Japan’s 2021 Tax Reform introduces tax incentives for carbon neutrality and digital transformation

Executive summary

The Japanese Government has set goals to reach zero greenhouse emissions by 2050 and to promote the digital transformation of the Japanese economy. To achieve these goals, certain tax incentives have been introduced. These incentives have been introduced as part of the wider Industrial Competitiveness Enhancement Act.

On 26 March 2021, Japan’s 2021 tax reform bill (the Bill) was enacted following passage by the Japanese Diet. Under the provisions of this Bill, certain Carbon Neutral and Digital Transformation investments qualify for tax incentives amounting up to a maximum of JPY1.5b for Digital Transformation and up to JPY5b for Carbon Neutrality. The amount of the respective tax credit depends on the investment amount as well as satisfying specific conditions.

This Alert summarizes the key provisions relevant to these incentives and also highlights action points for taxpayers.

Detailed discussion

Background

The Japanese Government will incorporate Carbon Neutrality and Digital Transformation related measures into the Increased Competitiveness Enhancement Act (The Act). The amendments to the Act are expected to take legal effect during July 2021.

Taxpayers will have access to these tax incentives if the following conditions are met:

• A taxpayer prepares a business plan in line with the specific conditions under the Act.
• Such business plan is certified by either the Ministry of Economy, Trade and Industry or by another Ministry. Note: Business plan applications are expected to be accepted from August 2021.
• The business plan is properly executed.

Digital transformation investment tax incentive

The use of digital technology should contribute to the business transformation of the taxpayer, resulting in substantial changes in business processes, strategies leading to improvement in productivity and the development of new products, production and sales methods. Projects that could qualify for tax incentives are, for example, plant automatization and E-commerce automated warehouse solutions. Digital transformation-related investments include software, machinery and equipment.

Digital transformation-related investments of up to JPY30b (US$300m) as certified under a business adaptation plan made by 31 March 2023 will either be eligible for a 3% to 5% tax credit or for 30% special depreciation.

Carbon neutral investment incentive

Carbon neutral-related investments reduce greenhouse gas emissions in the production process and contribute to making products that accelerate decarbonization. There are specific decarbonation benchmarks that need to be achieved for the tax incentives to become available.

Carbon neutral-related investments of up to JPY50b (US$500m) as certified under an environment adaptation plan made by 31 March 2024 will either be eligible for a 5% to 10% tax credit or for 50% special depreciation.

Next steps

Whereas the exact details of the Act will only become known at a later date and the amended Act is expected to take legal effect during July 2021, taxpayers should consider the following actions at this time:

• Review Digital Transformation and Carbon Neutrality Investment plans and determine if such investments could qualify for tax incentives
• Review the timeline for making these investments. The relevant time for the investments to be made is between the date when the revised Act takes legal effect somewhere in July 2021 and 31 March 2023 for Digital Transformation and 31 March 2024 for Carbon Neutrality. To qualify for these tax incentives, taxpayers may already have to plan to speed up or delay certain investments to be within the specific timeframe
• Continuous monitoring of the latest developments regarding the Act Including what information to include in the business plan and what is the precise application procedure to business plan certification by (which) relevant Ministry

It is important to note that these incentives may be subject to various limitations. For example, the sum of the carbon neutrality tax credit and the digital transformation tax credit cannot exceed 20% of the corporate income tax payable.

Profile of a potentially qualifying taxpayer

Taxpayers with a substantial corporate tax liability in Japan and investment plans for Carbon Neutrality and Digital Transformation will potentially find these incentives attractive. The timeframe for the qualifying investments is relatively tight and there is a certification process, therefore taxpayers should start the initial assessment promptly.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Co., Tokyo

• Balazs Nagy

For inquiries in relation to tax matters for Japan inbound investments, please contact any of the following members of our Inbound Tax Advisory Services Team:

EY Tax Japan – Inbound Japan Tax Advisory Services Team

• Karl Gruendel, Leader of Inbound Client Services
• Satoru Araki, Japan Tax Controversy Services
• Mark Brandon, International Corporate Tax Services
• Lars Dahlen, General Domestic Japan Tax Services
• Makiko Kawamura, General Domestic Japan Tax Services 
• Balazs Nagy, General Domestic Japan Tax Services
• Keith Thomas, Transfer Pricing