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Fiscal and Tax Conditions of Japan and Colombia



The conditions under which the CFC tax system is applied are different in Colombia and Japan. In Japan, a company in which 50% of the shares or voting rights are held is considered a de facto controlling relationship and is considered a wholly owned subsidiary, whereas in Colombia, there is an additional condition that the taxpayer residing in Colombia owns, directly or indirectly, 10% or more of the shares of the company.


By: Ryoga Matsui Japanese Intern for the Colombian-Japanese Chamber, Gorom Association.


BEPS (tax base erosion and profit shifting) and related international tax measures


What is a tax haven?

Tax havens are countries or jurisdictions that offer significant tax advantages to corporations, such as low corporate tax rates or no tax at all. Many of these countries and regions are located on islands, such as the British Cayman Islands, the Virgin Islands, and the Bermuda Islands. Not only do these regions have small populations, but they often lack the resources to export overseas, making it difficult for them to develop their economies on their own. These regions have strategically lowered their corporate tax rates to make them an attractive option for foreign capital, which has allowed many huge companies to relocate there and consequently stimulate economic activity in the region. However, now countries are competing to lower corporate tax rates in order to attract foreign companies, and the original principle of taxation, the principle of egalitarianism, is collapsing.


What is CFC taxation?

It is also called "tax haven taxation. It is a system whereby income retained by subsidiaries (CFCs = Controlled Foreign Campanies) located in light tax jurisdictions is taxed as if it were a corporation of the country where the parent company is located. This system was established in response to the problem that the tax base of the country where the business is conducted is reduced by the transfer of profits, resulting in a shortage of funds for the administration of the nation's public policies. The problems related to securing financial resources caused by profit shifting and tax base erosion are collectively referred to as BEPS, which is an acronym for Base Erosion and Profit Shifting in English.


For example, suppose there are countries with high and low effective corporate tax rates, and a company operating in a country with a high corporate tax rate transfers its profits to a country with a low rate. Naturally, the company avoids paying taxes in its home country, and pays a lower amount of tax in the low effective tax rate country than it should have paid originally. In this situation, the number of countries with high corporate tax rates will decrease, and the structure will continue to lose money. In order to overcome this situation, the CFC taxation system was created in each country, and there are also treaties (double taxation agreements) that have been individually concluded with each country in relation to the CFC taxation system.


Under the CFC tax system, the same income is taxed twice, once in the home country and once in the country where the subsidiary is located. Such double taxation is generally avoided because of the possibility of losing fairness in taxation. The above double taxation agreement was created to eliminate such double taxation, and the hybrid of the CFC tax system and the double taxation agreement adjusts corporate tax rates to ensure that companies pay their appropriate corporate taxes while securing national tax revenues.


Please tell us more about the CFC tax system and double taxation agreements in Colombia and Japan.

First of all, the conditions under which the CFC tax system is applied are different in Colombia and Japan. In Japan, a company in which 50% of the shares or voting rights are held is considered a de facto controlling relationship and is considered a wholly owned subsidiary, whereas in Colombia, there is an additional condition that the taxpayer residing in Colombia owns, directly or indirectly, 10% or more of the shares of the company.


A double taxation agreement between Japan and Colombia took effect on September 4, 2022, with the aim of stimulating trade between the two countries. It allows for a tax credit equal to the amount of taxes originally due in Japan or Colombia but paid by the subsidiary abroad to the authorities in that country. It is important to note that in order to receive the benefit of the tax credit, a notification must be submitted to the tax authorities of the country in which the credit is being claimed every step of the way.


Why has BEPS attracted so much attention?

One of the criteria for determining whether or not to pay corporate income tax is whether or not a "permanent establishment (PE)," such as a factory, is located in a country. Based on the nature of their business, these IT companies have succeeded in reducing their tax payments by collecting their revenues from their non-permanent facilities in paper companies established in advance in countries with no or very low corporate income tax on intellectual property rights.


The famous tax-saving scheme used by these companies is known as the "Double Irish Dutch Sandwich. In the European country of Ireland, the rule was that even if an organization was established in Ireland, no tax would be collected on the corporation unless the country in which the actual management and control activities took place was Ireland. The above IT companies took advantage of the fact that the British Bermuda Islands is a tax haven and that the Netherlands is exempt from tax obligations for Irish companies doing business in the Netherlands thanks to a tax treaty involving Irish corporations, so that the "management control" functions, which are originally subject to taxation in Ireland, were performed in the British The "management and administration" functions, which were originally taxable in Ireland, were transferred to a subsidiary paper company in the Bermuda Islands, and the "licensing rights," which were also originally taxable in Ireland, were transferred to a subsidiary paper company in the Netherlands, achieving very large tax savings. In 2015, at the request of the U.S. government, the Irish government changed its taxation standards for controlled activities, and the OECD announced that by 2025 it would introduce a " digital taxation" by 2025. This will correct the problem that giant IT companies have had in the past of avoiding taxation in countries where their business activities actually take place by taking advantage of the "no taxation as long as there is no permanent establishment" characteristic. It is estimated that this will increase tax revenues in low-income countries by $13 to 36 billion overall, and is expected to benefit the entire world by allowing tax revenues from corporate taxation, which are concentrated in the U.S., to be distributed proportionally throughout the world.

What is global minimum taxation?

In 2021, the Organization for Economic Cooperation and Development (OECD) agreed that all member countries will pay a uniform minimum corporate tax of 15%. These countries include Japan and Colombia. This uniform rule is called "global minimum taxation" and is scheduled to be introduced on April 1, 2024. It is expected to have the effect of putting a halt to the aforementioned competition to reduce the effective corporate tax rate.


It is estimated that approximately 100 companies worldwide are subject to the global minimum tax. The global minimum tax will apply to companies with annual gross revenues exceeding 750 million euros in two of the last four years. If the effective corporate income tax rate falls below 15% in the country where the subsidiaries of these companies are located, that country will be able to impose an additional "top-up tax" on the companies. This will allow tax haven countries to secure the tax base of the country in which the parent company is located while retaining the right to increase tax revenues, thereby aligning the place of economic activity with the place of taxation.


However, some concerns remain with this new system. If the same effective tax rate is applied in tax havens as in countries where the parent company is located, tax revenues in countries where tax base erosion has been a problem will not increase if companies choose to pay taxes in tax havens. It has also been pointed out that this could lead to the creation of multinational corporations that are unable to cope with the complex systems in place. It may still take some time to try to build a simple system that is a peaceful solution for more stakeholders.


References

  • Bunn(2020). How Controlled Foreign Corporation Rules Look Around the World: Colombia and a Perspective of Latin America". Tax Foundation. https://taxfoundation.org/colombia-cfc-rules/

  • Fujioka, Kitamatsu, Murakami, Takami (2023). Digital Taxation 'to be in Force in 25 Years' OECD Draft Treaty". Nihon Keizai Shimbun. https://www.nikkei.com/article/DGKKZO72710990T10C23A7MM8000/

  • Nishiyama (2023). The purpose and background of the introduction of global minimum taxation. TKC Group. https://www.tkc.jp/consolidate/webcolumn/023896/

  • Oka(2022). The Global Minimum Tax Agreement and Tax Havens from the Data Perspective: Preparing for the New Tax Competition. Tokyo Foundation Policy Research Institute. Available at: https://www.tkfd.or.jp/research/detail.php?id=3955

  • Okamura(2016). The Significance and Challenges of the Combined Foreign Subsidiary Taxation System. Japan Tax Association. Available at: https://www.soken.or.jp/sozei/wp-content/uploads/2019/09/taikaikiroku2016_tokyo2.pdf

  • Yamaguchi(2018). 'The Double Irish Dutch Sandwich and Digital Taxation'. Yamaguchi Takeshi Tax Office . Available at: https://ty-tax-accountant.com/archives/4896

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