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Japanese Thin Capitalization & Earning Stripping Rules Explained

view of building exterior 327483 - Japanese Thin Capitalization & Earning Stripping Rules Explained

Thin Capitalization Rule

You may think that putting injecting capital into an organization in the form of loan is better (more tax efficient) than in form of cash because you may be able to reduce your organization’s taxable income via the interest it will paying you on the load. Interest must be deductible, right?

Unfortunately, this is not always the case. The thin capitalization rule limits interest expenses paid to its shareholder(s). The interest is restricted to the amount paid for loans up to triple of its own equity. For an example, if the equity is 100 and your loan is 370, the interest expense paid on any amount above 300 be deductible. Interest expense is allowed to be expensed only up to 300, which is three times the equity (100).

The rule is applicable to interest paid to an overseas entity which owns more than 50 percent of the interest paying company in form of direct or indirect ownership.

Japanese Earning Stripping Rule

There is also a rule restricting the total amount of interest that can be deducted from corporate taxable income in Japan. If the interest is more than 50% of taxable income (before the interest to its controlling party), the portion exceeding the 50% line cannot be deducted from its income. The rule is not applicable if the interest is less than 10 million Japanese yen.

(Note this rule has be revised in 2019)