Loophole allows tax avoidance by large companies posing as smaller ones

An increasing number of large companies are deliberately reducing their capital to obtain advantageous treatment as small and medium-sized enterprises under the tax system. If these moves are ploys to reduce taxes paid, they could undermine the fairness of the system.

The government and the ruling parties should review the tax system.

For enterprise tax, imposed by local governments, the pro forma standard taxation system is used as one method to determine the amount paid by a company, based on its capital and the total of its employees’ salaries, among other factors. As this approach makes tax revenues less susceptible to economic fluctuations, it was introduced in fiscal 2004 with the aim of stabilizing finances for prefectural governments.

A characteristic of the pro forma standard taxation system is that even companies in the red are required to pay a certain amount of tax, on the grounds that these firms still have obligations because they use public infrastructure and administrative services. However, companies with capital of ¥100 million or less are not subject to this system because they are treated as small and medium-sized enterprises.

Since last year, a number of companies that were hit hard by the COVID-19 pandemic have reduced their capital to ¥100 million or less, such as Skymark Airlines Inc., travel giants JTB Corp. and Nippon Travel Agency Co., and Kappa Create Co., the operator of the Kappa Sushi chain of conveyer-belt sushi restaurants.

It is unavoidable to some extent for companies to reduce their capital if the move is aimed at making up for their huge deficits.

However, it makes no sense if large, well-known companies can squeeze themselves into the small and medium-sized enterprises category in name only in order to escape being subject to the pro forma standard taxation system.

According to a private credit research firm, 55 listed companies that used to have capital of over ¥100 million reduced it to ¥100 million or less in 2020, nearly double the number from the previous year.

In its report, the Local Public Finance Council, a part of the Internal Affairs and Communications Ministry that oversees taxes imposed by local governments, said these moves were problematic. The council also noted that corporate activities have been distorted by the tax system.

According to the report, the number of companies subject to the pro forma standard taxation system has been decreasing since the pre-pandemic period. The figure fell to almost 20,000 in fiscal 2020 from nearly 30,000 in fiscal 2006.

So as to secure tax revenues, it is necessary to put a brake on the trend in which precious financial resources for prefectural governments have been dwindling.

Even companies in the black have been making moves to reduce their capital to ¥100 million or less, apparently with an aim to reduce their taxes. Among the companies that took such measures in fiscal 2020, nearly 44% were in the black, according to data from the private credit research firm.

Some experts say that capital has become less important for companies as an indicator of their creditworthiness.

In recent years, some management consultants have reportedly been advising companies on how to reduce their capital to gain status as small and medium-sized enterprises.

All these moves are taking advantage of loopholes in the tax system. Regarding the pro forma standard taxation system, the ministry said it will consider using new criteria for companies in addition to their capital, such as the number of employees, sales amounts and total assets. It is hoped that this issue will be discussed at the ruling parties’ research commissions on the tax system so that appropriate criteria will be established to get a clearer picture of the size of companies’ business activities.

(From The Yomiuri Shimbun, Dec. 10, 2022)