The Journal The Authority on Global Business in Japan

In the realm of Japan’s corporate tax laws, extending the net operating loss (NOL) carry-forward period might encourage corporate innovation and increased invest­ments. The American Chamber of Commerce in Japan (ACCJ) believes doing so would help boost the nation’s economy, and this view­point from the ACCJ Taxation Committee outlines why.

RECOMMENDATION
The ACCJ recommends that the Govern­ment of Japan (GOJ) extend the NOL carry-forward period under the Japanese Corporate Tax Law consistent with the periods applied in other major economies. The current carry-forward period is 10 years (for tax years starting on or after April 1, 2018), compared with unlimited carry-forward periods in the United States and many European countries.

This change is consistent with the aims set out in the GOJ’s Japan Revitalization Strategy 2016. The strategy paper states, “It is essential for companies in Japan to have positive determina­tion on shifting their internal reserves into future invest­­ment on facilities, innovation, and human resources,” to tackle the problem of revita­­liz­ing the Japanese economy. By extending the NOL carry-forward period, companies would have the incentive and capacity to make long-term investments in growth and innovation—particularly for new business lines and innovative projects that often take many years to become profitable.

Overall, an extension of the NOL carry-forward period would signal to investors, whether foreign or domestic, that the GOJ is committed to increasing growth and re­vi­­ta­li­zing the economy through practical solutions.

BACKGROUND
The ACCJ applauds the GOJ’s reduction in corporate tax rates from their historically high levels to rates more consistent with other member countries of the Organi­sation for Economic Co-operation and Development (OECD).

Yet, as important as bringing corporate tax rates in line with those of other countries is, the corporate rate is not the only tax condition that potential new market entrants will consider.

Growth companies—be they domestic startups or a result of foreign direct invest­ment (FDI)—will likely have several initial years of losses while they invest to build up production capabilities, distribution infrastructure, and market share. Given this, such companies will look less at the corporate rate in those initial years—when they will have little or even no income to report—and more at the long-term return on their investments.

One of the significant factors in deter­mining the return on investment during a startup period is the ability to apply those up-front losses in a tax effective manner over a long enough period to make the investment economically viable.

It has thus been the long-standing position of the ACCJ that extension of the NOL carry-forward period by Japan would stimulate both domestic innovation and FDI in growth industries, benefiting the overall Japanese economy. We have thus recommended that the GOJ lengthen the NOL carry-forward period from the 10 years under Japanese law (for tax years starting on or after April 1, 2018) to more closely match OECD norms, such as the unlimited carry-forward periods that now prevail in the United States as a result of tax reforms in 2017 and in Europe.

VARIABLE
One issue that should be addressed is the inconsis­tency with carry-forward periods found in other major developed economies. As shown in the accom­panying table, Japan, with its short carry-forward period, is already an outlier among its OECD trading partners.

Lengthening the period would not only bring Japan in line with its major trading partners, but would also:

  • Facilitate FDI
  • Strengthen incentives for investment in new industries and innovative startup companies
  • Support companies that have invested in Japan in the recent challenging years since the global financial crisis and through the triple disasters of 2011
  • Accelerate the growth and jobs connected with such investment

Significantly, in this period of fiscal consoli­dation, lengthening the NOL carry-­forward period would have largely back-ended fiscal costs compared wih other forms of tax stimulus. Investment incen­tives would be front-ended, contri­buting more quickly to growth and the tax revenues it would generate.

USAGE CAP
Another issue that should be addressed is the leveraging of the usage cap to manage permanently loss-incurring companies. The ACCJ acknowledges that there are concerns that permanently loss-incurring companies can use the NOL system as part of a strategy to avoid paying their fair share of tax. To increase the incentives for companies to become profitable, the GOJ has reduced the current NOL annual usage cap to 50 percent and increased the carry-forward period to 10 years for tax years starting on or after April 1, 2018.

The ACCJ does not have a formal position on the annual usage cap. However, even assuming that such a reduction may be useful both to incentivize profitability and accelerate tax revenue—understandable goals in light of Japan’s need for fiscal consolidation—this incentive will be most effective if the usage cap reduction is combined at the same time with a signi­fi­cant extension of the loss carry-forward period. Without that, Japan’s short carry-forward period increases the risk that losses, even those incurred for valuable investment in growth and innovative technologies, will expire before they can be absorbed.

Moreover, Japan is a significant outlier among the countries compared in the table below, insofar as both its annual usage cap and carry-forward period are restricted. For the other jurisdictions shown in the table, either the annual usage cap may be low (e.g., Germany and France) or the carry-forward period may be short (e.g., South Korea and Taiwan). Only Japan is restrictive in both areas.

While the annual usage cap has been significantly reduced to 50 percent for tax years starting on or after April 1, 2018, the ACCJ recommends extending the NOL carry-forward period signifi­cantly towards OECD standards, such as the indefinite periods available in the United States and Europe. This would allow Japan to avoid disin­centi­vizing valuable and innova­­tive invest­ments in many economic sectors. While Japanese legisla­tion creates excep­­­­­tions for small and medium-sized enterprises and newly established companies to carry forward losses without the usage cap (although for the first seven years only), the ACCJ believes that extending the carry forward period indefinitely for all companies would be more effective in creating jobs and fostering innovation. Such a move would fuel exactly the kind of growth that is a core goal of the GOJ’s Japan Revitalization Strategy 2016.

CONCLUSION
The ACCJ strongly supports all efforts to enhance the attractiveness of the Japanese economy for investment—particularly for growth companies and for FDI. As noted in the ACCJ’s Growth Strategy Task Force white paper, Charting a New Course for Growth: Recommendations for Japan’s Leaders, most new jobs in Japan are driven by a combination of foreign-invested companies and new startups.

Clearly, increasing the investment envi­ron­ment to expand exactly these kinds of job-creating enterprises must be a key part of the GOJ’s revitalization strategy. Increasing the NOL carry-forward period is a critical component of encouraging such investment.

By extending the NOL carry-forward period, companies would have the incentive and capacity to make long-term investments in growth and innovation.