Income Tax Treaty between the United States and Japan

 

United States-Japan Tax Treaty

Japan International Tax Compliance Rules

Quick Summary.  An island country comprised of an archipelago of nearly 7,000 islands comprising the Pacific Ring of Fire, Japan is located in the northwest Pacific Ocean off of East Asia.

Japan is a constitutional monarchy.  Its 1947 Constitution provides for a Prime Minister and a bicameral legislative organ (the National Diet) consisting of a House of Representatives and House of Councillors.  The Japanese legal system is historically influenced by Chinese law, although since the late 19th century, its judicial system has been largely based upon civil law precepts.  The primary body of statutory law is known as the Six Codes.  

U.S.-Japan Tax Treaty

Japan is comprised of 47 prefectures and eight regions.  Each prefecture is overseen by a governor.   

Japan is a member of the United Nations (UN), OECD, and G7.  

Japan Tax Treaty.

Currency.  Japanese Yen (JPY)

Common Legal Entities.  

  • Joint Stock company (Kabushiki Kaisha).
  • Limited liability company (Godo Kaisha).
  • Partnership
  • Branch of foreign corporation

Tax AuthoritiesNational Tax Agency (NTA)

Tax Treaties.  74 treaties; signed OECD MLI 7 June 2017

  • Income Tax Treaty
  • Technical Explanation
  • Income Tax Treaty (PDF)
  • Protocol
  • Technical Explanation
  • Protocol Amending the Convention between the Government of the United States of America and the Government of Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income
  • 2013 Technical Explanation of Protocol Amending the Convention between the Government of the United States of America and the Government of Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income

Corporate Income Tax Rate.  23.2%

Individual Tax Rate

0 1,950,000 0 5%
1,950,001 3,300,000 97,500 10%
3,300,001 6,950,000 232,500 20%
6,950,001 9,000,000 962,500 23%
9,000,001 18,000,000 1,434,000 33%
18,000,001 40,000,000 4,404,000 40%
40,000,001 and above 13,204,000 45%

 

Corporate Capital Gains Tax Rate23.2%

Individual Capital Gains Tax Rate

            Sale of stock: 20.315%

            Sale of real property: 39.63% depending on various factors

Residence.  

Individual: livening base in Japan or resided in Japan for a continuous period of 1 year or more.

Non-permanent resident: not Japanese national and has living base in Japan or resided for more than 1 year and 5 years or less in the last 10 years.

Permanent resident: Japanese national or has a living base in Japan or resided in Japan for more than 5 years in the last 10 years.

          Corporate: principal or main office in Japan

Withholding Tax.  

            Dividends.

Corporations and Individuals:  20%

Foreign corporations and nonresident individuals, non-treaty: 15% / 20%

            Interest.

Corporations and Individuals: 0% / 20%

Foreign corporations and nonresident individuals, non-treaty: 20%

            Royalties.

Corporations and Individuals: 0%

Foreign corporations and nonresident individuals, non-treaty: 20%

Transfer Pricing.

Sells property to or buys property from foreign-related person, transaction required to be arm’s length price.

CFC Rules.

Equity ownership test (owned more than 50% by Japanese corporations or resident) OR applicable tax rate is 30% (shell company) or 20% are included in the Japanese parent company’s taxable income under certain conditions.

Inheritance/estate tax55%


Historically, Japan generally imposed corporate tax on worldwide income in a tax system generally similar to that of the United States. The corporate tax comprises three levies: an income tax imposed at the national level, an enterprise tax imposed by prefect authorities and an inhabitants tax imposed by prefect or municipal authorities. The national corporate income tax rates are graduated, with lower rates for small and mid-sized companies. To the extent that income was subject to tax in both Japan and another jurisdiction, double taxation was relieved by operation of foreign tax credits or by operation of its various tax treaties.

In 2009, tax reforms moved the system towards a territorial regime. Introduced in an effort to encourage the repatriation of overseas earnings, the 2009 amendment to the tax laws introduced the foreign dividend exemption system. Under the foreign dividend exemption system, a company may omit 95 percent of qualifying distributions. To qualify, the dividends must be received from a foreign company in which the domestic corporation claiming the exemption has held at least 25 percent of the outstanding shares for a continuous period of at least six months. Foreign investment income, such as interest or royalties, is not exempted. In addition, gain from the transfer of shares in foreign subsidiaries does not qualify for the exemption.

Expenses

In general, all necessary and reasonable expenses, costs, and losses may be deducted from gross income in order to arrive at net income except where otherwise provided under the relevant laws. Japan does not have any rules that disallow a deduction for expenses of a Japanese resident corporation to the extent those expenses are attributable to exempt foreign dividends. However, Japan has thin capitalization rules designed to limit the ability of nonresidents of Japan to withdraw profits through deductible interest payments. No deduction is permitted for interest paid to a foreign controlling shareholder on indebtedness to the extent that the indebtedness causes the average balance of liabilities due (to either a foreign controlling shareholder or capital supplier) to the capital held by the foreign controlling shareholder to exceed a three-to-one ratio. Where a company maintains a less than three-to-one debt-to-equity ratio, it is not treated as thinly capitalized even if lending from a foreign controlling shareholder or capital supplier exceeds three times the foreign controlling shareholder or capital supplier’s equity interest. In cases where the total average liabilities for a year of a company that may be subject to this rule do not exceed three times its own capital, the disallowance of the interest deduction does not apply.

A foreign controlling shareholder is a nonresident or foreign company that controls the domestic company by reason of majority capital ownership, whether directly or indirectly, or owns more than 50 percent of the domestic and foreign company’s capital directly or indirectly, or has a special relationship with the company, such as one in which the domestic company’s business is dependent on transactions with the foreign shareholder.

Controlled foreign company rules

Japan has a set of rules under which the parent companies of specified foreign companies are considered to have received deemed dividends from the subsidiaries, in a manner similar to that of the CFC regime in the United States. The Japanese controlled foreign company regime is part of a set of anti-avoidance rules, including a general anti-avoidance rule for related corporations, to deter overly aggressive tax planning.

A controlled foreign company is a foreign corporation that is located in a low-tax country, is subject to an effective tax rate of less than 20 percent and is owned directly or indirectly by Japanese companies, resident individuals, or nonresidents who have a special relationship with residents, such as a family relationship, or are financially dependent on residents.

A portion of the income of a controlled foreign company is deemed to be income of the Japanese resident shareholder and is included in calculating the shareholder’s gross income if a Japanese resident or corporation directly or indirectly holds 10 percent or more of the outstanding shares of the controlled foreign company; or a Japanese corporation belongs to a family shareholder group that directly or indirectly holds 10 percent or more of the outstanding shares of the controlled foreign company. Dividends paid by a controlled foreign company to a domestic corporation that are subject to the foreign dividends exemption rule are excluded from the taxable income of the domestic corporation.

Japanese shareholders who directly or indirectly own 10 percent or more of the shares of a controlled foreign company are subject to taxation on their share of taxable undistributed profits of the subsidiary.

A controlled foreign company’s income is not deemed to be the income of the domestic corporation if the controlled foreign company is actually doing business in a low-tax country and satisfies the following requirements:

  • The controlled foreign company maintains an office, store, factory or other fixed place of business necessary to conduct its business in the country where the head office of the controlled foreign company is located;
  • The controlled foreign company actually controls and administers its business; and
  • If the business of the controlled foreign company is a wholesale, banking, trust, securities, insurance, or ocean or air transport business, the controlled foreign company does business with parties that are regarded as unrelated for the purpose of the controlled foreign company regime; or

If the business of the controlled foreign company is none of the above, the controlled foreign company does business mainly within the country where its head office is located.

A 2010 amendment to the Tax Special Measures Law created exceptions to the above exceptions. A proportionate share of certain passive income of a controlled foreign company may be included in the domestic company’s taxable income even in the above exceptions.

Other CFC measures were implemented in 2017.  

Gain or loss on the sale of foreign subsidiary stock

Capital gains from the sale or transfer of shares in foreign subsidiaries is not eligible for the foreign dividend exemption.

Tax Treaty Network – International Tax Attorneys

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