Policy Research Institute

Table of Contents

Vol. 126 : Feature Articles Concerning Tax Systems IV – BEPS and Response to Tax Avoidance


Summary of Articles

BEPS and Response to Tax Avoidance
― Japan Should Introduce a General Anti-Avoidance Rule (GAAR) ―

By Shigeki Morinobu (Professor, Law School, Chuo University)

(Abstract)

The tax avoidance case of Starbucks that occurred in the United Kingdom in 2012 sparked debate about international tax avoidance by companies such as Amazon and Google at G8- and G20-level meetings. In response, the Committee on Fiscal Affairs of the Organization for Economic Cooperation and Development (OECD) formulated the Action Plan on Base Erosion and Profit Shifting (BEPS), with a final report published in September 2015. From now on, Japan will consider how to deal with tax avoidance in response to the report. The debate about tax avoidance under the BEPS program made clear that Japan is lagging behind internationally in addressing this matter.

Many other countries have introduced a GAAR (General Anti-Avoidance Rule) into domestic legislation as a measure to deal with tax avoidance. On the other hand, not only has Japan not introduced a GAAR, but Japanese academic circles have also not even determined the definition of tax avoidance. Under these circumstances, the debate about tax avoidance has become muddled, as the tax avoidance cases of IBM and Yahoo have escalated confusion. If this issue remains unattended, it will not only make it difficult to accept recommendations concerning BEPS but also cause problems, including a decline in the fairness, predictability and legal stability of the tax burden, unfair competitive conditions for companies and difficulty in securing tax revenue.

Therefore, Japan needs to deepen the debate about tax avoidance and start discussions about legislative solutions through the introduction of a GAAR while clarifying the definition of tax avoidance practices (transactions) that are legally denied.

Keywords: BEPS, tax avoidance, General Anti-Avoidance Rule (GAAR), business-purpose approach, abuse-of-law approach, IBM case, Yahoo case

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Significance of Tax Avoidance and the G8 Countries’ Response

By Takashi Imamura (Professor, Nihon University, Law School)

(Abstract)

Tax avoidance is regarded as a problem in countries around the world, as is indicated by the discussions being held by the OECD (Organization for Economic Cooperation and Development) about how to respond to BEPS (Base Erosion and Profit Shifting). However, in Japan, debate about tax avoidance tends to be shunned, raising concern that the country is lagging behind internationally in introducing legislation and setting judicial precedents.

Therefore, this paper looks first at past debates conducted about tax avoidance as well as legislative response to and judicial doctrine related to the matter in Japan and then at legislative response and judicial doctrine in other G-8 countries. Subsequently, the paper examines the G-8 countries’ thoughts on and application of a General Anti-Avoidance Rule (GAAR), which is an effective legislative countermeasure against tax avoidance.

As a result, it became clear that the Japanese debate about tax avoidance has revealed such problems as the generally accepted definition of tax avoidance limiting the scope of practices to which the anti-avoidance rule is applied and the definition not functioning as a standard for distinguishing between tax avoidance and tax saving. It was also found that in Japan, there is insufficient legislation to provide for the denial of practices and calculations related to family corporations.

On the other hand, other G-8 countries have imposed an obligation to disclose transactions suspected to be tax avoidance practices or have established a GAAR, and they have also made some progress in developing judicial doctrine. In European countries in particular, the judicial doctrine has been developed in such a way as to regard tax avoidance as abuse of tax law. With respect to GAAR, it is notable that among the G-8 countries, the United States established a GAAR as a confirmatory measure in 2010, while the United Kingdom introduced a GAAR in 2013.

When we examine the status of the G8 countries’ response to tax avoidance, we must say that Japan is lagging behind in responding to it. Therefore, we believe that starting from the idea that tax avoidance is fundamentally abuse of law, Japan should consider legislation for a GAAR in reference to legislation in other G8 countries.

Keywords: tax avoidance, General Anti-Avoidance Rule (GAAR), abuse of law

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Challenges for General Anti-Avoidance Rule (GAAR) in Developing Countries and Implications for Japan
―With a Focus on Emerging Countries―

By Keiji Aoyama (Professor, Graduate School of Accountancy, Waseda University)

(Abstract)

A General Anti-Avoidance Rule (GAAR) is a legislative tool introduced and applied mainly in the field of income taxation in expectation that it will play its role as a countermeasure against artificial schemes to avoid meeting taxation criteria. As a result, example cases of GAAR introduction and application are usually seen in countries ― regardless of whether they are countries with a case law system or with a statutory law system ― where the importance of income taxation for revenue is high and where high-tax payers and large companies, namely potential users of such artificial schemes, are briskly conducting economic activities.

Observations of developing countries from this perspective found that (i) in many developing countries which have been unable to overcome problems such as poverty and extreme inequality due to the underdevelopment of social infrastructure, the tax system and administration continue to depend on a tax collection system relying on contact with a small number of taxpayers, such as tariffs, consumption tax and income tax levied mainly through withholding tax; (ii) it is difficult to accurately grasp income due to the presence of a huge underground economy; and (iii) in emerging countries, mainly BRICS, the importance of income taxation has been recognized anew amid the rapid advance of globalization, resulting in rapid development of GAAR in recent years together with the development of specific anti-avoidance measures as broadly defined, including transfer pricing and CFC tax regimes.

This paper aims to obtain knowledge that will be useful as reference for Japan to introduce a GAAR by examining example cases of application of the rule, which is gradually being introduced by emerging countries.

Among the four countries discussed in this paper (India, China, Brazil and South Africa), the cases of India, which came up with ingenious ideas with respect to the establishment of a panel in charge of approving application of GAAR (Approving Panel), and South Africa, whose system is as well-developed as the systems of Western countries, are presumed to be useful for Japan when considering legislation.

When we look at the four countries individually, we can see that in Brazil, a country with a statutory law system, as well as in India and South Africa, both of which have a case law system, limited denial of transactions has been granted by courts under the tradition of strict interpretation of tax laws. However, as these countries, as major players in the global economy, faced the need to respond to tax planning by multinational companies in the 21st century, all of them introduced modern legislation for GAAR. Even so, unfortunately, there has not been sufficient accumulation of GAAR interpretations to be used for case comparison because all three had difficulty developing guidance for specific application of GAAR. However, there are some points useful for Japan as a reference. For example, South Africa is actively referring to legislative achievements in British commonwealth countries that are advanced in GAAR legislation (e.g. Australia and New Zealand). India’s system has some design features which Japan should look at for reference, including the establishment of the Approving Panel, although India has put off the enforcement of GAAR because of the risk of foreign companies pulling out of India, including in the case of indirect transfer of shares.

On the other hand, China, which provides administrative bodies with powerful authority in rule-making and interpretation, has actively developed guidance in the form of directives following the establishment of a GAAR in 2007. However, with the GAAR applied mainly in cases of indirect transfer of shares by foreign persons, the scope of cases to which it is applied apparently remains narrow. Doubt has been raised about GAAR application in China in terms of consistency with existing treaties, so Chinese authorities have been including a provision confirming non-contradiction with the GAAR in an increasing number of new treaties.

When considering the wisdom of legislating a GAAR, Japan should benchmark mainly against the model of developed countries, but it is presumed that there is also something to be learned from the experiences of emerging countries with respect to the importance of GAAR guidance under the principle of no taxation without law, for example.

Keywords: anti-avoidance rule, tax systems in developing countries, tax treaties

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Systems for Disclosure and Registration of Tax-Avoidance Products as a supplement or alternative measure

By Go Kawada (Licensed tax accountant and professor, Ohara Graduate School of Accounting)

(Abstract)

This paper examines the system for disclosure and registration of tax avoidance products (so-called tax avoidance schemes), which has already been introduced in several countries as a supplementary or alternative measure to a General Anti-Avoidance Rule (GAAR). While this matter was taken up in BEPS Action 12, which has recently been published*, Japan still does not have such a system.

The purpose of this system is to deter tax avoidance and to obligate persons engaging in the development and sales of tax avoidance products (so-called promoters) and persons who purchase such products (investors) to report and disclose their activities to tax authorities in order to promptly respond to tax avoidance schemes that are put into practice.

More specifically, the system makes an advance disclosure of the types of schemes that are deemed by tax authorities to be tax avoidance schemes and requires promoters of such schemes and investors to report to the authorities. When reporting to the authorities, promoters are also required to disclose a list of customers.

Meanwhile, investors are required to disclose the contents of schemes they have used. It should be noted that violation of the disclosure obligation is usually subject to a civil penalty.

How to determine the schemes subject to the disclosure requirement differs from country to country. However, generally speaking, transactions involving incentive fees or containing a confidentiality provision are subject to the disclosure requirement.

Therefore, this paper seeks to provide useful insights for Japan when introducing the reporting by looking at the cases of major countries which have introduced the disclosure and reporting system and by examining problems occurring in those countries.

It should be noted that in the United States, the Government Accountability Office (GAO) conducts a fact-finding investigation to evaluate the enforcement status of this system and publishes the results. As an arrangement like this is presumed to become necessary when Japan introduces such a system, this paper also explains the outline of the arrangement.

* As is widely known, regarding “aggressive tax planning arrangements,” Action 12 under the Base Erosion and Profit Shifting (BEPS) program, which was published on October 5, 2015, stated that taxpayers should be required to disclose such arrangements to governments.

Keywords: GAAR, tax avoidance schemes, disclosure and registration of tax avoidance schemes, tax shelters, BEPS, promoters, investors, ATTA, important advisors

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U.K. Aaronson Report and GAAR

By Naoki Oka (Chief litigation officer, Tokyo Regional Taxation Bureau; former Senior Advisor (International), National Tax Agency)

(Abstract)

In 2013, the United Kingdom introduced into statutory law a “moderate” General Anti-Avoidance Rule (GAAR) that is “targeted at abusive arrangements.” This paper discusses the history of the attitude of the U.K. courts towards tax avoidance cases, the political initiative of the coalition government (inaugurated in 2010), and the Aaronson report (2011) which provided a basis for the GAAR legislation in the U.K. It also describes the provisions of the enacted law (2013).

Tax avoidance is the use of “legal” arrangements to reduce tax burden, and the legality of form of such arrangements poses the greatest challenge in counteracting this problem. It is necessary to distinguish between tax avoidance (to be counteracted) and tax saving (to be accepted). To this end, developing a “basic concept” is likely to be essential.

The Aaronson report set forth abusive transactions as a target of the U.K. GAAR, and created an objective standard of assessment known as the “double reasonable test.” In addition, a number of innovative ideas were introduced into the system to counteract tax avoidance arrangements, notably, the establishment of the GAAR Advisory Panel to deal with taxpayers’ concerns over possible expansion of the tax agency’s discretionary power, and the introduction of a special evidence rule that legally obligates courts to respect the GAAR Guidance published by the HMRC (which is not a law).

The Supreme Court of Japan decided, in its recent judgments (29 Feb 2016), that abuse of tax law provisions shall be counteracted under the targeted general anti-avoidance rule in Japan. Since “abusive transactions” have been the ‘key’ both in the Supreme Court decisions and in the U.K. GAAR, U.K. experience in this area would be insightful for Japan in applying existing rules and designing new ones to counteract tax avoidance.

Keywords: tax avoidance, tax planning, the Japanese tax system, the U.S. tax system, GAAR, BEPS, tax issue trials

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Debate about Denial of Tax Avoidance in Japan

By Katsuhiko Sakai (Professor, Faculty of Commerce, Chuo University)

(Abstract)

Debate about the denial of tax avoidance is muddled because the definition of “tax avoidance” is unclear. If we follow the generally accepted meaning of “tax avoidance,” which is to avoid meeting taxation criteria, the result of tax avoidance is not being taxed. Recently, it has been pointed out that an act of avoiding the tax burden through means different from conventional tax avoidance arrangements, namely an act of seeking to become eligible for application of tax reduction or exemption by meeting tax reduction or exemption criteria (e.g. the Resona Bank case), is left out of the debate about tax avoidance. As this shows, there are limits to the existing debate about the definition of tax avoidance. Therefore, the terminology should be unified into “tax avoidance,” which refers to avoiding meeting the taxation criteria, and “tax saving,” which refers to an act of seeking to meet the criteria for tax reduction or exemption, whereas “tax avoidance” as an end result and an attempt at tax avoidance should be distinguished. Meanwhile, acts of illegitimate tax avoidance and illegitimate tax saving that cannot be sufficiently explained within the framework of the concepts of “tax saving,” “tax avoidance” and “tax evasion” betray the will of the Diet and exploit potential legal loopholes, so legislative response is necessary. This paper points out legislative challenges that should be addressed after maximum consideration is given to the liberal aspect of the principle of no taxation without law.

Keywords: principle of no taxation without law, liberalism, democracy, potential loopholes, Resona Bank case, Iwase case, tax saving, tax avoidance, tax evasion, denial of acts and calculations, criteria for tax reduction or exemption, taxation criteria, developmental formation, abuse

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Economic Circles’ Thoughts on Establishment of Comprehensive Anti-Tax Avoidance Rule

By Yasuhisa Abe (Managing director, Japan Business Federation)

(Abstract)

This paper summarizes problems related to the current anti-tax-avoidance rule in Japan and considers the direction of reform necessary to eliminate arbitrary interpretation and administration by the tax authorities, enhance predictability for taxpayers and protect their rights.

More specifically, the paper takes up Article 132 and the following articles of the Corporate Tax Act and confirms that the provisions of these articles are questionable from the perspective of the principle of no taxation without law and that they are not only causing confusion in actual tax filings and payments as well as tax affairs administration but also significantly undermining predictability for taxpayers based on example court cases in recent years.

In addition, the paper shows that the BEPS project was launched in response to acts of tax avoidance in international taxation as its starting point and that the absence of a comprehensive anti-tax avoidance rule could become a major obstacle to reforming Japan’s tax system so as to adapt it to the BEPS project.

Based on the above, regarding what a comprehensive anti-tax avoidance rule suitable for Japan should be like, the paper proposes a rule that incorporates business-purpose criteria that enables taxpayers to make effective rebuttal while making it a principle to apply abuse criteria requiring that it be obvious that the act of tax avoidance itself, if disregarded, would significantly undermine the fairness of taxation.

Please be reminded that this paper is entirely based on my own personal opinions and does not represent the opinions of Keidanren (Japan Business Federation).

Keywords: principle of fair taxation, abuse criteria, business purpose criteria, tax avoidance, tax arbitrage, BEPS Action 12, the Mandatory Disclosure Rule, prior confirmation system

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Debate about Anti-Tax Avoidance Measures under the BEPS Project, etc.

By Kentaro Ogata (Director, international tax policy, Tax Bureau, Ministry of Finance)

(Abstract)

In recent years, a global trend of international cooperation in countering cross-border aggressive tax planning (ATP) has emerged. While views regarding the definition and meaning of tax avoidance remain widely divergent in Japan, it is internationally well established that ATP refers to those tax-planning practices that violate the spirit of law while following its letter and effective countermeasures against ATP have been discussed accordingly. Under the BEPS project by the OECD and G20 which has led such international discussions, several key issues have been discussed including: (i) with respect to the Principal Purpose Test (PPT) rule in tax treaties, the combination of the LOB rule, akin to specific criteria for particular tax items, and PPT, akin to the General Anti-Avoidance Rule; judgment made in light of the purpose test as well as the object and purpose of treaties based on the doctrine of abuse of law; and the significance of introducing PPT provisions throughout a network of tax treaties; (ii) with respect to transfer pricing, the separation of the process of delineating actual transactions to identify true legal relationships and the process of non-recognition and re-characterization; the appropriateness of non-recognition based on the economic substance doctrine and the arm’s length principle; and clarification of commercial rationality as a criterion for non-recognition; (iii) with respect to the Mandatory Disclosure Rule, the purpose and effects of the system to report tax avoidance schemes and its relationship with GAAR. Meanwhile, the Diverted Profit Tax in the United Kingdom, which was introduced while the BEPS project was still ongoing, provoked another round of discussions with respect to the appropriate approaches to nullify tax avoidance because it was introduced as a new tax independent of generally applicable anti-avoidance rules and also because it adopted such criteria as tax avoidance criteria based on a purpose test and mismatch criteria based on the reduction of tax burden and the economic substance.

Underlying the abovementioned international debate are the awareness and sense of crisis over the complexity of cross-border ATP arrangements and the need to deal with such arrangements by adopting a flexible general rule. The debate therefore is full of important implications for discussing the GAAR.

Keywords: BEPS, PPT (Principal Purpose Test), transfer pricing, non-recognition and re-characterization, MDR (Mandatory Disclosure Rule), DPT (Diverted Profit Tax), tax planning, ATP (Aggressive Tax Planning), tax avoidance, abuse of law, GAAR (General Anti-Avoidance Rule)

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Reflection on Burden of Proof Related to Cases of Taxable Transaction Schemes (including GAAR) under BEPS ―International Burden of Proof―

By Kuniyasu Inami (Assistant Professor, National Tax College Japan)

(Abstract)

It is important to check on the state of the burden of proof in tax lawsuits in developed countries to collect information useful for considering the burden of proof related to the GAAR. Therefore, this paper checks on the state of the burden of proof in the United States, the United Kingdom, France, Germany, Italy, Canada and Australia. The paper examines the reasons why in these countries taxpayers tend to bear the burden of proof, according to the contents of the EATLP Congress that was held in 2011, and it recognizes the need to consider once again what the burden of proof in Japan should be like.

Keywords: burden of proof, EATLP Congress, person close to the evidence

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Generational Accounting Analysis in Consideration of Japan’s Fiscal Sustainability

By Nobutoshi Kitaura (Senior researcher fellow, Institute for International Policy Studies)

(Abstract)

This paper analyzes generational accounting in a way that takes account of Japan’s fiscal sustainability together with population estimates based on various assumed total fertility rates. I distribute non-transfer government expenditures as well as government transfers to each generation in order to calculate lifetime benefits. The paper’s conclusion is as follows.

First, in the baseline scenario (which assumes the continuation of the current policy; a case with an assumed total fertility rate of 1.35), the current generation of people aged zero, who represent the current younger generations, will receive net benefits, which means negative number of net tax payments, of 13.18 million yen (the difference between the lifetime benefits of 88.8 million yen and the lifetime tax payments of 75.61 million yen; net benefits equivalent to 7% of lifetime income). Although past analyses found that younger generations will make net tax payments, the estimation results of this paper, which projects net benefits for these generations, are presumed to be reasonable given that there have been huge fiscal deficits for 40 years and that Japan will continue to record fiscal deficits under the current policy. However, the current policy cannot be continued, because the amount of outstanding public debts as a ratio of GDP will continue to grow to a few thousand percentages by 2100.

Second, under the fiscal consolidation scenario (a case with an assumed total fertility rate of 1.35), in which fiscal consolidation is implemented so as to ensure fiscal sustainability, the current generation of people aged zero will make net tax payments of 9.65 million yen (the difference between the lifetime benefits of 74.51 million yen and the lifetime tax payments of 84.16 million yen; net tax payments equivalent to 5% of lifetime income).

The net tax payments equivalent to 5% of lifetime income under the fiscal consolidation scenario may appear to be large. However, it must be kept in mind that under the assumption that the fiscal budget is balanced and that the age structure of the population is stable with a total fertility rate of 2.07, the current generation of people aged zero would have to make net tax payments equivalent to 2.7% of lifetime income in order to maintain the current fiscal benefit level and the tax payment structure. Even if the balanced budgets are assumed, all generations have to make net lifetime tax payments, because the tax payments will be made in the near future while the benefits will be received when the generation becomes old; therefore, present values of lifetime benefits are smaller than those of lifetime tax burdens.

Third, under the baseline scenario (a case with an assumed total fertility rate of 1.35), net tax payments to be made by future generations as a result of sum of current public debts and net future lifetime benefits produced by the current generations will total 2,134 trillion yen (42.49 million yen net tax payments per person, equivalent to 24% of lifetime income). Under the fiscal consolidation scenario (with an assumed total fertility rate of 1.35), the total amount will be 288 trillion yen (5.72 million net tax payments per person, equivalent to 3% of lifetime income). Fiscal consolidation will drastically reduce the burdens on future generations. In addition, under the fiscal consolidation scenario, the inequality between the current generation of people aged zero and the future generations will be mostly resolved.

Fourth, a comparison between the fiscal consolidation scenario and the baseline scenario based on the assumed total fertility rate of 1.35 shows that net tax payments to be made by the current generation of people aged zero will increase by 22.84 million yen, or 270,000 yen per year (a decrease of 170,000 yen in benefits and an increase of 100,000 yen in tax payments), while net tax payments to be made by elderly generations (people aged 65 or older) will grow by 6.33 million yen, or 450,000 yen per year (a decrease of 390,000 yen in benefits and an increase of 60,000 yen in tax payments). The increase in total net tax payments is larger for younger generations because (i) these generations will bear more of the increased burden of tax and social security payments due to their longer future work periods and (ii) benefits from education services received at younger ages will also be reduced, together with reduction of social security benefits received at older ages. Meanwhile, the increase in per-year net tax payments to be made by elderly generations is large because (i) the reduction of social security benefits, which account for a large portion of the total benefit amount, is steep due to the assumption in our estimate that the reduction in government expenditures through fiscal consolidation will be made by reducing all expenditure items at a universal rate and (ii) the discounted present value of benefits for elderly generations is large as they receive benefits in the near future (although social security benefits for younger generations will also be reduced, the present value for them is small due to the effects of accumulated interest rates over their long remaining lifetime).

Fifth, while an improvement in the total fertility rate will not significantly affect the amount of net benefits for the current generation of people aged zero (and net benefits as a percentage of lifetime income) nor sum of current public debts and net future lifetime benefits produced by the current generations, the amount of net tax payments to be made by future generations will be considerably reduced due to substantial population increase of the future generations. However, improving the total fertility rate alone would not ensure fiscal sustainability. Various scenarios (the fiscal consolidation scenario and the public debt stabilization scenarios (i) and (ii)), where fiscal sustainability is to be ensured, equally indicate the need to implement fiscal consolidation so as to bring the net tax payments as a percentage of lifetime income for the current generation of people aged zero to around 5%.

Finally, a comparison between the fiscal consolidation scenario (a case with an assumed total fertility rate of 1.35) and the scenario of counteracting the low total fertility rate and delaying the starting age of pension benefits to 70 years old (a case with an assumed total fertility rate of 2.07) shows that future net tax payments will increase by around 4 million yen for all current generations, when the fertility rate is to be achieved through policy measures(e.g. implementing countermeasures against the low total fertility rate and delaying the starting age of pension benefits to 70 years old). Net tax payments as a percentage of lifetime income for the current generation of people aged zero is 5% under the fiscal consolidation scenario (a case with an assumed total fertility rate of 1.35) and 6% under the scenario of counteracting the low total fertility rate with the increase of fiscal expenditures and delaying the starting age of pension benefits to 70 years old (a case with an assumed total fertility rate of 2.07). If the net tax payments as a percentage of lifetime income would be little different under the two scenarios, a desirable option for younger generations, who will become parents of future generations, will probably be actively raising the total fertility rate through policy measures, thus having younger generations see a vibrant, youthful Japanese society.

The results of the author’s analysis are presumed to be mostly reasonable compared with the results of recent studies. However, the results of generational accounting analysis are influenced by changes in the trends in the economic growth rate, interest rates and total fertility rate, among other factors, and they also depend on the policy mix of government expenditure reduction and tax hikes that ensures a fiscal sustainability. When implementing fiscal consolidation in the future, it is highly important to ensure transparency and accountability by conducting analysis as to which generation should be prepared to bear how much of an increased burden. I hope that further careful analysis will be conducted by the government and private-sector economists.

Keywords: generational accounting, fiscal consolidation, government debt, the aging society with a low total fertility rate, total fertility rate

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Any article in the Review reflects the writer's own opinion, and has nothing to do with any statement issued by the Ministry of Finance or the Policy Research Institute.