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The plan, unveiled by the Ministry of Economy, Trade and Industry (METI) in May, has drawn comparisons to the American Jobs Creation Act, which triggered fund repatriation by US firms in 2005 and gave a boost to the dollar.
The dollar rose 13 percent against the euro that year, the only year it gained on the single currency between 2002 and 2007.
The tax change, if it goes ahead, will likely spur a rise in fund repatriation to Japan and such flows could pack a punch.
Japanese firms have retained overseas earnings of around 17 trillion yen ($159.1 billion). They could bring home about 3 to 5 trillion yen, or 20 to 30 percent of undistributed overseas earnings, analysts estimated, based on the amount of funds repatriated under the US tax break, also known as the Homeland Investment Act.
But given big Japanese firms' appetite for overseas investment, and low interest rates that make parking money here unattractive, actual fund repatriation could be smaller.
‘Japanese firms have been actively heading abroad due to hopes for high earnings opportunities overseas,’ said Yujiro Goto, an economist for Nomura Securities.
‘Unless this situation changes, they are unlikely to suddenly bring money home just because of some changes to the tax system.’
METI is aiming for permanent reform opposed to a temporary, one-year exemption as was the case in the United States. Thus, Japanese firms won't have to rush to bring money home.
The new system could come into effect in the 2009/10 fiscal year starting next April if it gains parliamentary approval.
‘If this were to be temporary legislation then I think we would see companies bring back a chunk of money at once, maybe around 60 to 70 percent of what they have,’ said Yukio Yoshida, a director for Shimadzu Corp's finance department.
But if the measure is made permanent, the pace of fund repatriation would depend on a host of factors, such as whether there are any financing needs for big capital investment in Japan or the outlook for currencies, Yoshida said.
Repatriating profits from overseas subsidiaries to parent companies in Japan is only regarded as a transfer of cash flow and does not have any impact on consolidated profits.
But to maximise their yen-denominated cash flow, firms may have an incentive to repatriate funds when the yen is weak and to hold off when it is strong, corporate officials say.
Any funds parked in countries with relatively low tax rates such as the Netherlands, which has a corporate tax rate of 25.5 percent, may be a particular target for fund repatriation, since such money may have been left abroad mainly for tax reasons.
The tax reform could have more impact on the yen's moves against the euro rather than the dollar, said Nomura Securities' Goto, who estimates that 12 percent of Japanese firms' undistributed overseas earnings are parked in the Netherlands.
EASIER TAX MANAGEMENT
Japan now employs a worldwide tax system in which all income companies earn, whether at home or abroad, are subject to the country's effective corporate tax rate of roughly 40 percent.
Firms are required to pay corporate tax in Japan when they bring back overseas earnings, although they receive an indirect tax credit, or exemption, for any taxes they have paid abroad.
What this means is that if companies repatriate income from countries with lower corporate tax rates than Japan, they must pay the difference between what they paid in corporate taxes overseas and what they would have had to pay in Japan if such profits had been earned at home.
Under METI's proposal, Japan will stop levying corporate taxes when companies repatriate profits in the form of dividends from their overseas subsidiaries.
‘It would be possible to repatriate funds based on fund demand and without restrictions,’ said Shinji Sato, general manager of the corporate tax department at Mitsui & Co.
But the reform may also help facilitate overseas investment by removing some tax-management headaches.
Under the current system, while first- or second-tier subsidiaries are eligible for foreign indirect tax credit, any lower-tier subsidiaries are not, said Mitsui & Co's Sato.
Fewer hassles like that would be welcome news for Japanese firms, which seem likely to remain hungry to invest abroad.
Overseas production is expected to account for an increasingly higher percentage of Japanese manufacturers' overall business going into 2012, a Cabinet Office survey showed.
‘If the accumulation in retained earnings has been for the purpose of expanding business at overseas locations in the future, then it would be hard to imagine that there would be any huge repatriation of funds to Japan,’ Satoru Ogasawara, an economist at Credit Suisse, said in a research note.
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