1. Introduction: A Growing M&A Market and Rising Advisory Costs
Japan’s M&A market has been experiencing unprecedented momentum in recent years. In 2025, both the number and scale of deals reached record highs — roughly 2.5 times the deal count and more than three times the aggregate value compared to around 2010, in the aftermath of the global financial crisis. This growth has been driven by outbound investment, industry consolidation, and, more recently, a surge in AI-related investment.
Executing large-scale M&A transactions requires engaging outside experts to value target companies and identify risks through due diligence (“DD”). As deal sizes have grown, however, the fees paid to these experts — what we refer to here as “M&A advisory costs” — have grown substantially as well. Their tax treatment has become an issue that CFOs can no longer afford to overlook, given its direct impact on investment efficiency and cash flow management.
2. The Accounting-Tax Divergence: Increasingly Complex Cost Treatment
The question of when M&A costs should be recognized in profit or loss is answered differently under accounting rules and under tax law.
Accounting Treatment
For consolidated financial statements, Accounting Standards Board of Japan (ASBJ) Statement No. 21, “Accounting Standard for Business Combinations,” as revised on September 13, 2013, requires that acquisition-related costs paid to external advisors (M&A advisory costs) be expensed in the period incurred (paragraph 26). Before this revision, fees and commissions considered part of the acquisition consideration were included in acquisition cost. The 2013 revision moved to a uniform expensing approach, both to improve comparability with International Financial Reporting Standards (IFRS) and to eliminate the practical difficulty of determining exactly which costs should be treated as part of acquisition cost.
Non-consolidated (standalone/parent-only) financial statements, however, are treated differently depending on the form of the acquisition. For share transfers or share acquisitions (acquiring subsidiary shares), acquisition cost on a non-consolidated basis is calculated not under the business combination accounting standard but under the accounting standard for financial instruments and its related implementation guidance. Under that guidance, incidental costs of acquiring financial assets are, in principle, included in acquisition cost — meaning that DD and similar acquisition-related costs incurred in a share acquisition continue to be capitalized into acquisition cost on a non-consolidated basis, as before. By contrast, in a merger-based acquisition, expenditures incurred for the merger are expensed in the period incurred even on a non-consolidated basis (paragraph 84-7 of the Guidance on Accounting Standards for Business Combinations and Business Divestitures). This expensing treatment for mergers predates the 2013 revision.
In other words, the rule is not simply “consolidated = expense, non-consolidated = capitalize.” More precisely: (i) for share acquisitions, the treatment diverges between consolidated (expensed) and non-consolidated (capitalized) statements, while (ii) for mergers, both consolidated and non-consolidated statements expense the cost. Because share acquisitions are the most common form of M&A in practice, the situation described above — where the same cost is treated differently within the same company depending on which financial statements are being prepared — does arise frequently. That said, it’s worth noting this divergence specifically concerns share acquisitions, not M&A transactions generally.
Treatment Under Corporate Tax Law
Under corporate tax law, particularly in share acquisitions, Article 119, Paragraph 1, Item 1 of the Order for Enforcement of the Corporation Tax Act provides that “expenses incurred for the purchase of securities” must be included in the acquisition cost of those securities (shares). Tax authorities have historically interpreted this provision fairly broadly, and have generally required that most M&A advisory costs, including DD costs, be capitalized into the acquisition cost of the asset — thereby denying immediate deductibility.
This creates an “accounting-tax divergence”: costs that are expensed as incurred under accounting standards (at least in consolidated financial statements) are often required to be capitalized for tax purposes. This divergence is a material concern for CFOs and investors managing investment efficiency and cash flow.
Reference sources:
- ASBJ Statement No. 21, “Accounting Standard for Business Combinations” (ASBJ official site): https://www.asb-j.jp/jp/accounting_standards_system/details.html?topics_id=123
- Order for Enforcement of the Corporation Tax Act, Article 119 (e-Gov Japanese Law Search): https://laws.e-gov.go.jp/law/340CO0000000097
3. The Key Issue: What Counts as “Expenses Incurred for the Purchase”?
The central practical question is whether DD costs represent “costs directly necessary for the purchase” or merely “expenses incurred to decide whether or not to purchase.”
Most rulings previously issued by Japan’s National Tax Tribunal have come down on the side unfavorable to taxpayers:
- 2010 ruling: Costs of a financial investigation conducted after the board of directors had already decided to proceed with an acquisition were required to be capitalized into acquisition cost, on the grounds that the investigation informed that decision.
- 2024 ruling: Even before a board resolution, DD costs were held to require capitalization once a letter of intent had been submitted, on the grounds that this indicated an “intent to acquire specific shares” already existed.
This pattern has generally held that once a specific acquisition has become sufficiently concrete, associated costs are treated as an “asset,” not as an immediately deductible expense.
4. A Turning Point: The New Legal Interpretation in the 2026 Tokyo District Court Ruling
This established practice was challenged by a Tokyo District Court ruling issued on February 18, 2026. In this case, a taxpayer dissatisfied with a 2022 tribunal ruling sought judicial review, and the court partially overturned the tax authority’s reassessment.
The court’s landmark distinction:
The court took a narrower view of the scope of Article 119, Paragraph 1, Item 1 of the Order for Enforcement.
- Recognized as immediately deductible expenses: fees for information provided in connection with M&A intermediary services, interim advisory fees, and legal due diligence costs.
- Required to be capitalized into acquisition cost: success fees paid upon execution of the share transfer agreement.
This ruling is significant because it marks the first time a Japanese court has indicated that investigative costs such as DD fees may not necessarily fall within “expenses directly incurred for the purchase of securities.”
5. What CFOs and Investors Should Watch Going Forward
While this ruling opens a path toward the immediate deductibility of DD costs, several points warrant continued attention:
- The pending appeal: The tax authority has appealed the ruling, and the matter has not yet been legally settled. The outcome of the appellate proceedings should be monitored closely.
- The importance of contractual and documentary precision: To support the distinction between “direct costs of purchase” and “investigative costs incurred to inform a decision,” companies should ensure that the scope of services in advisor engagement contracts is clearly documented, and that the decision-making process (including board minutes and related records) is rigorously maintained.
6. Conclusion
The tax treatment of DD costs in M&A transactions is not merely an accounting technicality — it is a substantive management issue with direct implications for a company’s tax costs and investment efficiency. The judiciary’s willingness to place some limits on the tax authority’s historical “capitalize everything” posture represents a meaningful step toward greater predictability for many companies.
Our firm will continue to monitor the latest judicial developments and provide our clients with practical guidance to help them maintain strong governance and tax compliance.