Japan - Tax impact on warranty clauses | KPMG | GLOBAL

Japan - Tax impact of warranty clauses

Japan - Tax impact of warranty clauses

Tax impacts of warranty clauses in Japan.

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Does the seller grant warranties or indemnities to the purchaser when acquiring a company?

Yes, the seller grants warranties or indemnities to the purchaser when acquiring a company.    

Does the tax treatment of the warranty depend on its legal classification (e.g. indemnity vs. reduction in the purchase price vs. others)?

Not only the legal classification of the warranty, but also the substance/nature of the warranty would be important in determining the tax treatment.    

Is classification of the contractual warranties as a price reduction clause or an indemnity clause relevant in your jurisdiction? Are mixed clauses included in the SPA (for instance, a warranty drafted partially as a price-reduction clause for the portion corresponding to the purchase price and as an indemnity clause for the amount exceeding the purchase price)?

Mixed clauses are not common and typically such payments are treated as price reductions in the SPA.   

Is the classification usually mentioned in the SPA?

No.   

Are there criteria to distinguish between a price reduction clause and an indemnity clause? Could you briefly describe these criteria?

As mentioned above, there is no clear treatment distinguishing between a price reduction or an indemnity, and it would depend on the substance/nature of the item. However, if the payment is made to the target company (and not to the purchaser), it cannot be treated as a price reduction.  

What is the most common type of warranty in your jurisdiction?

Price reduction would be the most common recently.  

Is a tax warranty usually provided by way of a separate warranty agreement (different from the SPA)?

No.  

Is it usual / a market practice to negotiate after-tax settlements, i.e. to reduce the price adjustment to a net payment (i.e. indemnity minus the tax effect of the deduction for the acquirer or target) or to guarantee full indemnification (i.e. gross-up payment to guarantee a net indemnity)?

The purchaser would try to negotiate a gross-up arrangement.   

Acquirer

  Corporate Income Tax Personal Income Tax
Price reduction clause The price adjustment has no direct impact on the taxable income of the purchaser. It is treated as a decrease in the investment value of the shares. Consequently, future capital gains will be increased. The price adjustment may be treated as taxable income.
Indemnification clause The price adjustment is treated as taxable income The price adjustment is treated as taxable income.

Vendor

  Corporate Income Tax Personal Income Tax
Price reduction clause The price adjustment is treated as tax deductible in general. The price adjustment would be treated as a loss but whether it has any tax effect would depend on the individual’s situation.
Indemnification clause The price adjustment is treated as tax deductible in general. The price adjustment would be treated as a loss but whether it has any tax effect would depend on the individual’s situation.

Target

Price reduction clause If paid to the target, the price adjustment is treated as taxable income.

Contact

Megumi Ishihara

KPMG in Japan

Partner – Deal Advisory, M&A Tax

Tel : 813-6229-8191

megumi.ishihara@jp.kpmg.com
 

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