By carrying out a qualified merger with a wholly-owned (100%) subsidiary that holds net operating loss carryforwards, the surviving company can succeed to those carryforward losses (Article 57, Paragraph 2 of the Corporation Tax Act). However, because it is conceivable that a company could acquire a dormant company with large carryforward losses and then carry out a qualified merger in order to inherit those losses and reduce its corporation tax—an act of tax avoidance—certain restrictions have been put in place. Specifically, unless either one of the following requirements is not met, the carryforward losses cannot be succeeded to (Article 57, Paragraph 3 of the Corporation Tax Act):
- The qualified merger satisfies the “Joint Business requirements” (such as the business relatedness requirement, business scale requirement, and specified officer succession requirement) (Article 112, Paragraph 3 of the Order for Enforcement of the Corporation Tax Act).
- A control relationship has existed continuously between the merged corporation and the surviving corporation from the date five years prior to the first day of the fiscal year of the surviving corporation in which the date of the qualified merger occurs (Article 112, Paragraph 4, Item 1 of the Order for Enforcement of the Corporation Tax Act).
- Where either the merged corporation or the surviving corporation was established after that date five years prior, a control relationship has existed continuously between the merged corporation and the surviving corporation from whichever is later of the date of establishment of the merged corporation or the date of establishment of the surviving corporation (Article 112, Paragraph 4, Item 2 of the Order for Enforcement of the Corporation Tax Act).
In addition, losses arising from the transfer of assets that the merged corporation held prior to the formation of the control relationship are subject to restrictions on deductibility (Article 62-7, Paragraph 2 of the Corporation Tax Act).
https://www.zeiken.co.jp/hourei/HHHOU000000/62-7.html
The following is an account of a court case involving a well-known golf course management company (hereinafter “PGP”) that operates a business acquiring and turning around failed golf courses. PGP merged a substantially dormant, wholly-owned subsidiary holding carryforward losses—first passing it through a merger with a company that satisfied the joint business requirements—and then merged it with a subsidiary in which it did not hold a full (100%) controlling interest but rather a 99.999% stake, in order to succeed to the carryforward losses. This arrangement was subsequently denied by the tax authorities.
2009
PGP purchased shares in a golf course management company, PGPAH6, from a trading company, making it a wholly-owned subsidiary. Because this golf course company was suspected of having hidden liabilities—including suspicions that its manager had embezzled funds—PGP carved out the golf course business through a spin-off-type company split and established a subsidiary (PGP Chiba) to house it.
Subsequently, PGPAH6 transferred its shares in PGP Chiba to PGMP1, generating a loss of ¥5.7 billion. After transferring its shares in PGP Chiba, PGPAH6 conducted essentially no further activity and fell into a dormant state.
https://omikawa-tax.jp/pgm_precedent/
February 2017
PGPAH6 Co., Ltd. was absorbed through merger by PGMP4 Co., Ltd., another wholly-owned subsidiary of PGP Co., Ltd., and PGMP4 succeeded to ¥5.7 billion in carryforward losses. PGMP4 Co., Ltd. operates a golf course business.
On the same day, conditional on the completion of the foregoing merger, PGMP4 Co., Ltd. merged with PGP Property Co., a 99.999% subsidiary of PGP Co., Ltd. While PGP Property is not a wholly-owned (100%) subsidiary, both PGMP4 Co., Ltd. and PGP Property operate the same golf course business, so if the joint business requirement and the employee succession requirement were satisfied, the merger would meet the qualification requirements.
During the tax audit, the question of whether the carryforward losses could be succeeded to by PGP Property became an issue. In other words, in 2017 PGPAH6 was absorbed by merger into PGMP4 Co., Ltd., and was then subsequently absorbed by merger into PGP Property. Because PGP Property was not a wholly-owned (100%) subsidiary of PGP, if PGPAH6 had been merged directly into PGP Property, the joint business requirement and employee succession requirement would not have been satisfied, and the carryforward losses could not have been succeeded to. However, by inserting an intermediate merger with PGMP4 Co., Ltd.—which likewise operates a golf course business—in between, the carryforward losses were, on their face, lawfully succeeded to.
The tax authorities denied this arrangement, holding that it fell under the category of “cases found to result in an unjust reduction of the tax burden for corporation tax purposes” as set out in Article 132-2 of the Corporation Tax Act.
https://laws.e-gov.go.jp/law/340AC0000000034#Mp-Pa_2-Ch_5-At_132_2
This is a notable case in which, although the taxpayer lost before the National Tax Tribunal, the taxpayer prevailed at both the district court and the high court level—an unusual outcome.
