Newsletter
TAX TREATMENT OF TAX-DEFERRED SHARES REDEEMED ON CAPITAL REDUCTION
Both the former Statute for the Encouragement of Investment (repealed in January 1991) and the Statute for Upgrading Industry (SUI) before the amendments of December 1999 contained provisions regarding "tax-deferred" shares, whereby newly issued shares that a shareholder acquires when a company uses retained earnings to increase capital for statutorily defined purposes are exempt from inclusion in the shareholder's taxable income for that year; they are instead taxed only when they are transferred, given as a gift, or distributed as part of the estate of a deceased person. The shares' value should then be declared as income, at the par value, or at the actual transfer price, or at the then-current market price at the time of a gift or estate distribution, whichever is lower. However, there was no express statutory provision governing how shareholders should be taxed if a company redeems tax-deferred shares to reduce capital in order to offset losses.
Rulings issued by the Ministry of Finance and judgments of the Supreme Administrative Court both expressed the view that such shares should be taxed according to their par value, on the grounds that the duty to pay tax on income from the tax-deferred shares arose when a shareholder acquired them, and the preferential tax provisions merely postponed the time at which such tax is levied. Therefore, tax liability should be calculated according to the shares' par value at the time of acquisition.
But shareholders have argued that when a company redeems tax-deferred shares to reduce its capital to offset losses, shareholders receive no actual income from the transaction, and it is therefore unreasonable to tax such shares at their par value. This has led to a number of disputes and litigation between the tax-collection authorities and taxpayers.
In view of the above disputes, and considering that the practice of taxing tax-deferred shares at their par value when the actual income shareholders receive is zero does not conform to the principles of taxation on substantive income and of taxation according to the ability to pay, legislators recently added Article 19-4 to the SUI. The amendment was promulgated on 9 January 2008 and took effect on 11 January 2008.
Article 19-4 of the SUI provides that when a company redeems tax-deferred shares to reduce its capital to offset losses, the shares' closing market price on the day of the capital reduction, in the case of a TSE- or OTC-listed company, or the company's net asset value per share, in the case of an unlisted company, should be counted toward a shareholder's taxable income for the year in which the capital reduction is made. But if the closing price or net asset value per share on the day of the capital reduction is greater than the tax-deferred shares' par value, then the par value should be used for the income calculation. This provision will benefit holders of tax-deferred shares in companies whose faltering operations force them to reduce capital to offset losses.