1. Case Introduction

Company A is a Luxembourg tax resident and has a wholly-owned subsidiary B in Japan. In 2015, the company split B. For this business, the National Tax Agency of Japan requires that the retained earnings corresponding to the shareholding ratio of each subsidiary after the split should be regarded as dividend distribution, and income tax and reconstruction special tax should be withheld and paid at a tax rate of 20.42%. However, Company A believes that according to the Agreement between Japan and the Grand Duchy of Luxembourg for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Income Taxes (hereinafter referred to as the “Japan-Luxembourg Agreement”), withholding income tax should be withheld and paid at a tax rate of 5%, and the National Tax Agency of Japan should refund the overpaid tax. Therefore, Company A filed a lawsuit with the court, and the first instance court supported all the claims of Company A. The National Tax Agency of Japan was dissatisfied with the first instance judgment and appealed to the Tokyo High Court. The Tokyo High Court upheld the first instance judgment and rejected the appeal of the National Tax Agency of Japan.

2. Focus of the Dispute

The focus of the dispute in this case is whether Company A is eligible for the 5% preferential tax rate stipulated in the Japan-Russia Agreement. Company A and the National Tax Agency of Japan hold different views on this.

(I) Company A believes that according to Article 10 of the Japan-Luxembourg Agreement, the tax rate applicable to dividend distribution is no more than 5%. Therefore, its income deemed as dividend distribution should be subject to withholding tax at the 5% tax rate stipulated in the Agreement, and the excess of 1.394 billion yen and its surcharge should be refunded.

(II) The National Tax Agency of Japan believes that Company A should not be subject to the preferential tax rate stipulated in the Japan-Luxembourg Agreement. In the tax agreement, the preferential tax rate for dividend distribution between parent and subsidiary companies needs to meet the shareholding period requirement, that is, the parent company should hold a certain share of the subsidiary company’s shares 6 months (or 12 months) before the end of the year to which the profit distribution belongs. Specifically, it includes:

1. Understanding of “the day that ends the year to which the profit distribution belongs”. In the context of Article 3, paragraph 2 of the Japan-Luxembourg Agreement, the “day that ends the year to which the profit distribution belongs” in this case should be understood as “the day before the stock split date” or “the day before the date of acquisition of the company’s equity”.

2. Understanding of “the accounting period”. This case involves deemed dividend distribution, not actual dividend payment. Since the concept of “deemed dividend distribution” is not explained in the Japan-Luxembourg Agreement, the accounting period corresponding to deemed dividend distribution cannot be interpreted according to the agreement, and should be interpreted in accordance with Japanese domestic law. According to Article 22, paragraph 2 of Japanese domestic law (Corporate Tax Law Enforcement Order of August 1, 2012), the period from the day after the decision on profit distribution is made to the actual payment of dividends is deemed to be dividend distribution. Therefore, in this case, “the end of the year to which the profit distribution belongs” should be understood as “the date on which the profit distribution decision is made.”

Based on the above arguments, the National Tax Agency of Japan believes that Company A has not met the shareholding period requirements and should not enjoy the treaty treatment.

3. Final Decision

On February 16, 2023, the Tokyo High Court made a final judgment, determining that the “end date of the fiscal year in which the profit distribution (dividend) is made” is the “end date of the year in which the profit distribution is made.” The specific basis for the judgment is as follows:

（1）Regarding “the end of the year to which the profit distribution belongs”, the interpretation should first be made in accordance with Article 3, paragraph 2 of the tax treaty. The view advocated by the National Tax Agency of Japan that the interpretation should be made in accordance with Article 31, paragraph 1 of the Vienna Convention, a general interpretation document of the treaty, is not accepted due to insufficient evidence.

（2）Regarding “dividends and bonuses”. According to Article 10, paragraph 3 of the Japan-Luxembourg Agreement, “dividends and bonuses” refer to income derived from the right to share profits through shares or other relationships, as well as income derived from other corporate rights that are taxed in the same manner as share income under the laws of the country of which the company distributing the profits is a resident. Article 10 of the Japan-Luxembourg Agreement shall apply to all those who meet the above conditions. In addition, dividends and bonuses paid by enterprises, whether paid from current income or from retained earnings, fall within the concept of “dividends and bonuses”. Therefore, the argument of the National Tax Agency of Japan that “the accounting period corresponding to the deemed dividend distribution does not exist” is rejected.

（3）Regarding the “holding period” condition. According to Article 10 of the 2010 Agreement, the “holding period” condition shall be determined by the contracting states of the Agreement, and Article 10, paragraph 2 of the 2017 revised Agreement, the beneficial owner of the dividend is a legal person with a direct shareholding ratio of 25% or more within 365 days before (inclusive of) the actual payment date. The National Tax Agency of Japan proposed the “holding period requirement” for the purpose of reducing double taxation on dividend distribution between parent companies and subsidiaries and preventing abuse of low tax rates. However, the court held that the above provisions did not constitute the necessary condition of “satisfying the 6-month holding period” and rejected the holding period requirement advocated by the National Tax Agency of Japan.

（4）The above-mentioned argument of the National Tax Agency of Japan, on the one hand, advocates that the relevant provisions should be interpreted according to the Japan-Luxembourg Agreement, and on the other hand, advocates that the relevant provisions of this case should be interpreted according to the terms in domestic law. These actions are contradictory and will not be accepted. In addition, the National Tax Agency of Japan has objections to the terms that have been legally interpreted in this case, and all claims that there are different interpretations will not be accepted.

4. Implications for “Going Global” Enterprises

In the process of conducting production and operation abroad, “going global” enterprises may enjoy the preferential treatment of tax treaties signed between my country and the contracting countries. The implementation of tax treaty clauses in various countries may change due to various reasons. Based on the above judgment, the National Tax Agency of Japan revised the implementation of the “end of the year to which the profit distribution belongs” in the tax treaty in March 2023.

（1）Past Implementation

In the past, if the deemed dividend distribution (the portion of the amount paid to the parent company that exceeds the capital) did not specify the year in which the distribution was deemed to be distributed, the Japanese tax authorities determined the “end of the year to which the profit distribution belongs” according to the type of stock split, and then determined whether the equity holding period requirement was met. If it was a stock split type, the “day before the stock split date” was used as the “end of the year to which the profit distribution belongs”; if it was a self-held equity type, the “day before the date of acquisition of the company’s equity” was used as the “end of the year to which the profit distribution belongs.”

（2）New Implementation Approach

In light of the Tokyo High Court ruling on February 16, 2023, the Japanese tax authorities’ past approach to deemed dividend distributions without a deemed distribution year is no longer applicable.

Specifically, if it is a deemed dividend distribution of the stock split type, the “end of the year to which the stock split date belongs” will be used as the “end of the year to which the profit distribution belongs” to determine the equity holding period requirement; if it is a deemed dividend distribution of own equity, the “end of the year to which the company’s shares were acquired” will be used as the “end of the year to which the profit distribution belongs” to determine the equity holding period requirement.

Note: For the determination of the equity holding period requirement for deemed operating years in deemed dividend distribution, the original treatment method is still applicable. Specifically, for deemed dividend distribution with deemed operating years, the “end date of the deemed operating year” is used as the “end date of the year to which the profit distribution belongs” in the tax treaty to determine the equity holding period requirement. In addition, generally speaking, in the case of year-end dividend distribution, the “end date of the operating year” is used as the “end date of the year to which the profit distribution belongs”, and in the case of mid-term dividend distribution, the “end date of the provisional accounting year” is used as the “end date of the year to which the profit distribution belongs”, and the equity holding period requirements are determined separately.

（3）Tax refund application procedures

Since the new treatment has been retroactively applied, the equity holding period requirements for the preferential tax rate on dividend distribution between parent companies and subsidiaries that are subject to the tax treaty should be re-determined. If the amount of income tax withheld is particularly large, the withholding agent should submit the “Tax Treaty-Related Withholding Tax Refund Request” and “Tax Treaty Application” to its competent tax authority, and then apply for a tax refund.

When applying for a tax refund, you must submit the date on which the event deemed to be a dividend distribution occurred, as well as information that can prove the holding period requirement.

In addition, according to law, no refund will be given for the amount of corporate income tax withheld that has been paid for more than 5 years.

In this case, the court ruled that if the dividend clause of the treaty does not clearly stipulate that the shareholding ratio time limit must be met to enjoy the preferential tax rate, the time limit should not be used as a necessary condition for enjoying the preferential tax rate of the treaty. Therefore, “going out” enterprises should pay close attention to the changes in the implementation of the host country’s tax treaty clauses and make timely adjustments to their own production and operation decisions and strategies to meet the requirements for enjoying the tax treaty treatment. In addition, if the change in the implementation of the tax treaty causes adverse effects, legal tools can also be used to protect their own rights and interests, such as through the mutual consultation procedure of the tax treaty.