The Journal The Authority on Global Business in Japan

Advocacy | Viewpoints

Compiled by the Taxation Committee, Foreign Direct Investment Committee,
ACCJ Financial Services Forum, and Growth Strategy Task Force

Enhance Investment and Stimulate Economic Growth through Extension of the Net Operating Loss Carry-forward Period


To promote greater long-term investment in Japan and stimulate growth in line with Prime Minister Abe’s Japan Revitalization Strategy, the American Chamber of Commerce in Japan (ACCJ) recommends that Japan lengthen the carry-forward period allowed for companies to utilize net operating losses (NOLs) from the current nine years to an unlimited period.

The ACCJ also recommends that the extension be applied to all existing losses. This step would encourage new investment into innovative technologies and industries that would require massive start-up capital (e.g., in industries such as energy or biotechnology), and would enable all types of companies to undertake large-scale reorganizations to transform their business.

In its viewpoints, Tax Reform for Enhanced Financial Competitiveness and Sustainable Economic Growth (ACCJ Financial Services Forum, October 2008) and Enhance Investment and Stimulate Economic Recovery through Extension of the Net Operating Loss Carry-forward Period (Foreign Direct Investment Committee, ACCJ Financial Services Forum, Taxation Committee, May 2009), and its white paper, Charting a New Course for Growth—Recommendations for Japan’s Leaders, the ACCJ called for the unlimited extension of the NOL carry-forward period, noting the important role such an extension could play in stimulating productivity, bolstering investment, creating new job opportunities, and fostering economic growth.

The ACCJ appreciates that the NOL carry-forward period was in fact extended from seven to nine years as part of the 2011 tax reform, but believes an unlimited extension is needed to spur material investments and to put Japan on a level playing field with its global peers. Ongoing developments now clearly underscore the importance of immediate action on the NOL carry-forward period to help businesses deal with the rapidly changing environment by encouraging necessary and new investment for growth.

Nine Years Is Not Enough
The NOL carry-forward extension from seven to nine years in the 2011 tax reform is still not sufficient to fully support the growth of innovative businesses and new investments. The restriction limiting NOL deductions to 80 percent of the current tax base, which was introduced simultaneously and applicable only to large size companies and certain special-purpose entities, also undermines the overall effect of the extension.

As Nippon Keidanren notes in its Proposal Concerning FY 2013 Tax System Reforms, Japan’s revised NOL carry-forward period still leaves Japan uncompetitive with other jurisdictions and should be extended to apply indefinitely.

Extension of the carry-forward period would encourage growth businesses to take risks or restructure their business models, and assure them that up-front costs and investments can be utilized over longer periods—indeed, such an extension would promote exactly the kind of long-term planning needed to promote innovative businesses and technologies. Expeditious extension of the NOL carry-forward period would drive a positive growth cycle by attracting risk capital, both foreign and domestic, for new investments in Japan, which would in turn create new jobs, stimulating consumption and sustainable economic growth.

Encouraging New Investments
Innovative businesses will be a major driver for next-generation economic growth. There are many steps that the government could take to spur new investments from a tax perspective, but road, simple and across-the-board measures, as opposed to narrowly focused special measures, would be the most effective.

For example, relaxation of restrictions in utilizing NOLs in corporate restructuring and mergers and acquisitions would help businesses restructure, in part by attracting additional capital and investment from new investors. Expanding carry-back provisions beyond small and medium-size enterprises (SMEs) to large corporations, and increasing the number of years that NOLs can be applied would also be stimulative.

Each of these measures has merits, such as providing generally profitable companies with greater liquidity, and should also be considered. But, especially considering that the restriction of limiting NOL utilization to up to 80 percent of current-year tax base provides a minimum annual tax base, extending the allowable carry-forward period has the added benefit of boosting growth with no material current revenue loss for the government.

The availability of an unlimited carry-forward period would improve investment economics by making it almost certain that the tax benefits of investing money today will eventually be realized. In uncertain times, companies may hesitate to make investments if the payoff for such investments may not occur until after the end of the carry-forward period since the company would essentially be paying tax on a recovery of their initial investment rather than on actual taxable income.

Promoting FDI
The comparatively short carry-forward period in Japan has direct implications for foreign direct investment (FDI). In the current environment, the limited period to utilize losses places Japan at a competitive disadvantage in attracting FDI. Overall, foreign investment into Japan plummeted from $14 billion in January 2008 to less than $2 billion in January 2013.

By comparison, the United Kingdom, Germany, France, Australia, Hong Kong, and Singapore have unlimited carry-forward periods, while in the United States, the carry-forward period is 20 years.

In a report by the Organisation for Economic Co-operation and Development (OECD) at the end of 20111 that focused on tax-loss utilization, 10 of the 17 major territories surveyed had unlimited carry-forward periods. Of the remaining seven major territories, only Italy and Switzerland had carry-forward periods shorter than Japan’s at the time of the OECD survey, and significantly, Italy in fact amended its tax rules shortly thereafter to adopt the unlimited carry-forward period of other major European countries2. Japan is clearly an outlier, and risks becoming more so as other countries move to lengthen their carry-forward periods.

Japan’s effective tax rate is still among the highest in the OECD even after the recent tax rate cut, due in part to the short carry-forward period. Japan can lower the effective tax rate and stimulate investment by lengthening the time during which NOLs can be used.

Japan’s rival countries in the region such as South Korea and Taiwan have lower effective tax rates than Japan. Their NOL carry-forward periods are 10 years, not attractive by OECD standards, but still longer than Japan’s period, and without a usage limitation. Japan has lost a competitive edge against rival markets in the region. Now is the time to introduce a competitive tax system, ideally one that will not just match the Asia region’s minimum standards, but that will give Japan a competitive advantage.

Countries with a longer NOL carry-forward period are more attractive to companies considering investment venues, thus enticing risk money for investments into new opportunities in that country. Japan should take active steps to ensure that risk money is rightfully assigned to new opportunities in Japan by allowing an indefinite NOL carry forward period.

Support Creating Jobs, Enhancing Innovation When Most Needed
Effectively utilizing NOLs over an extended period is a critically important economic tool to promote innovation, thereby creating new jobs and growth. Traditional stimulative tax policies such as research and development (R&D) tax credits and accelerated depreciation, benefit profit-making companies.

However, these policies are not effective for start-ups and new joint ventures that are making losses in earlier years since there is no tax to credit‚ and incremental expenses simply result in increased NOLs.

The extension of the NOL carry-forward period may not be a high-priority tax agenda item for large blue chip companies that usually have sufficient revenues from different lines of business. But it is critically important for the tax system to support growing companies and to attract new risk money in order to create new job opportunities and encourage growth of the economy.

R&D-intensive industries and capital-intensive industries, such as biotechnology, are likely to generate losses for many years before realizing a profit. In his recent pledge to boost private sector capital spending by 10 percent over the next three years, Prime Minister Abe targeted precisely these industries as being vital to sustainable growth and vowed to “sweep away any impediments to domestic investment, whatever they may be.”3 The importance of longer carry-forward periods is accordingly magnified for such business models, in order to match losses incurred at an earlier stage with profit generated at a later stage.

The carry-forward extension is an important incentive to attract innovative industry, from which promotion of investment, increase in employment and future increase in tax revenue can be expected as a result of innovation clusters, because the extension contributes to long-term technical innovations through improvement of future cash flow and effective tax rates. In other words, offering the ability to effectively use NOLs is an important policy tool for attracting leading technologies in order to boost economic prosperity in Japan.

In addition, applying the extension of the NOL carry-forward period to all existing losses would provide further support for start-ups and new joint ventures. In the life sciences sector, for example, most of the firms that have publicly listed their shares in recent years have been recording consecutive-year losses. Application of an indefinite carry-forward period to all existing NOLs would greatly help these firms endure until their investments successfully turn into commercial products and the firms start realizing a profit.

Support Transformation of Traditional Business
Another important aspect in achieving successful economic growth is facilitation of the transformation of traditional businesses into new models responding to the ever changing market. Lengthening the carry-forward period would help modernize industries such as agriculture and fishery to navigate through TPP challenges by offering the ability to effectively utilize NOL, even if this required significant initial investment.

NOL extension would also facilitate corporate restructuring and support traditional companies making difficult operational decisions in changing how their business is run, in order to be better attuned to the business environment. Changing operations to improve productivity, which often involves significant investment and cost, can also be supported by NOL extension.

Fiscally Efficient Stimulus

Given the current fiscal position of the Japanese government, extending the allowable carry-forward period to an unlimited period offers a very stimulative tool without creating a fiscal challenge in the near term while the new growth business is incurring losses. Carry-forward extension represents a sound way to promote investment, strengthen competitiveness, create jobs, and enhance growth, without a material immediate negative impact on tax revenues.

For the reasons noted above, Japan should move expeditiously to extend the NOL loss carry-forward period from the current nine years to an unlimited period. In aligning with most developed economies in this way, Japan should also ensure that eligible losses include all existing NOLs to provide a strongly stimulative growth-supportive impact.

This will incentivize new investment and faster restructuring, improve the investment climate surrounding innovative business, and provide a fiscally prudent means for the government to support Prime Minister Abe’s Japan Revitalization Strategy, spurring robust and sustainable economic growth.

1. OECD, Corporate Loss Utilisation through Aggressive Tax Planning, (OECD Publishing, 2011).

2. Italy introduced a new rule in 2011, which allows a corporation to carry forward NOLs for an unlimited time while it introduced a usage limitation rule on such tax losses similar to Japan’s 80 percent restriction rule. Under that rule, NOLs can offset 80 percent of current-year income.

3. “DJ: Japan PM Pledges to boost Capex in Quest for Sustainable Growth.‚” Nikkei, May 17, 2013.