Japan Corporate Tax-Cut Plan to Hurt Smaller Businesses

Prime Minister Shinzo Abe’s efforts to lower Japan’s corporate tax rate are increasingly set to include steps to ensure more businesses pay at least some levies, a move that endangers the survival of a swathe of smaller firms.

Abe, who stepped up political pressure for a cut with a January speech in Davos, Switzerland, faces opposition to the move among lawmakers concerned at the hit to fiscal revenue in the nation with the world’s biggest debt burden. Government advisers are floating making companies pay taxes on capital and salaries, in addition to profits -- currently only applicable to those with capital exceeding 100 million yen ($980,000).

The compromise could help reduce the impact of reduction in the effective corporate tax rate, which Deputy Economy Minister Yasutoshi Nishimura this week said the administration wants to implement next year. At the same time, it augurs pain for profitless businesses that have kept going in part thanks to expansive monetary policies dating back to the late 1990s.

“Quite a number of so-called zombie companies have survived even after profitability at Japanese companies fell in the aftermath of the burst of the bubble,” said Takero Doi, an economics professor at Keio University who is also a member of a government panel subcommittee on corporate tax reform. “Ensuring some revenue after cutting the corporate tax rate is a good thing.”

Job Rolls

Smaller companies employed almost 25 million people as of March 2013, according to the Small and Medium Enterprise Agency, and any increase in bankruptcies in the sector could offer a pool of labor for more successful businesses at a time when the nation’s population is shrinking. The number of smaller firms totaled 1.5 million, the latest data show.

“It’s important to change the structure of the corporate tax and not just debate the tax rate level,” Hiroko Ota, who heads the corporate tax subcommittee, said in an interview on March 24. “We have the best opportunity now to discuss how corporate taxes should be in the era of globalization.”

With an underperforming stock market flagging a warning that investor interest in Abenomics is waning, Abe’s government is preparing for June a round of structural changes designed to boost potential growth in the world’s No. 3 economy. The Topix index of shares is up about 2 percent in the past year, compared with a 15 percent jump in the MSCI World Index.

Third Arrow

Corporate-tax cuts are envisioned as a centerpiece of this year’s installment of Abe’s “third arrow” of reform -- monetary and fiscal stimulus formed the first two arrows.

With companies holding a near-record 222 trillion yen in cash as of December, and plowing more investment abroad, policy makers have identified a tax reduction as a way to bolster the appeal of investing at home. Companies increased investment abroad to a record 69 trillion yen in the final three months of 2013, up 40 percent from a year before, Bank of Japan data show.

Meantime, direct investment to Japan sank to 17.8 trillion yen in 2012, compared with a 2008 peak of 18.5 trillion yen. The government aims to double the investment to 35 trillion yen in 2020.

“Japan needs more foreign direct investment and we want to do more to encourage corporations to invest here,” Nishimura said in an interview in New York April 30. “We want to come up with a road map that gets us much closer” to an effective corporate tax rate below 30 percent, Nishimura said. The current level of about 35 percent is the second-highest in the Group of Seven, and compares with levies of about 24 percent in South Korea and 23 percent in the U.K.

Potential Fillip

A 5 percentage-point cut in the company tax rate would raise real private capital investment by 0.28 percent a year -- and by 0.52 percent in the case of a 10 percentage point reduction, according to estimates by Haruka Kazama, an economist at Mizuho Research Institute in Tokyo.

The government needs to convince tax-policy experts in Abe’s ruling Liberal Democratic Party wary of the fiscal impact of lower levies, Nomura Holdings Inc. economists Shuichi Obata, Minoru Nogimori and Tomo Kinoshita wrote in an April 30 note. “It is likely to have its work cut out for it in terms of persuading the LDP tax commission to drop its objections.”

That’s where the wider tax base comes in, potentially affecting millions of smaller enterprises. Among 2.76 million Japanese corporations, 99 percent are small firms capitalized at or below 100 million yen, and about 73 percent aren’t making profits to pay corporate taxes, Ministry of Finance data show.

Low Profitability

Explanations for the low share of profit-making enterprises range from earnings being hit by the yen’s appreciation over much of the past decade to subdued domestic growth to increased electricity costs after the March 2011 earthquake shuttered nuclear power plants and the use of accountants to ensure limited tax payments.

The 73 percent of Japanese companies that don’t pay taxes contrasts with levels of about 56 percent in Germany, 48 percent in the U.K. and 46 percent in the U.S., according data from Japan’s finance ministry.

Other options discussed at the corporate tax panel include tightening restrictions on carrying over losses to reduce future taxable income, calculating depreciation costs evenly each year and reviewing various policy-linked special tax breaks.

Special tax breaks for companies applied to about a third of all firms, totaling 1 trillion yen in fiscal 2012.

“The debate is likely to come to a head in May,” Nomura analysts wrote this week. “The government and the LDP tax commission will have to agree” on how tax-rate cuts will be funded, they wrote.

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