Tax support system

1) Reserve of overseas investment loss

Due to the nature of the resource development business, such as the high risk of failure and vulnerability to national risks, overseas resource development projects may incur large losses. In Japan, overseas resource development companies can accumulate a reserve in order to prepare for such losses and corporate risk (such as a decrease in the value of acquired shares and bad debt loss²⁰). It is a reserve system that allows companies to include a reserved amount in their deductible expenses. In Japan, when a domestic company (investor) that has submitted a Blue Declaration²¹ acquires the stocks and bonds of a resource development company that meets certain requirements, it shall accumulate an amount equal to or less than a certain percentage of the acquisition price as reserve funds, which will be included as a loss amount for the current year.²² The types of resources covered by this system are: petroleum, combustible natural gas, metallic minerals, coal, and wood (development only).

In 1973, Japan introduced the Reserve of Overseas Investment Loss System,²³ in accordance with Article 55 of the Special Taxation Measures Act, Article 32-2 of the Enforcement Decree of the Special Taxation Measures Act, and Article 21 of the Enforcement Regulations of the same Act. The system’s special tax treatment is a sunset clause that is effective during a limited period of time and can be extended when necessary. The Ministry of

20

貸倒損失(bad debt loss): loss due to non-recoverable debt (bad debt).

21 A document that declares a clear and fair income, income tax, corporation tax, etc, calculated based on a bookkeeping method that is in compliance with related laws, such as double-entry bookkeeping.

22 oilgas-info.jogmec.go.jp, 石油天然

ガス

23 経済産業省(2016d, p.69).

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Economy, Trade and Industry has been extending the clause at each deadline. The most recent extension of the sunset clause, until March 31, 2018, was possible due to the “Request for 2016 Local Tax Revision.”

The reserve amounts accumulated for resource development projects differ depending on the stage of the project. In the exploration²⁴ and development stages, 70% and 30% of the total investment amount are deposited as a loss reserve over a period of five years. If the project proceeds without any loss, the reserve will be included in the net income for the following five years (one-fifth will be included in each of the five years).²⁵

Companies gain two benefits by allowing investors in exploration and development projects to include an accumulated loss reserve amount for covering investment losses. One is a reduction of the impact of loss risk on companies, and the other is the improvement of cash flow. If a project fails, the accumulated loss reserve can be included in the gains, thus reducing the losses incurred through an accounting technique. Therefore, this system can offset the financial risks of investment in exploration and development and has the effect of a deferred tax payment if the project succeeds, thus enabling the company to manage its funds at an interest rate of zero. Cash flow can also be improved by securing the liquidity of operating funds. Under this system, Japanese companies’

investment in exploration and development has been promoted, resulting in an improvement in Japan’s self- development ratio and contributing to the achievement of the policy goal of securing a stable supply of energy and mineral resources for the country.²⁶

According to the “Request of 2016 Local Tax Revision” in 2016, which contributed to the extension of the reserve of overseas resource development loss in Japan, Japan’s self-development ratio for petroleum and natural gas was 24.7%, as of 2014. Projects that reached the commercial production stage using the reserve of overseas resource development loss accounted for 60% of all self-development projects, thereby proving that the reserve system contributed to maintaining and improving the self-development ratio. In the case of non-ferrous metals, projects using the reserve system accounted for more than 80% of all self-development projects. The reserve system has proven to be quite effective in increasing the self-development ratio, which has risen from 53% in 2010 to 59% in 2013.²⁷

2) Depletion deduction system

Depletion refers to the reduction in value of natural resource reserves (such as petroleum, coal, and minerals)

24 100% of the investment amount until 2009, 90% until 2015,

25 経済産業省(2016e, pp.26~27)

26 経済産業省(2016d, p.69)

27 経済産業省(2016d, p.73).

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through production. In order to sustain their businesses, petroleum development companies need to secure a petroleum reserve equal in size to the amount they have actually produced. The value of resource development companies in general can be sustained only if they secure resource reserves equal in size to the amounts by which the resources have been depleted, which can be done by purchasing mines or conducting exploration projects.

The Japanese depletion deduction deducts a percentage of the gross sales or net profit to secure exploration funds for acquiring new resource reserves to compensate for the depleted resources. In general, the depletion deduction is a concept that corresponds to the depreciation of tangible assets, which is also analogous to the concept of including reserve assets of a decreased value (due to the production of natural resources) in the losses.

In the case of Japan, however, the depletion deduction is used to support exploration projects by compensating for decreases in the value of reserve assets caused by production. New mines are usually located in places where the development environment is relatively poor compared to those of existing mines, thus requiring higher exploration costs and involving greater risk. The Japanese depletion deduction also includes the concept of deducting a provision (or reserve) amount from taxable income for high-risk exploration activities.

In Japan, the depletion deduction system includes the exploration provision system and the special deduction for new mine exploration expenditure (depletion deduction and overseas depletion deduction). Funds required for new exploration are deposited as reserves, and when the funds are actually spent to cover exploration expenses, they can be deducted from the net income. In this way, an incentive is provided that enables oil and gas companies to continue carrying out new exploration activities.

Table 2-10. Japan’s tax benefits for oil and natural gas development

Category Description Deduction Rate

Reserve of overseas investment

loss

If a domestic investor acquires specific stocks of a resource development company that meets certain requirements and then accumulates a certain percentage of an amount equal to or less than the acquisition value as a reserve, according to a particular type of share, the reserved amount will be included in the losses for the current business year.

If the investment project fails, the reserved amount is added to the profit of

Exploration: 70%

Development:

30%

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the withdrawal, which is offset by the loss of the investment project, thus contributing to the leveling of closing accounts.

If the investment project proceeds smoothly, an equal amount of this reserve is divided evenly and included in the profits for the next five years, after a five-year grace period.

Depletion deduction system (provision

for exploration)

To compensate for the decrease in the reserved amount of natural resources due to production, funds for exploring new mines are deposited as a provision (or reserve). Part of the provision (or reserve) amount that meets certain criteria is deducted from taxable income.

This tax benefit in the mining industry is a special treatment in taxation that allows a tax payer to deduct exploration expenses from revenue if an accumulated reserve amount is spent as exploration expenditure within five years.

12% of sales or 50% of net

income

Source:経済産業省 (2016e, pp.26~27), summarized by the author.

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