee's acquisition expenses only in Article 60(1) cases... would unfairly inflate the donee's taxable gain compared to other taxpayers, creating an imbalance. This judgment is positively evaluated for resolving this inequity".
Nevertheless, the commentary concedes that "the Court's interpretation of Article 60(1) is not one that can be easily derived from the literal wording of the statute, and early legislative amendment to explicitly state this would be desirable". It contrasts this with Article 58 (tax deferral for asset exchanges), where "Income Tax Enforcement Order Article 168 explicitly clarifies that transfer expenses and incidental costs can be added to the exchanged basis, and that holding periods can be tacked".
The commentary also suggests that any future legislative clarification "should also examine the appropriateness of allowing the donee to inherit the donor's losses" if the asset had depreciated in the donor's hands. This is because "the legislative intent of 'taxpayer unacceptability' of tax at the time of gift (due to no concrete realization), as stated by this judgment, would argue against allowing loss carryover under Article 60(1), unless one assumes a change in the taxable unit".

Relationship between Article 60(1) and Article 9(1)(17) (Non-taxable Income from Gifts)

While this judgment "does not directly address the relationship between Article 60(1) and Article 9(1)(17) (which makes income from gifts non-taxable for income tax purposes because it is subject to gift or inheritance tax), a topic that became a subject of discussion following a Supreme Court judgment of July 6, 2010 (Minshu Vol. 64, No. 5, p. 1277 – Case 34 in this series)", the commentary suggests that "the theory of this judgment implicitly denies that the donor's accrued gain becomes non-taxable income for the donee under Article 9(1)(17) at the time of the gift". "Fundamentally, accrued gain is conceptualized starting from the 'amount expended to acquire'. If Article 9(1)(17) were fully applied at the gift stage, the donee's basis would logically be the fair market value at the time of the gift plus any incidental expenses like the Fee in this case". "However, the theory of this judgment, which understands that the gain is the difference between the sale price and the donor's original cost plus the donee's incidental expenses, strongly suggests an interpretation that the donee has already received the benefit of Article 9(1)(17) at this stage (by not being taxed on the gift's value as income at the time of receipt)".

Broader Implications and Discussion

This Supreme Court decision has several important implications for taxpayers and tax practitioners:

Inclusion of Donee's Incidental Costs: It clarifies that when a carryover basis applies under Article 60(1), legitimate incidental acquisition expenses paid by the donee (like name transfer fees, registration costs, etc.) can be added to the donor's carried-over cost to arrive at the total acquisition cost for the donee.
Preventing Over-Taxation under Deferral Rules: The ruling emphasizes that tax deferral mechanisms should not be interpreted in a way that ultimately results in a higher overall tax burden on the combined gains of the donor and donee than if the asset had been sold directly by the donor or acquired normally by the donee.
Need for Legislative Clarity: The case highlights areas where the statutory language regarding complex tax provisions, particularly those involving interactions between different principles like realization, deferral, and non-taxable income, could benefit from greater clarity to avoid interpretive disputes.
Substance in Tax Deferral: The Court looked to the substance of the tax deferral – ensuring the donor's untaxed gain is eventually taxed to the donee, without unfairly penalizing the donee for their own legitimate acquisition-related outlays.

The "Considerations for Discussion" in the provided commentary raise a pertinent question: "When assets are acquired through inheritance or gift from an individual, inheritance tax or gift tax is imposed. Should these tax amounts also be included in the acquisition cost as incidental expenses for acquisition by inheritance or gift, even without applying Article 39 of the Act on Special Measures Concerning Taxation (which allows inclusion of inheritance tax in certain cases)?".

Conclusion

The Supreme Court's February 1, 2005, judgment in the "Golf Club Membership Gift Case" provides crucial guidance on calculating the acquisition cost of gifted assets under Japan's carryover basis regime. By allowing the donee to include their own incidental acquisition expenses, such as name transfer fees, in the total acquisition cost, the Court ensured that the tax deferral mechanism of Article 60, Paragraph 1 of the Income Tax Act does not lead to an unfair overstatement of the donee's taxable capital gain. This decision underscores a principle of fairness in the application of tax deferral rules and acknowledges the economic reality of costs incurred by recipients of gifts.