ASLI Working Paper Series

Publication Title The Concept of Qualified Reorganization in Japan
Publisher Asian Law Institute
Series WPS004
Publication Date Jul 2009
Author/Speaker Tetsuya Watanabe
Reorganization transactions such as mergers and corporate divisions are generally taxable both at shareholder and corporation levels. However, if the transactions are qualified reorganizations under the law, gains or losses and deemed dividends are not recognized, and the basis of the assets or stocks transferred is carried over. Consequently, they are sometimes referred to as “tax-free reorganizations.”

Since the meaning of “merger” (gappei) and “corporate division” (bunkatsu) in Corporation Tax Act are basically borrowed from the Companies Act, the concepts of qualified reorganization are also based on the Companies Act. As a result, if a transaction is not a reorganization under the Companies Act, it cannot amount to a qualified reorganization under the Corporation Tax Act.

However, it is not necessarily logical to treat tax law as based on private law such as the Commercial Code or the Civil Code. The provisions of private law are not enacted or amended in consideration of tax law. Moreover, since the new Companies Act, which came into force in May 2006, not only relaxes the consideration rules relating to reorganization but also changes drastically the concepts of capital and dividends, the pre-existing difference between the Companies Act and Corporation Tax Law is now even greater.

It is also true that not all reorganizations under the Companies Act are treated as qualified transactions in tax law. The default rule in tax law is “disqualified reorganization” and only transactions which meet specific requirements are allowed tax deferral treatment. In the case of mergers, transactions must be mergers under the Companies Act in order to be qualified mergers for tax purposes. This is the starting point. To obtain deferral on the basis of qualified mergers, transactions must satisfy several requirements under tax law.

According to the 2000 report from the Tax Commission, “The Basic Theory for Tax System of Corporate Reorganization such as Mergers and Corporate Divisions”, two continuities namely “continuity of control to the transferred assets” at the corporate level and “continuity of investment” at the shareholder level formed the bases for tax deferral treatment. But the rationale for such reasoning, and the relationship between this ground for deferral and the current provisions, is not entirely clear.

This paper examines the current requirements and the rationale for qualified reorganizations and compares them with type C reorganization under U.S. tax law.

In U.S. tax law, “a statutory merger or consolidation” is one of type of reorganization, i.e, type A reorganization under the Internal Revenue Code, I.R.C. §368(a)(1)(A) (2007). However, there is also a type of reorganization which is the same acquisitive transaction as type A reorganization, and similar to a merger, but not based on state law. This is type C reorganization under I.R.C. §368(a)(1)(C).

Type C is referred to as a “de facto merger” or “practical merger.” Transactions which are not mergers under state law but have the same character as mergers may enjoy tax deferral treatment if they satisfy specific requirements under the tax law. This idea seems to be useful for considering Japanese tax law polices from a comparative point of view.
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