The Ministry of Finance (MoF) recently released data which shows that the global recession is having a marked impact on the taxes that Japanese companies pay to the government. According to the data, the corporate tax-take took a 30% tumble to 10.01 trillion yen, the largest year-on-year fall since records for this source of tax were first compiled in 1947.

Overall, the tax take fell 13.2%, or some 6.75 trillion yen, leaving the MoF with some egg on its face. While the ministry probably couldn’t have predicted the true impact of the Lehman implosion when it reduced the overall tax forecast from 53.6 trillion yen down to 46.42 trillion yen in December, nonetheless, it was looking less than smart after the actual tax income came in at just 44.26 trillion yen.

This shortfall is cause for serious concern, since the government seems to want to stick its head in the sand by saying that the economy will still grow by a healthy amount in 2010. As a result, they have have not cut their budget—indeed it is blowing out.

I’m not quite sure why they can’t figure out that if last year the very negative figures in fact included six healthy months of income prior to the Lehman collapse, then what will the tax take be if every month of income will be as bad as it has been recently? It’s apparent to me, at least, that the nation’s tax take will probably sink below 40 trillion yen, and thus all the “by the skin of our teeth” calculations made by the government regarding meeting increased social security payments are pretty much out the window.

While the global stock markets may be temporarily up, I think the recovery in stocks is both illusory and superficial, and is not going to last very long. Indeed, my take is that Japan will follow an inevitable slide in the U.S. markets, following what will probably be a significant bout of inflation due to printing more than 100% more dollars in that economy over the last nine months. This will cause further disruption to the global economy and thus sideswipe any rosy recovery of domestic tax revenues next year.

As a reminder, last week’s U.S. jobs report of 9.5% unemployment shows that U.S. companies don’t think things are getting better. Instead, they’re hunkering down for a lot worse to come.

The fall in tax revenues couldn’t come at a worse time for the government, as it has committed to some huge fiscal stimulus spending, as well as having to pick up the additional costs of more unemployed, more pension claims from the baby boomer retirement surge that started in 2007, and more special assistance for creditors hurt by increasing bankruptcies. Last week Teikoku Databank, Japan’s equivalent of Moody’s, said that a near-record 18 listed companies went under in the first six months of this calendar year, leaving behind liabilities of more than 1 trillion yen in debts. Their investors and vendors would be having to turn to the banks for loans to cover these losses.

On July 1, the government endorsed a plan for its highest budget ever (need a dose of reality anyone?), of 52.67 trillion yen for fiscal 2010, saying that stimulus is more important than financial discipline. One wonders just how the government thinks it will meet its social security costs in particular, which will increase by 1.09 trillion yen in 2010, to 25.1 trillion yen—about half of the overall proposed budget. Mention has been made that the extra costs will be met by corresponding cost cutting in defense, eduction, and medical outlays, but with a 10 trillion yen shortfall in tax, North Korea’s missile posturing, and increasing negative publicity about the failing medical system, it is difficult to see how this would be possible.

Perhaps the government feels it can issue a lot more new bonds, and this is a possibility, especially if the U.S. dollar takes a bad tumble and global investors seek a relatively “safe haven” currency such as the yen. Currently, bond proceeds as a portion of General Account income are down 8.2% over last year, but by arm twisting of the big institutional funds, as well as directly and indirectly raiding the Japan Post Bank, which probably won’t be privatized after all, the government probably still has another 1-2 years of fudging they can do before finally having to pull the pin on the “tax grenade”—being the raising of national consumption tax to 10% or 12.5%.

This perfect storm in government debt control is no doubt creating some strong pressures on the Tax Office to try to rake in some more income until the consumption tax jackpot of 2011 or 2012. We already know that they are set to implement some aggressive corporate tax reclamation strategies. One of these is transfer pricing taxes, which is an area open to interpretation and some juicy claims.

It doesn’t help that the law was changed so that not only overseas subsidiaries of multinationals but now also their branches as well, will be subject to Japanese tax. This bodes badly for some foreign firms who have tried to structure their holdings in Japan to avoid having to pay tax in two jurisdictions.

One recent application of the new transfer pricing tax law and its interpretation is to be found in the Tax Office’s current spat with Amazon.com. The Tokyo Regional Tax Bureau has told Amazon that it owes them 11.9 trillion yen in taxes for unreported income in Japan over a three-year period to 2005, since the company operated as if its branch office was a permanent operation in Japan and thus is taxable domestically.

Amazon.com is apparently saying that the tax claim is inappropriate because it is already paying taxes for Japan sales under the bilateral tax treaty between the U.S. and Japan, to the IRS of the U.S.

Our take is that the Tokyo Regional Tax Bureau is using this as a test case to see if it can lock in some of the multinational revenues into the Japanese side of the equation. But this could be a risky undertaking, because there are no doubt a lot more Japanese firms operating in the U.S. who could similarly be hit with IRS demands if this claim was to go through.

It’s not just Amazon and other foreign firms; the new transfer pricing policies will hurt Japanese multinationals as well. Despite various tax holiday offers, Japanese companies know full well that domestic corporate tax rates are significantly higher than in other industrialized nations, and thus having to repatriate more profits home would seriously damage their international competitiveness.

I think that instead of going after more taxes from companies, which in any case are pretty much shielding the government from the real costs of the recession by keeping most permanent employees employed, the government should simply consider cutting back the social security entitlements. The easiest way to do this would be to raise the retirement age to 70 or 75. I’m expecting this will happen anyway, so why not get it over and done with?

Terrie Lloyd writes a weekly newsletter for entrepreneurs and business people about business and political opportunities in Japan.

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12 Comments

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  MichaelJP at 09:29 AM JST - 19th July

  Regarding Japan wishing to double-tax Amazon.com, making them effectively pay tax both in the U.S. and in Japan and therefore putting them at a significant competitive disadvantage, this could make their business -- based on slim profit margins -- untenable here. It would be a pity if they pulled out of Japan since it would impact many local businesses that benefit from Amazon sales... e.g. package delivery services, local producers who resell via Amazon, etc.

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  DeepAir65 at 10:53 AM JST - 19th July

  tax laws here are crazy. The exodus of foreign companies to countries like HK and Singapore will continue and drive their tax revenue down even further as the high net income foreigners continue to leave

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  mousepotato464 at 11:05 AM JST - 19th July

  During a global recession tax revenues decrease. Wow, what an insight. Increasing taxes will not help much. They should have decreased their spending 18 monthes ago when the downturn began.

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  Weasel at 02:27 PM JST - 19th July

  They should have decreased their spending 18 monthes ago when the downturn began

  mousepotato, you ought to know that the government never has time for rational solutions.

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  sharky1 at 03:15 PM JST - 19th July

  Stop sending out foreign aid until the economy is healthy enough to support it. Take care of Japan first, then you will be able to help other nations. ...DUH!!!

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  GW at 06:18 PM JST - 19th July

  Wud help also if more j-companies paid taxes, most cook the books so they loose a little or just break near even so they dont have to pay taxes, they foist that responsibility onto their employees.

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  ThonTaddeo at 06:38 PM JST - 19th July

  Raise the retirement age to 75 for women (who already live 7-8 years longer, karoshi being unknown for them) and 70 for men.

  Do it now before the baby boomers get to that age and stop anything like it from happening. That generation will happily bankrupt the world as long as they get theirs.

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  MichaelJP at 07:38 PM JST - 19th July

  The government should simply cut back on its massive spending. Problem solved. We all no there's no chance of that happening though.

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  noborito at 08:19 PM JST - 19th July

  ThonTaddeo, what are you talking about. 90% of women don't work past 40. The ones that do, are sad indeed and wouldn't help the economy at all.

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  sfjp330 at 03:37 AM JST - 20th July

  Since the bubble in the early 90's Japan, their domestic demand has been flat. The export profit for the companies has depended primarily on fluxuation of currency exchange between dollar and yen. Yen exchange rate is currently at 93-94 yen per dollar, and this makes extreme difficulty of Japanese export companies. I am wondering why China's currency, even at this time of the world recession, their currency is still peg at 6.83 yuan per dollar. This has not changed for 2-3 years. This creates stability for Chinese export, and their GNP growth is almost 7 percent this year. China has substantial political influence on currency exchange do to large loan to U.S. Why can't Japan have more influence on currency exchange to make rates around 105-110 yen more substainable?

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  DeepAir65 at 02:01 PM JST - 20th July

  Why can't Japan have more influence on currency exchange to make rates around 105-110 yen more substainable?

  because the world is more scared of China than Japan - Japan's day is over and I really would be surprised if very, very soon it loses it's place as the worlds second largest economy - if it has not already done so

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  sfjp330 at 04:57 AM JST - 21st July

  DeepAir65; "World is more scared of China than Japan"

  Regarding substantial fluxation in yen is more about lack of investors and speculation in short term in weak economy Japan. China on the other hand, has more stable world wide investors, especially from U.S. (last year was over $200 billion trade surplus with U.S.) and majority of the trade surplus are direct result of investment from U.S. companies. The speculation prognosis seem to indicate continue growth for China. This will bring continous potential investors and speculators. The result will be more of a future stable currency for China. My question is what can Japanese Govenment do to attract potential investors to Japan rather than China?

  Japan, regardless of the economic change will be third largest economy soon. Not bad for having 10 percent of population of China.

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