In tax reform, Abenomics giveth, and taketh away

 By Tetsushi Kajimoto and Shinichi Saoshiro Reuters/Tokyo

For corporate Japan, burdened by one of the industrialised world’s steepest tax rates, a tax cut at the centre of Prime Minister Shinzo Abe’s latest growth strategy will end up giving with one hand and taking back with the other.

While the headline tax rate will fall, Tokyo, under pressure to shore up its finances with a public debt twice its annual GDP, is seeking to offset the tax cut by scaling back exemptions and deductions favouring small and loss-making companies.

That regime – in which fewer than a third of firms shoulder the entire corporate tax burden – has been seen as essentially subsidising inefficiency and punishing profitability.

“Corporate tax cuts and broadening the tax base would make Japan’s taxation fairer and more stable, even though it would impose a burden on unprofitable companies that are not paying corporate tax, many of which are small and unlisted,” said Hiroshi Watanabe, senior economist at SMBC Nikko Securities.

“If the government continues to levy high tax on profitable firms, that would drive more firms out of Japan.”  The changes, part of the latest instalment of Abe’s “Third Arrow” of growth-promoting structural reforms, will mean short-term pain for the 70% of Japanese firms that pay no corporate tax, especially among the small firms that employ seven out of 10 Japanese workers.

In other developed economies such as the US and Britain, by contrast, more than half of firms pay corporate tax.

But in the longer term, the changes are expected to nurture more profitable firms, while it is hoped the lower tax rates will encourage foreign direct investment and capital spending to spur growth under the reflationary policies dubbed “Abenomics”.

A number of foreign companies with Japan-listed units, including Oracle Corp and the Coca-Cola Co, will also be among the main beneficiaries of the tax cut, according to SMBC Nikko Securities.

Abe’s cabinet approved on June 24 the plan to cut Japan’s corporate tax rate – among the highest in the world at above 35% – to less than 30% over several years. Decisions on how to offset revenue losses and other details were deferred, but a government tax panel has issued proposals that included expanding taxation to companies with less capital, meaning that even loss-making firms will have to pay local corporate tax.  The panel also proposed changes to deferral provisions, which let companies carry forward losses to offset future taxes.

Those generous carry-forward provisions resulted, for example, in Toyota Motor Corp – one of Japan’s most profitable manufacturers and its most valuable by market capitalisation – paying no corporate tax for the five tax years from the onset of the global financial crisis in 2008.

The Ministry of Finance estimates that each percentage point of tax cuts would reduce government revenue by about ¥470bn ($4.6bn) a year. Cutting the tax rate below 30% would cost some ¥2.8tn in terms of lost revenue.  Nomura Securities estimates that a 6 percentage point cut in corporate tax could boost GDP by around 0.3% over time, although the effect would be smaller if revenue losses were financed by alternative sources.

“The immediate impact of the tax cut may be small. But in the long run, lower corporate tax rates would encourage foreign direct investment and boost cash flow at profitable firms and encourage them to raise capital spending and wages,” said Minoru Nogimori, economist at Nomura Securities.

Among the 34-member OECD economies – whose average rate is around 25% – Japan’s corporate tax rate ranks second after the US. In Britain, Germany and Canada, the rate is below 30%.

In Asia, China and South Korea impose a corporate tax around 25% and Singapore at 17%.

Some observers believe the effort to encourage foreign direct investment is coming just as Japanese small and medium size enterprises (SMEs) are looking attractive to foreign buyers.