Japan’s Investment Incentives: Opportunities in 2023
Foreign and local investors are equally eligible for incentives offered by both central and local governments in Japan. These incentives typically come in the form of tax breaks, grants, and loan assistance. The Development Bank of Japan plays a key role in this process, providing extensive financing assistance to foreign companies at various operational stages. Notably, its long-term financing facilities are accessible to qualified foreign and domestic companies that undertake projects as part of their long-term investments in the country. Interestingly, the Japanese tax-incentive regime predominantly favors small and medium-sized enterprises (SMEs), reflecting the understanding that many SMEs lack the financial resources to expand their businesses.
Every year, Japan’s tax reforms introduce a new set of benefits, determined by the prevailing economic conditions. In the tax reform law of 2021/22 effective from April 2021, several incentives were introduced. One notable incentive is related to digital transformation investment. This incentive involves an additional special depreciation of 30% in the investment year, or a tax credit of 3% or 5% of the investment amount, for investments in cloud-based systems, software improvements, and certain other assets that enhance productivity. Companies that are eligible for this incentive are known as blue-form tax filers, referring to those using a specific type of tax return. These companies must have their business adaptation plans approved by the Ministry of Economy, Trade and Industry (METI) or other relevant authorities by the end of March 2023.
In addition to the digital transformation incentive, the tax reform law introduced incentives for carbon-neutral investments. This incentive consists of a special 50% depreciation, or a tax credit of 5% or 10%, for investments in qualifying assets that contribute to reducing greenhouse gas emissions. The eligibility criteria for this incentive are similar to those of the digital transformation investment, with the addition that the companies’ environmental adaptation plans must be approved before the end of March 2024.
The 2021/22 tax reform law includes new rules for carrying forward tax losses. These rules allow companies to offset “special” carried forward net operating losses against up to 100% of taxable income, instead of the standard 50% offset limit. As with previous incentives, companies eligible for this benefit are blue-return tax filers, and their business adaptation plans need to have been approved by the METI or other relevant authorities by the end of March 2022. The losses eligible for offset under this provision include those incurred in the fiscal year 2020/21, and certain conditions apply to the fiscal years in which losses may be offset, including that they must start before April 1st, 2026.
The tax reform of 2022/23, effective from April 2022, has maintained several incentives, albeit with some modifications. Among these is the tax credit for research and development (R&D) expenses. This provision, considered a “permanent measure” under the Corporate Tax Law of 1965, offers tax credits in the range of 2-14% (or 12-17% for SMEs) of the total R&D expenses. The rate is contingent on the rise or decline in R&D expenditure. Starting from April 1, 2023, the maximum limit of 14% will be reduced to 10%.
A significant feature of the 2022/23 tax reform is the tax credit available to corporate employers who elevate the average salary payment of their Japan-based employees during the current fiscal year relative to the previous one. For large corporations, a 15% tax credit is given if the total salary of consistently employed individuals increases by at least 3%, and 25% if it rises by at least 4%. This is a change from the previous tax reform where large companies qualified for a 15% tax credit after increasing total wages by at least 2%, and there was no provision for a 25% tax credit. An extra tax credit of 5% is provided if education and training costs have grown by at least 20%, which is the same as the previous tax reform. For SMEs, the tax credit remains unchanged at 15% if total salary increases by at least 1.5%, and 30% if total salary jumps by at least 2.5%, with the latter being a new provision under the 2022/23 tax reform. SMEs are also eligible for an additional 10% credit if their education and training costs have risen by at least 10%.
The tax reform of 2022/23 places stringent conditions on large corporations seeking to avail tax credits for investments in Research & Development (R&D), digital transformation, carbon neutrality, and fifth-generation (5G) technologies. If these corporations fail to meet specific salary increase requirements, they are excluded from the benefits. These requirements stipulate that total employee salaries must have increased by at least 0.5% in the fiscal year 2022/23, and by at least 1.0% in fiscal year 2023/24, compared to the previous respective years. Moreover, the tax reform retains the requirement for these corporations to boost domestic investment to qualify for this incentive, with the total tax credit capped at 20% of the total tax liability.
An SME in this context is defined by certain characteristics. The stated capital should not exceed ¥100m. Majority ownership should not rest with a large company, and two-thirds of the shares should not be held by two or more large companies. A company without stated capital also qualifies as an SME if it employs 1,000 or fewer full-time employees.
The tax reform of 2016/17, together with the Act for Strengthening Business Capabilities of SMEs, effective from 2016, introduced further incentives for SMEs regarding tax payments on fixed assets. SMEs that purchase an asset listed in an approved productivity enhancement plan can have the tax base for the eligible asset reduced by half within the first three years of acquisition. The machinery or equipment must meet specific criteria: released to the market within the previous ten years, enhances productivity by at least 1% annually compared to the previous model, and the acquisition cost is at least ¥1.6m per unit. This incentive was available through the end of March 2023.
Under the SME Business Enhancement Act, incentives are provided to companies that introduce systems, sensors, or robots to improve productivity. The incentives include a 30% special depreciation rate for new software, apparatuses, machinery, equipment, or devices. Alternatively, a 3% tax deduction can be claimed in place of the special depreciation rate. Furthermore, the 2019/20 tax reform introduced a special depreciation system as an incentive for SMEs investing in disaster prevention or mitigation facilities. To qualify, the investment must be part of a government-approved plan.
The Japanese central government also offers subsidies for companies that meet specific objectives. For example, the Subsidy Program for Projects Promoting Foreign Direct Investment, Site Location, and Regional Development subsidizes the cost of establishing regional headquarters or R&D sites in Japan, subject to a ceiling of ¥500m per case. To support businesses affected by the COVID-19 pandemic, the government continues to implement relief measures. The latest supplementary budget, enacted in May 2022, provides subsidies for accommodation and transport fees and offers shopping and dining vouchers for domestic tourists to bolster the struggling tourism industry. Some prefectural and municipal governments continue to provide low-interest or no-interest unsecured loans to SMEs, loan guarantees, and subsidies for employee leave payments as of the end of August 2022.
Incentives by Industries
The Development Bank of Japan extends concessionary long-term loans at low interest rates and provides loan guarantees for various ventures. These include initiatives involving anti-pollution technology, maritime transport, natural resources and energy, which also covers energy-saving devices, technology development, and urban renewal. The terms of these loans vary depending on the nature of the project.
In March 2021, the Industrial Competitiveness Enhancement Act underwent a revision, approved by the parliament, and became effective in the subsequent month. Under this revised Act, the government set up a debt-guarantee system specifically designed for private loans extended to large-scale venture businesses.
The Bank of Japan, the country’s central bank, in June 2021, announced the creation of an investment fund aimed at private-sector efforts to combat climate change. The initiative offers one-year, zero-interest funds to financial institutions for relending to businesses that have projects targeting climate change adaptation. This scheme, which will continue until March 2031, allows unlimited rollovers.
In December 2021, the Diet, or the Japanese parliament, approved legislation that establishes a certification system for production facilities specializing in high-performance semiconductors. These semiconductors are critical for high-speed processing of large amounts of data essential for 5G technology. Effective from March 2022, the law provides grants for the execution of certified plans.
A new economic security law, the Act on Promotion of Economic Security by Integrated Implementation of Economic Measures, was passed in May 2022 and is set to gradually come into force from 2023. The law allows the government to designate certain strategic resources, like rare-earth metals, semiconductors, batteries, and pharmaceuticals, as essential for economic sustainability. Suppliers of these resources will need to develop individual plans to ensure a stable supply, and in return, they will receive financial aid from the government.
The government provides a subsidy of ¥2m to each buyer of a fuel-cell vehicle sold by Japanese car manufacturers and also subsidizes the cost of constructing hydrogen fueling stations. These subsidies are designed to incentivize Japanese car manufacturers to continue developing this technology, with the aim of reducing the cost of each fuel-cell car to about US$20,000 by 2025.
Introduced in 2020, the open innovation tax incentive allows a 25% tax deduction for companies investing in innovative technology start-ups. The investment needs to be at least ¥100m for a Japanese company and ¥500m for a venture company based overseas. The qualifying start-ups must be less than 15 years old, and their R&D expenditures should be at least 10% of gross revenue.
In 2017, the Tokyo metropolitan government presented a “global financial city vision,” which outlined measures to reestablish the Japanese capital as an international financial center. The proposed measures include an amendment of the inheritance tax regime and the introduction of an accelerator program targeting financial technology (fintech) firms. Additionally, the Tokyo metropolitan government is providing subsidies to foreign asset management and fintech companies setting up operations in Tokyo.
Incentives by Region
Japan offers a variety of regional incentives, largely aimed at investments outside the main metropolitan areas. Some of these incentives are tied to regional economic-development projects, with the goal of balancing development between national economic centers and local regions. Concessionary loans from the Development Bank of Japan (DBJ) are available for rural development. Additionally, local governments offer tax breaks, subsidies, and low-interest financing. Nearly all of Japan’s 47 prefectures, and many municipalities, offer tax incentives and subsidies to attract investment.
The tax reform of 2015/16, as amended by the 2017/18 tax reform, promotes businesses relocating their headquarters from the 23 wards of the Tokyo metropolitan area to other locations. Additional first-year depreciation rates are available at 25% of the acquisition cost of a building if the investment aligns with an approved relocation plan, and at 15% if it’s for expanding an existing operation. These plans must be approved by the prefectural government where the business is to be relocated or expanded, and the asset should be acquired within two years of approval.
Starting from 2018, capital investments that can stimulate local economies qualify for special depreciation rates or tax deductions. For machinery and appliances, the depreciation rate is 40%, or alternatively, a 4% tax deduction can be claimed. For buildings, the depreciation rate is 20%, or a 2% tax deduction can be opted for. The investment must be at least ¥10bn and should align with basic plans approved under the law by the relevant prefecture or municipality.
Blue-form corporate tax filers, referring to those using a specific type of tax return, who make contributions to local governments, may qualify for deductions from corporate tax and receive tax credits against corporate, enterprise, and inhabitant taxes. This is known as the corporate hometown tax. For enterprise tax, the tax credit can be up to 10% of such contributions, capped at 20% of the enterprise tax liability.
Japan has established a network of foreign-access zones (FAZs) to promote regional development by designating harbors, airports, and regions surrounding these facilities as import centers. These FAZs are managed by prefectural governments and are divided into “special concentration zones” for wholesalers, retailers, manufacturing processors, distributors, and other import-related businesses. Companies operating in these sites can qualify for various benefits.
However, these FAZs have not attracted a large number of foreign companies. High transport costs for sending products to Japan’s major urban consumer markets largely offset any savings offered by the sites. Therefore, the expected advantages of operating in these zones have not been fully realized.
The Ministry of Economy, Trade and Industry (METI) runs many industrial-policy programs to support regional economic development through industrial clusters, business incubation, and urban redevelopment. For instance, under METI’s Subsidy Program for New Business Establishments in Areas Recovering from Tsunami and Nuclear Disaster, the government may subsidize part of the cost of land acquisition, building construction, and installation of production equipment for manufacturers, and business support service industries such as call centers. This project aims to create employment in areas affected by the 2011 tsunami and Fukushima nuclear accident. The subsidy rates go up to two-thirds of the cost for SMEs and up to one-half of the project cost for non-SMEs.