The enactment of the "Mimasaka City Commercial Power Generation Panel Tax Ordinance" (the "Panel Tax Ordinance") in Mimasaka City, Okayama Prefecture has the potential to significantly impact not only those solar power operators in the area, but also solar, wind and other renewable energy source operators and investors all across Japan. The ordinance of a municipality could affect the entire future of Japan’s decarbonization.
As Japan and other countries around the world take on the ambitious challenge of decarbonization under the 1.5°C Paris Agreement target ("[h]olding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels"), Mimasaka City enacted a Panel Tax Ordinance on December 21, 2021 that will levy a new tax on solar power operators based on the solar panel surface area (the "Panel Tax"). This is essentially a "renewable energy tax" as opposed to a carbon tax, and some estimates show that the new burden on a solar project utilizing bank loans can amount to approximately 10% of income as described below.
For the Panel Tax Ordinance to be enforced, a consent by the Minister for Internal Affairs and Communications (the "Minister") must be granted. If such consent is granted and the Panel Tax is then actually imposed, the fear is that other local governments may enact similar ordinances or even levy taxes on other renewable energy sources, such as wind power, which has finally been picking up speed in the Japanese market.
In this Alert, we provide an overview of Mimasaka City's Panel Tax Ordinance and consider its potential to shake up the Japanese renewable energy market and greatly impede the realization of Japan's decarbonization policies.
The City Council of Mimasaka City (population 27,000; located in Okayama Prefecture) passed the Panel Tax Ordinance imposing the Panel Tax as a "Non-stipulated Special-purpose Tax" (Local Tax Act, Articles 5.7 and 731.1) at a plenary session on December 21, 2021, and it was promulgated on the same day by the mayor, Seiji Hagiwara. Mayor Hagiwara, a former bureaucrat at the Ministry of International Trade and Industry (now the Ministry of Economy, Trade and Industry) and a former member of the House of Representatives, has been a strong advocate for the introduction of the Panel Tax, and, after failing twice since the submission of the first bill in 2019, his administration resubmitted the revised bill to the City Council with exemptions for certain small-scale operators that has now become the official ordinance of the city (for the text of the Panel Tax Ordinance, see here; available only in Japanese); please also see our Alert on the issue as of June 4, 2019).
The Panel Tax Ordinance defines "Power Generation Business" as "the business of generating electricity using solar power facilities located within the city limits" and "Operator" as "a person who conducts power generation business" (Article 2(6) and (7)); it stipulates that a Panel Tax shall be imposed "on Power Generation Business, upon the Operator thereof" (Article 3). The Panel Tax will apply not only to new power generation businesses in Mimasaka City, but also to existing power projects that are already in operation. The tax basis (the act or item to be taxed (tax object), expressed in a monetary amount) is the "total area of the solar panels of the solar power facilities used for the purpose of the Operator's Power Generation Business (Article 6.1)" as of January 1 each year (Article 5), and the tax rate is 50 yen per square meter (Article 9). The Panel Tax Ordinance exempts operators of certain small-scale facilities, that is, (1) solar power facilities installed in a building component, such as roof-mounted solar power facilities, (2) solar power facilities with an installed capacity of less than 10 kW under the FIT approval and (3) solar power facilities with an installed capacity of less than 50 kW under the FIT approval wherein the project area under the same FIT approval does not include certain areas such as designated erosion control areas or landslide prevention areas (Article 4.1).
Operators subject to the Panel Tax are required to submit an annual return to the mayor by April 30 stating the value of the total panel surface area as of January 1 of the same year (Article 7). If no return is submitted (for projects with installed capacity of 50 kW or more under the FIT approval), the mayor shall calculate the taxable panel surface area (m2) as the "total solar cell output" (or DC value) expressed in kW under the FIT approval multiplied by six (6) (calculated after rounding down to the nearest 1 kW)(Articles 11, 8.2 and 8.3). This same method of calculation may also be used by operators (Article 8.5), which means, despite some unclear wording, that an operator is likely to be allowed to choose its preferred method for calculating the tax basis. Further, a tax credit of up to 20% of the Panel Tax shall be granted if an operator makes a contribution to local residents and other stakeholders that meets certain requirements (Article 10).
Given that certain terms in the Panel Tax Ordinance appear to be defined based on the assumption that relevant facilities will have received a FIT approval under Article 9.3 of the Act on Special Measures Concerning Procurement of Renewable Energy Electricity by Electric Operators (Act No. 108 of 2011, the "Renewable Energy Act"), the Panel Tax may be intended to apply only to solar power facilities that have received a FIT approval; however, since there is no assumption of FIT approval in the definitions for the terms "Operator," "Power Generation Business," "Solar Power Facilities" or "Panel" as used in the provisions stipulating the tax basis, the Panel Tax can be interpreted to apply even to non-FIT solar power generation businesses, such as those under increasingly appealing corporate PPA schemes.
The Local Tax Act (Act No. 226 of 1950), a national law on the taxes of local governments, sets forth tax categories such as prefectural resident tax and enterprise tax for prefectural tax, and tax categories such as municipal resident tax and property tax for municipal tax, and stipulates detailed provisions regarding these taxes. In addition to these taxes specifically provided by the Local Tax Act ("Stipulated Tax"), the Local Tax Act also allows prefectural and municipal governments to establish a general tax or special-purpose tax under categories that they independently create ("Non-stipulated General Tax" and "Non-stipulated Special-purpose tax, " collectively "Non-stipulated Tax"; Local Tax Act, Articles 4.3, 4.6, 5.3 and 5.7; the term "general tax" means a tax levied without specifying the purpose for which it is to be used, and the term "special-purpose tax" means a tax levied for the purpose of paying specific expenses).
Although a prefectural or municipal government may impose a Non-stipulated Special-purpose Tax to cover specific expenses specified by municipal ordinance (Local Tax Act, Article 731.1), it must consult with and obtain the consent of the Minister to do so (Article 731.2). The Minister must grant consent except when he/she deems that (1) the tax basis is the same as that of the national tax or other local taxes and the burden on residents (taxpayers) is significantly excessive; (2) the tax imposes a serious obstacle for the commerce of goods across prefectures and cities; or (3) the tax is otherwise not appropriate in light of national economic policies (Article 733). Further, since the power of local governments to enact ordinances is granted only within the scope of national laws and regulations (Article 94 of the Constitution; Article 14.1 of the Local Autonomy Act), as stated in the Supreme Court decisions discussed below, it is a matter of course that implementation of a Non-stipulated Special-purpose Tax shall not be in conflict with the Local Tax Act or any other national laws and regulations.
The provision requiring the Minister’s consent under the Local Tax Act can be interpreted as a means to exercise appropriate control mainly from a policy perspective upon local ordinances introducing Non-stipulated Tax. In particular, the wording of the phrase "not appropriate in light of national economic policies" under the Local Tax Act clearly suggests that the Minister must make a decision from a policy perspective, and it should be construed that the Minister is responsible for properly exercising discretion in deciding whether an ordinance introducing a Non-stipulated Tax is "not appropriate in light of national economic policies." In October 2020, the Japanese government announced its commitment to 2050 carbon neutrality under the 1.5°C target and has made significant progress in discussing reforms to promote renewable energy. In June 2021, the Act on Promotion of Global Warming Countermeasures (Act No. 117 of 1998, hereinafter the "Global Warming Act") was amended by Act No. 54 of 2021 to clearly position the 1.5°C target and 2050 carbon neutrality as "basic principles” of national climate change countermeasures (Article 2-2 of the Global Warming Act). The amended Global Warming Act will oblige municipal governments to make efforts to specify decarbonization plans in their respective areas (Articles 21.4 and 21.5 of the amended Global Warming Act; effective April 1, 2022). Thus, it is expected that decarbonization efforts will be further accelerated at both the national and local levels. In this context, we need to closely watch during the process of the consultation and consent whether the Minister will make any resolute determination that the Panel Tax Ordinance and its levying of a new tax exclusively on solar power operators is "not appropriate in light of national economic policies." As mentioned in the introduction above, since the potential influence of the Panel Tax Ordinance could expand to many renewable energy projects outside of Mimasaka City and have a significant negative impact on the implementation of the government’s decarbonization policies, the Minister’s decision to grant or not grant consent will inevitably demonstrate both domestically and internationally where the Japanese government stands on the promotion of renewable energy.
As noted in (1) above, the Minister could refuse to grant consent on the grounds of "same tax basis" and "significantly excessive burden." That is, the Local Tax Act also expects that the Minister will exercise appropriate control over unreasonable burdens brought by double taxation. In this regard, power generation facilities that include solar panels are already subject to property tax (municipal government Stipulated Tax) as "depreciable assets" under the Local Tax Act. Mimasaka City explains that property tax and the Panel Tax do not overlap because the tax object of the property tax is “assets” (the tax basis is the assessed value thereof) whereas the tax object of the Panel Tax is the business activities of solar power plants (the tax basis is the panel surface area thereof), but this explanation does not change the fact that both taxes focus on the power generation facility in the course of tax calculation. The "same tax basis" has been interpreted by the Ministry of Internal Affairs and Communications ("MIC") as including "cases where the tax bases are deemed the same substantively" (the Notification from the Director General of the Local Tax Bureau of MIC, Document "総税企" No. 179, November 11, 2003; "Processing standards and points to be noted concerning the consent to the establishment or change of extra-legal general tax or extra-legal special purpose tax" (the "2003 Notification")), and previously, with regard to the establishment of a new "utility pole tax" as a Non-stipulated General Tax, the national authority determined that "Utility poles are tax object of property tax and should therefore not be subject to a new Non-stipulated General Tax" (Response of the Director of the Municipal Tax Division, Document "地財委税" No. 1875, November 16, 1951). Thus, we believe that the tax basis issue should be approached from a substantive perspective and that municipal governments should not be allowed to evade the intent of the law simply by dividing the same object of taxation into an assessed value and surface area.
Even if we were to accept the argument of Mimasaka City and assume that these two taxes do not overlap due to the formalistic difference in the tax objects, the structure in which the Panel Tax is imposed on the same object that is already taxed remains the same because the business activities of power generation are already subject to corporate enterprise tax (prefectural tax for which tax is calculated based on the amount of income multiplied by a certain tax rate among other related amounts).
In addition, the Panel Tax levies 50 yen per square meter of solar panel. In the case of certain projects selling electricity at a more favorable price than the market price under the support of the FIT scheme, Mimasaka City explains that this would be equivalent to approximately 0.75 to 2.5% of revenue. In mega-solar projects, however, as it is common to finance initial costs utilizing bank loans, most (e.g., 75%) of the revenue after deducting operational costs would be allocated to repayment of the loans and only the residual (25%) would be allocated to investors. In such case, the reduction of income by 2.5% would result in reduction in return by 10% (2.5 divided by 25%), which significantly lowers the IRR, in the eye of investors. Since mega-solar projects operate by recovering a large amount of initial investments while repaying the loan over a long period of time before gaining profit, the continuous taxation of the Panel Tax for the duration of the project would be burdensome. Moreover, while the existing property tax reflects reductions in value due to annual depreciation, and while the existing corporate enterprise tax reflects the amount of any losses, the Panel Tax will be permanently imposed for the duration of the project in the same amount based on the existence of assets that are indispensable to the project, regardless of the value of those assets or the amount of profits or losses. Thus, for operators, the Panel Tax could significantly impact income to the extent that a project becomes unfeasible and would be nothing other than a double tax that imposes a significantly excessive burden (Local Tax Act, Article 733(1)). The heavy burden in terms of the amount and duration of taxation will clearly hinder the purpose and effect of renewable energy policy which the government has been promoting and is not appropriate in light of the government's economic policies (Article 733(3)). Considering the fact that there are many projects being supported by the FIT scheme under the Renewable Energy Act, consistency with national economic policies (Local Tax Act, Article 733(3)) must be questioned also in connection thereof as such an excessive tax burden would overturn the premise of the FIT scheme, which was meant to attract private investment in renewables by guaranteeing the purchase of electricity for a certain period of time at a fixed price taking into account the operational costs, including taxes.
Moreover, although the Panel Tax Ordinance states that the purpose of the Panel Tax is "to cover the cost of measures for disaster prevention, living environment and natural environment" (Article 1), there is no satisfactory explanation provided as to why such a general purpose should be financed through a tax exclusively imposed on solar power generation businesses. This point was specifically questioned by five out of 18 members of the Mimasaka City Council who voted against the proposal, but there were no forthcoming answers. In fact, it is questionable whether Mimasaka City sufficiently discussed the considerations pointed out in the 2003 Notification, which states that "in the view of the purpose and the object of the Non-stipulated Tax, the head of the local government and the council should give sufficient consideration as to whether such taxation is an appropriate means, and whether there are more appropriate means other than taxation."
The Minister should properly consider all of these circumstances and properly exercise authority to grant or not grant consent for the Panel Tax Ordinance; renewable energy operators, investors and other interested parties in Japan and abroad are advised to keep careful watch.
As noted above, the provisions of ordinances enacted by local governments are invalid if they violate national laws or regulations. According to supreme court precedents, such violation of national laws and regulations by a local ordinance "must be determined by comparing the intent, purpose, content and effects of both to establish whether or not there is any conflict between them" (Saikō Saibansho [Sup.Ct] (Full Bench), September 10, 1975, Sho 48 (aあ) no. 910, KEISHŪ vol. 29, no. 8, p. 489 [Tokushima City Public Safety Ordinance Case]; hereinafter the "1975 Supreme Court Decision").
The 1975 Supreme Court Decision was cited in a Supreme Court decision in which all five justices unanimously ruled that a "temporary special enterprise tax" (Non-stipulated General Tax) by Kanagawa Prefecture was unlawful and invalid because it conflicted with the provisions of the Local Tax Act regarding corporate enterprise tax (Stipulated General Tax) (Saikō Saibansho [Sup.Ct] (First Petty Bench), February 18, 2013, Hei 22 (gyō-hi行ヒ) no. 242, MINSHŪ vol. 67, no. 3, p. 438 [Kanagawa Prefecture Temporary Special Enterprise Tax Case]; hereinafter, the "2013 Supreme Court Decision"). The district court ordered (affirmed by the Supreme Court) the prefecture to pay to the taxpayer a refund with additional interest, holding the provisions of the local ordinance imposing a temporary special enterprise tax (Non-stipulated General Tax) on the amount equivalent to losses in the previous years that were to be deducted in the calculation of the tax basis for the corporate enterprise tax (Stipulated General Tax) were invalid. The Supreme Court held that the provisions of the Local Tax Act regarding the Stipulated General Tax "are not optional but mandatory, except when there are specific provisions construed as permitting ordinances to establish provisions different therefrom," and, just as "it is not permissible . . . for an ordinance relating to Stipulated General Tax to amend the content of mandatory provisions of the Local Tax Act relating to the Stipulated General Tax," the Court held, it is also “impermissible as being contrary to the intent and purpose of the provisions of the Local Tax Act and interfering with its effect . . . to have the ordinance related to a Non-stipulated General Tax substantively change the content of . . . the mandatory provisions relating to Stipulated General Tax as set forth in the Local Tax Act."
Thus, the Supreme Court ruled that, albeit with respect to the relationship between a Non-stipulated General Tax and a Stipulated General Tax, the provisions of an ordinance introducing a Non-stipulated Tax are unlawful and invalid if they are contrary to and substantially alter the mandatory provisions (i.e., provisions that are not permitted to be amended by ordinance) on the Stipulated Tax under the Local Tax Act. If the same logic is applied to the general relationship between a Non-stipulated Tax and a Stipulated Tax, then the provisions of the Panel Tax Ordinance would be unlawful and invalid if they are deemed to substantially amend the content of the Local Tax Act provisions related to, for example, the property tax or corporate enterprise tax.
In relation to the property tax, which, as noted above, substantively shares the same tax basis, the Panel Tax is, in effect, equivalent to expanding the tax basis of the property tax; in addition, as the Panel Tax is levied without taking into account the decline in value of assets, it would significantly change the way commercial assets are taxed. Besides, although, for property tax, municipal governments are allowed to set a higher tax rate than the standard rate of 1.4% (excess tax rate), that should not mean municipalities can raise the tax rate as much as they want to, and, in fact, most of the local governments that impose an excess tax rate adopt 1.50% or 1.60%; creating a new tax for which the tax basis is substantively the same as property tax and placing heavy burdens on taxpayers is questionable from such perspective as well. Further, as the maximum amount of the tax basis of large-scale depreciable assets for property tax that a municipality can collect is capped in accordance with its population (Article 349-4 of the Local Tax Act), the Panel Tax may be incompatible with the intention of such provision. Moreover, while the Local Tax Act provides mitigation measures for the property tax on certain solar power facilities (non-FIT) (Article 15.27 of the Supplementary Provisions of the Local Tax Act), the Panel Tax cancels the effects of such measures. Even when seen as a tax on the business activities rather than assets as Mimasaka City argues, the Panel Tax significantly changes the taxation on business activities as it is a continuous levy of a fixed amount based solely on the fact of having assets indispensable to the conduct of business, while the corporate enterprise tax (prefectural tax) considers the fluctuation of income and loss. Additionally, as the maximum tax rate for corporate enterprise tax is limited (limited tax rate) (Local Tax Act Article 72-24-7, paragraphs 8 and 3), it should be examined whether the purpose of such limitation is thereby subverted if the Panel Tax would effectively result in cancelling the effect of such upper limit.
So as not to grant consent to an unlawful ordinance, the Minister should consider the principles set out by the 2013 Supreme Court Decision and thoroughly examine the legality of the Panel Tax Ordinance.
Following the declaration of carbon neutrality by 2050 on October 2020 by then Prime Minister Yoshihide Suga, many reforms to promote renewable energy have been discussed in Japan. Many local governments have announced their own commitments to carbon neutrality by 2050, the number of which amounts to 492 with an area population of 112.27 million as of November 30, 2021 (see here for local governments that have expressed their commitment; available only in Japanese). There is no doubt that the promotion of renewable energy is one of the most effective and fundamental measures in this series of decarbonization efforts, and with the amendment of the Global Warming Act, it is expected that local governments will accelerate their efforts to promote renewable energy.
Mimasaka City has not announced a commitment to carbon neutrality by 2050; it instead enacted the Panel Tax Ordinance, which, as mentioned above, runs counter to the national policy of decarbonization and the promotion of renewable energy. If these kinds of local government ordinances were to be enforced with the consent of the Minister, it would be tantamount to sending a message from the national government that taxing renewable energy sources and thus imposing a competitive disadvantage does not go against the government’s policies. This may lead other local governments to follow suit or expand the scope of taxation to wind power generation and other renewable facilities as well. Thus, the Panel Tax Ordinance presents a new risk factor for the Japanese renewable energy market as a whole that could greatly hinder the implementation of Japan's decarbonization measures. It is hoped that these risks will be eliminated as soon as possible through the appropriate exercise of authority by the Minister.
The Panel Tax Ordinance will affect not only solar projects in Mimasaka City but also renewable projects all across the nation and will have a material impact on the realization of Japan's future decarbonization policy. After international society reaffirmed the importance of pursuing the 1.5°C target at COP26 held in Glasgow in November 2021, the Panel Tax Ordinance is an issue that hits close to home, not only for renewable energy operators, investors and other parties involved in the renewable energy business, but for all people across Japan and around the world.