Executive summary

Japan’s 2021 tax reform bill introduced Carbon Neutrality and Digital Transformation (CN&DX) related tax credits to the Japanese tax legislation. Qualifying CN&DX investments may now qualify for tax incentives. The tax incentives take the form of tax credits and extra depreciation. The maximum amount of available tax incentives is JPY1.5bn for digital transformation and JPY5bn for carbon neutrality. The exact amount depends on the size of investment and meeting specific conditions.

In addition to the CN&DX-related tax credits, the tax reform bill also introduced special net operating loss (NOL) related rules to enable companies that incur COVID-related losses to utilize them in an efficient manner.

A business plan certification, issued by the relevant Ministry, should be obtained prior to the (qualifying) investments being made. Government guidelines have been issued for the application and certification process and as of 2 August 2021, taxpayers can apply for the incentives.

This Tax Alert summarizes the key issues relevant to applying for these incentives and highlights action points for taxpayers. It also highlights the NOL-related special measures.

Detailed discussion

Carbon Neutrality and Digital Transformation

The Japanese Government has set the goal to reach zero greenhouse emissions by 2050 and to promote the digital transformation of the Japanese economy. CN&DX tax incentives were introduced to Japanese tax legislation by the 2021 Tax Reform Package.

These incentives are tied to the wider Industrial Competitiveness Enhancement Act (Act). The Japanese Government duly incorporated CN&DX-related measures into the Act. All necessary legal provisions took legal effect on 2 August 2021.

Under the new rules:

• A taxpayer prepares a business plan in line with the specific conditions under the Act.
• Such business plan is certified by either the Ministry of Economy, Trade and Industry (METI) or by another Ministry.
• The business plan is properly executed.

Following such action, the taxpayer will have access to the tax incentives for qualifying investments.

Guidelines have been issued for the application and certification procedures (including guidelines about what conditions and benchmarks should be met by the taxpayer’s business plan) on the METI homepage. The legal and procedural background is therefore completed and as of 2 August 2021, taxpayers can apply for certification.

METI officials have mentioned in informal discussions that it is possible for taxpayers to come to them for pre-consultation before filing the actual application for certification. Such pre-consultation can provide additional clarity and can reduce uncertainties regarding the process.

Potential next steps

With the application process “open,” taxpayers with CN&DX plans should consider the following steps:

• Review investment plans: Review CN&DX Investment plans – Could such investments qualify for tax incentives? What would be the amount of potential tax incentives? Does the taxpayer expect to generate sufficient taxable income to benefit from these tax incentives?
• Review the timeline: The relevant time for the investments to be made is between the date when the certification is granted and 31 March 2023 for Digital Transformation and 31 March 2024 for Carbon Neutrality. To qualify for these tax incentives, taxpayers may already have to plan to speed up or delay some investments to be within the specific timeframe.
• Review and understand the application and certification procedure.

Profile of a potentially qualifying taxpayer

Taxpayers with a substantial corporate tax liability in Japan and CN&DX investment plans will find these incentives attractive. The timeframe for the qualifying investments is tight and there is a certification process. Taxpayers should start the initial assessment promptly.

Additional special measures for companies that incur COVID-related NOLs

If a company incurs an NOL (which can be attributed to the impact of COVID) in a financial year that includes any date between 1 April 2020 and 1 April 2021 (or any date between 1 February 2020 and 1 April 2021 in specific cases), new rules will apply.

NOLs can generally be offset against 50% of future taxable income. Under the new rules, if a company has its business plan certified (the business plan does not have to include Carbon Neutrality or Digital Transformation but has to meet certain benchmarks), it can continue to offset 50% of the COVID-related NOLs against taxable income under general rules but it can also offset COVID-related NOLs against the remaining taxable income up to the amount of qualifying investment for a maximum of five years.

The procedural background to claim this incentive is similar to the procedure necessary for CN&DX-related incentives. The taxpayer is required to have its business plan certified and to execute the investment plan to make qualifying investments. Companies can already start the application for certification to take advantage of this measure as well.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Co., Tokyo

• Balazs Nagy | balazs.nagy@jp.ey.com
• Akira Miyazaki | akira.miyazaki@jp.ey.com