Tax Law

Japan Embraces Pillar Two: Understanding the New Global Minimum Tax Rules and Their Impact on Multinationals

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read
Slide mapping Japan’s Pillar Two rollout: 15 % global minimum tax timeline, IIR calculation flow, CbCR safe-harbor tests and compliance checklist for MNEs.

TL;DR

  • Japan implements the OECD Pillar Two 15 % global minimum tax from fiscal years starting 1 Apr 2024 via a stand-alone Income Inclusion Rule (IIR).
  • Top-up tax applies to MNE groups with €750 m+ revenue; Japan follows OECD GloBE mechanics, offers CbCR safe harbors through 2026, and will add UTPR/QDMTT later.
  • US-headquartered groups must model ETR gaps, collect GloBE data and prepare GIR filings within 15 months of year-end.

Table of Contents

  • The OECD's Global Minimum Tax Framework: A Brief Overview
  • Japan's 2023 Tax Reform: Implementing the IIR
  • Calculating the Top-Up Tax: Key Steps in Japan
  • IIR Allocation and Tax Rate in Japan
  • Simplifying Compliance: Transitional CbCR Safe Harbors
  • Compliance and Administration in Japan
  • Effective Date and What Lies Ahead
  • Conclusion

The international tax landscape is undergoing a seismic shift, driven largely by the OECD/G20 Inclusive Framework's two-pillar solution to address the tax challenges arising from the digitalization of the economy. Pillar Two, specifically, aims to establish a global minimum effective corporate tax rate of 15% for large multinational enterprises (MNEs). Japan has moved swiftly to integrate this framework into its domestic law, enacting key components of the Pillar Two Global Anti-Base Erosion (GloBE) rules as part of its 2023 Tax Reform.

Effective for fiscal years beginning on or after April 1, 2024, these new rules introduce a top-up tax mechanism primarily through an Income Inclusion Rule (IIR). This development holds significant implications for US-based and other MNE groups operating within the scope of the rules, necessitating a thorough understanding of Japan's approach and proactive preparation for compliance.

The OECD's Global Minimum Tax Framework: A Brief Overview

Before delving into Japan's specific legislation, it's helpful to recall the architecture of the OECD's Pillar Two GloBE rules. The core objective is to ensure that MNE groups with consolidated global revenues exceeding €750 million pay an Effective Tax Rate (ETR) of at least 15% on their profits in each jurisdiction where they operate.

The GloBE rules employ a system of interlocking mechanisms:

  1. Income Inclusion Rule (IIR): This primary rule imposes a top-up tax on a parent entity with respect to the low-taxed income of its foreign constituent entities. It generally applies top-down, starting with the Ultimate Parent Entity (UPE).
  2. Undertaxed Profits Rule (UTPR): Acting as a secondary or backstop rule, the UTPR applies when the IIR doesn't fully capture low-taxed income (e.g., if the UPE jurisdiction hasn't implemented an IIR). It allows other jurisdictions where the MNE group operates to collect a portion of the remaining top-up tax, typically by denying deductions or requiring an equivalent adjustment.
  3. Qualified Domestic Minimum Top-up Tax (QDMTT): This allows a jurisdiction to impose a top-up tax on the excess profits of domestic constituent entities within an MNE group that are taxed below the 15% minimum rate. Crucially, any tax paid under a QDMTT generally reduces the top-up tax liability calculated under the IIR or UTPR for other jurisdictions concerning that same income, effectively giving the source jurisdiction the first right to tax profits up to the 15% minimum.

The entire system relies heavily on standardized definitions and calculation methodologies outlined in the OECD Model Rules, Commentary, and administrative guidance to ensure international consistency.

Japan's 2023 Tax Reform: Implementing the IIR

Japan's 2023 Tax Reform introduced the "Corporate Tax on the Global Minimum Taxable Amount" (国際最低課税額に対する法人税 - Kokusai Saitei Kazeigaku ni Taisuru Hōjinzei), effectively implementing the IIR. Notably, this was established as a distinct national tax, separate from the existing Corporate Income Tax Law, alongside a corresponding "Local Corporate Tax on the Specified Base Corporate Tax Amount" (特定基準法人税額に対する地方法人税 - Tokutei Kijun Hōjinzeigaku ni Taisuru Chihō Hōjinzei). This structure likely reflects the need to allocate revenue appropriately between national and local levels.

1. Scope of Application:

  • MNE Group Threshold: The rules apply to "Specified Multinational Enterprise Groups, etc." (特定多国籍企業グループ等 - Tokutei Takokuseki Kigyō Gurūpu Tō). This aligns with the OECD standard, targeting MNE groups whose total consolidated revenue was €750 million or more in at least two of the four fiscal years immediately preceding the tested fiscal year.
  • Jurisdictional Presence: The group must have constituent entities or permanent establishments (PEs) located in two or more jurisdictions. Purely domestic groups are outside the scope.
  • Excluded Entities: Certain types of entities are specifically excluded from being constituent entities subject to the GloBE rules, even if part of an in-scope MNE group. These include governmental entities, international organizations, non-profit organizations, pension funds, and certain investment funds or real estate investment vehicles that are Ultimate Parent Entities (UPEs), along with specific holding vehicles owned by these entities. This largely mirrors the OECD Model Rules.
  • International Shipping: Income derived from international shipping activities and qualified ancillary activities is excluded from the GloBE tax base calculation, reflecting the unique nature and often separate tax regimes applicable to this industry globally.

2. Liable Taxpayer under the IIR:

The IIR imposes the top-up tax liability on parent entities within the MNE group. Under Japan's rules, Japanese parent entities (including intermediate parent entities and partially-owned parent entities) will be liable for their allocable share of the top-up tax calculated for low-taxed foreign constituent entities in which they hold an ownership interest. The liability flows down the ownership chain if higher-level parent entities are not subject to a qualified IIR.

Calculating the Top-Up Tax: Key Steps in Japan

The calculation process under Japan's IIR closely follows the OECD's GloBE framework, performed on a jurisdictional basis.

1. Determine GloBE Income or Loss:

  • Starting Point: The calculation begins with the financial accounting net income or loss of each constituent entity as used in preparing the UPE's consolidated financial statements (under an acceptable financial accounting standard like IFRS or relevant GAAP).
  • Adjustments: This accounting profit/loss is then adjusted according to GloBE rules to arrive at the GloBE Income or Loss. Adjustments align accounting concepts with tax principles, primarily addressing permanent differences between book and tax income (e.g., excluding dividends from GloBE income under certain conditions, adjusting for specific stock-based compensation expenses, adding back certain fines and penalties).

2. Determine Adjusted Covered Taxes:

  • Covered Taxes: These are generally taxes recorded in the financial accounts of the constituent entity with respect to its income or profits, including taxes imposed under Controlled Foreign Company (CFC) regimes.
  • Adjustments: The current tax expense accrued in the financial accounts is adjusted for several items, including:
    • Taxes not related to income (e.g., indirect taxes, resource taxes).
    • Amounts related to uncertain tax positions.
    • Crucially, adjustments for temporary differences between accounting and tax treatment, primarily managed through deferred tax accounting. Japan's rules incorporate specific adjustments to deferred tax expense, including a recapture mechanism for temporary differences that do not reverse within five years.

3. Calculate the Jurisdictional Effective Tax Rate (ETR):

The ETR for each jurisdiction is calculated by dividing the sum of the Adjusted Covered Taxes of all constituent entities located in that jurisdiction by the Net GloBE Income of that jurisdiction (the aggregate GloBE Income less the aggregate GloBE Loss of entities in that jurisdiction).
ETR = Jurisdictional Adjusted Covered Taxes / Jurisdictional Net GloBE Income

4. Calculate the Top-Up Tax Percentage:

If the jurisdictional ETR is below the 15% minimum rate, a Top-Up Tax Percentage is calculated:
Top-Up Tax Percentage = 15% - ETR
(If ETR is 15% or above, the percentage is zero).

5. Determine the Jurisdictional Top-Up Tax:

  • Substance-Based Income Exclusion (SBIE): Before applying the top-up rate, the GloBE rules provide a carve-out for income attributable to substantive activities within a jurisdiction. This SBIE is calculated based on a percentage of the carrying value of eligible tangible assets and eligible payroll costs located in the jurisdiction. For the initial years (including 2024 when Japan's rules take effect), the carve-out is 8% for tangible assets and 10% for payroll, gradually decreasing over ten years to 5% for both.
  • Excess Profit: The jurisdictional Net GloBE Income is reduced by the SBIE to arrive at the Excess Profit.
  • Calculation: The Jurisdictional Top-Up Tax is calculated as:
    Jurisdictional Top-Up Tax = (Net GloBE Income - SBIE) * Top-Up Tax Percentage
  • Impact of QDMTT: If the jurisdiction has implemented a qualified QDMTT, the amount of tax paid under that QDMTT related to the constituent entities' profits will reduce the Jurisdictional Top-Up Tax calculated for IIR purposes (potentially to zero).

IIR Allocation and Tax Rate in Japan

Once the Jurisdictional Top-Up Tax is determined for a low-taxed jurisdiction, Japan's IIR allocates that tax liability to the Japanese parent entities holding ownership interests in the relevant constituent entities.

  • Allocation: The allocation is based on the parent entity's proportionate share of the GloBE income of the low-taxed constituent entity. Complex rules apply for tiered structures. Importantly, the calculation effectively excludes the portion of the top-up tax attributable to non-controlling interests.
  • Taxable Base: The sum of the amounts allocated to a Japanese parent entity from all low-taxed jurisdictions constitutes its "Taxable Base International Minimum Tax Amount" (課税標準国際最低課税額 - Kazei Hyōjun Kokusai Saitei Kazeigaku).
  • Tax Rate: This tax base is subject to the "Corporate Tax on the Global Minimum Taxable Amount" at a rate of 100/90.7. Additionally, the "Local Corporate Tax on the Specified Base Corporate Tax Amount" applies to this national tax amount at a rate of 9.3/90.7. The combined effect ensures that the tax collected by Japan corresponds appropriately to its share of the 15% global minimum tax framework, accounting for the division between national and local corporate tax revenues.

Simplifying Compliance: Transitional CbCR Safe Harbors

Recognizing the complexity and compliance burden associated with the full GloBE calculations, the OECD framework includes provisions for safe harbors. Japan has adopted the Transitional Country-by-Country Reporting (CbCR) Safe Harbors outlined in the OECD guidance.

These safe harbors use data readily available from an MNE group's CbC Report to provide temporary relief from the detailed GloBE calculations for certain lower-risk jurisdictions. If a jurisdiction meets one of the following three tests for a fiscal year during the transition period (generally fiscal years beginning up to December 31, 2026), the top-up tax for that jurisdiction is deemed to be zero for that year:

  1. De Minimis Test: The jurisdiction has total revenue of less than €10 million and profit before income tax of less than €1 million according to the CbC Report.
  2. Simplified ETR Test: The jurisdiction has a "Simplified ETR" (calculated using CbCR data and simplified covered tax figures from financial statements) equal to or greater than the specified transition rate (15% for 2024, 16% for 2025, 17% for 2026).
  3. Routine Profits Test: The jurisdiction's profit before income tax is equal to or less than the SBIE amount calculated under the GloBE rules.

MNE groups must elect to apply these safe harbors annually. While offering significant temporary relief, groups must still collect the necessary data to perform the tests and eventually transition to the full GloBE calculations when the safe harbor period ends or if a jurisdiction fails the tests.

Compliance and Administration in Japan

The introduction of the global minimum tax brings new compliance obligations for affected Japanese entities:

  • Tax Return Filing: A Japanese constituent entity liable under the IIR must file a specific tax return for the "Corporate Tax on the Global Minimum Taxable Amount" and pay the tax due. The deadline is generally 13 months after the end of the relevant Target Fiscal Year (with a potential extension to 16 months for the initial year).
  • GloBE Information Return (GIR): A standardized GloBE Information Return (GIR) containing detailed information required for the GloBE calculations must be submitted. Generally, each constituent entity located in Japan is required to file the GIR. However, this requirement may be waived if another entity within the group (e.g., the UPE or a designated filer) files the GIR in a jurisdiction with which Japan has a qualifying competent authority agreement for the automatic exchange of GIR information. The deadline for the GIR is typically 15 months after the end of the Target Fiscal Year (extended to 18 months for the transition year).

The reliance on consolidated financial data and CbCR information underscores the critical need for robust data collection, management, and reporting systems within MNE groups.

Effective Date and What Lies Ahead

  • Effective Date: Japan's IIR ("Corporate Tax on the Global Minimum Taxable Amount") applies to Target Fiscal Years beginning on or after April 1, 2024.
  • Future Legislation: Japan has indicated that legislation for the UTPR and potentially a QDMTT will be considered in the FY2024 Tax Reform or later, following further international developments and guidance. The timing of UTPR implementation globally (e.g., the EU aims for fiscal years starting from December 31, 2024) will likely influence Japan's schedule.
  • Interaction with Existing Rules: The interplay between the new GloBE rules and Japan's existing tax framework, particularly its Controlled Foreign Company (CFC) rules, remains an area requiring careful consideration. While the 2023 reform included only minor related adjustments, further integration or "decluttering" may be explored in the future to reduce overlapping compliance burdens.
  • Ongoing Guidance: MNEs must continuously monitor administrative guidance issued by both the OECD Inclusive Framework and the Japanese tax authorities (National Tax Agency - NTA) regarding the interpretation and application of these complex rules.

Conclusion

Japan's enactment of the IIR marks a significant step towards implementing the global minimum tax agreement. While the UTPR and QDMTT are still forthcoming, the IIR applicable from April 2024 presents immediate challenges and compliance requirements for large MNEs with Japanese parent entities or subsidiaries. US-based multinationals falling within the scope must urgently assess the impact of these rules, evaluating ETRs across their jurisdictions, modeling potential top-up tax liabilities under the IIR, assessing eligibility for transitional safe harbors, and ensuring their data systems can handle the complex calculations and reporting demands. Proactive engagement with tax advisors and careful monitoring of both Japanese and global developments will be essential for navigating this new era of international taxation.