International in-bound investment
- What is the scope of Japanese taxation for foreign companies? How do foreign companies end up paying Japanese tax?
- Does a company have to have a taxable presence to pay Japanese tax? What types of taxable presence (or ‘PE’) can an foreign company have in Japan?
- Can a foreign company be a Japanese resident company?
- Is there any limitation on the deduction of interest costs in Japan?
- How do I tell if my Japanese investment is debt or equity for Japanese tax purposes? What are the main differences?
- How can I tell if my foreign entity is a pass through entity or a corporation for Japanese tax purposes?
- Is there a branch profits tax in Japan?
International tax issues – out bound investment
- How are dividends from non-Japanese companies treated for Japanese tax purposes?
- Can Japanese companies get a credit for non Japanese taxes?
- Does Japan have something similar to US Subpart F or UK CFC legislation?
Posts on international tax issues
Please click on the “International” category to access posts relating to international tax matters. Also look through the list below to see a selection of different international tax posts.
- Treatment of income from tokumei kumiai contracts under Japan’s tax treaties
- Scope of definition of permanent establishment under Japan’s tax treaties
- Japanese tax treaties in English on the web
What is the scope of Japanese taxation for foreign companies? How do foreign companies end up paying Japanese tax?
In contrast to Japanese companies which are taxed on their worldwide income, foreign companies are taxed only on their Japanese source income as defined under Japanese tax law. The domestic law definition of Japan source income may be modified for some countries that have signed tax treaties with Japan, with such modification, in broad terms, being intended to reduce double taxation by reducing the overlap between Japan’s definition of taxable income and the other treaty country’s definition.
Given the above a key starting point to understand Japanese taxation of foreign companies is the Japanese law definition of Japan source income and then to look at whether any tax treaty applies to modify this definition. Once you have worked out what is Japan source income the next steps are to calculate its amount, attribute it to the correct time period, apply the appropriate tax rate and finally arrange to settle the right amount of tax unless not already correctly settled by tax withholding. All of these steps can include an element of subjectivity and also involve some relatively complex fact finding or practical implementation.
As can be expected, in order for income to be treated as Japan source income it has to have some connection with Japan. Defining the scope of that connection is one of the key issues in Japanese and any international tax issue. Back to top
So what is Japan source income?
CLT Article 138 lists the different types of Japanese source income and related cabinet orders define their scope in more detail. The list includes the “usual suspects”: Income from carrying out business in Japan, income from the use or ownership of assets in Japan, income from the transfer of assets in Japan, interest income, dividends along with a number of more specialized categories. Please see the posts on Japan source income for further details.
One key point to note is that the scope of Japan source income for a foreign company will depend on whether or not a foreign company has a taxable presence in Japan (in tax terms a permanent establishment or ‘PE’) and if it does, the type of such presence. Please see posts tagged PE for more details. Back to top
Does a company have to have a taxable presence to pay Japanese tax? What types of taxable presence (or ‘PE’) can an foreign company have in Japan?
A foreign company can settle its tax liability on Japan source income through either suffering withholding tax for some classes of income or through filing a tax return for other classes of income.
The scope of Japan source income for a foreign company and the way in which the liability is settled can vary depending on the presence of the foreign company including the type of PE. For Japan tax purposes there are three different types PE: A branch or similar office of the foreign company, a long term construction project and certain agents of the foreign company. The last two of these PEs have a slightly different scope of taxation.
A Japanese tax liability that has to be met through tax filing also sometimes arises for companies that do not have a taxable presence in Japan. The most common example is the sale of shares in Japanese companies under certain circumstances (for example a holding of 25% or more of the shares in a Japanese company with the sale of 5% or more of the shares gives rise to Japanese source income and a Japanese tax filing requirement). In these circumstances the foreign company has to appoint a tax representative in Japan to carry out the tax filing concerned.
More details on the above can be found in the posts on PEs and Japan source income. Back to top
Can a foreign company be a Japanese resident company?
As a practical matter, no. The definition of a domestic company that is resident for Japanese tax purposes is a company that has it head or main office in Japan. Accordingly a company must be incorporated in Japan to be regarded as resident for Japanese tax purposes.
Japanese tax law does not apply concepts of “place of central management and control” or similar that are used by some other tax systems such as the UK. Back to top
Thin capitalization: Japan applies a think capitalization system that limits the deductibility of interest paid to certain defined foreign controlling parties and also to certain domestic or foreign third parties who may be lending under a guarantee or similar specified arrangements. There is a safe harbor rule of three times equity, a rule that allows the debt:equity ratio of comparable companies to be used under certain circumstances (although this is rarely applied) and a rule that applies specially to certain defined cross border repo contracts. Thin capitalization is also applied to branches (including branches of banks in Japan).
Transfer pricing: Interest should be paid at an arm’s length rate to be deductible. Back to top
How do I tell if my Japanese investment is debt or equity for Japanese tax purposes? What are the main differences?
In contrast to the US, the concept of hybrid debt for tax purposes is pretty much unknown in Japan. Whether an instrument is debt or equity for Japanese tax purposes will depend on the legal form which will also be consistent with the accounting treatment. Back to top
How can I tell if my foreign entity is a pass through entity or a corporation for Japanese tax purposes?
Regrettably this remains a difficult issue in Japanese taxation. There are no formal regulations on this point similar to the US regulations and the only known formal Japanese tax authority pronouncement on the issue is a web-site posting referring to the taxation of US LLCs. This posting states that a US LLC should be treated as a corporation for Japanese tax purposes given:
LLCs are established based on the LLC law of each US state for the purposes of carrying out commercial acts.
Along with the establishment of the entities, they are given a commercial registration.
The entities are recognized as have a legal form that allows them to sue or be sued
Under the uniform LLC law the entity is separate legal body from its members and is given separate legal personality with rights and powers necessary and sufficient as an individual to carry on commercial activity.
While this helps with a US LLC, there is little guidance on the treatment of other foreign legal forms. Back to top
Is there a branch profits tax in Japan?
No Back to top
International tax issues – out bound investment
How are dividends from non-Japanese companies treated for Japanese tax purposes?
Up until 2008 and the start of 2009 Japan taxed dividends from foreign subsidiaries (as defined) and gave a credit for foreign taxes paid – both directly through withholding on the dividends and indirectly for taxes paid at the subsidiary level. This system included features similar to other tax + credit systems such as the US including limiting the amount of credit to Japanese taxes on foreign source income, allowing carry forward of excess credits or spare capacity to credit foreign taxes (for up to three years).
In a drastic change from the above system in the 2009 tax reform for financial years starting on or after 1 April 2009 Japan has in principal changed from a tax + credit system to a foreign dividend exemption system. For dividends or other distributions in this period from subsidiaries where a Japanese domestic company owns either (a) 25% or more of the total number of issues shares of the foreign company (excluding treasury shares of the foreign subsidiary and either by number of shares or value of shares; or (b) owns 25% or more of the number or value of voting shares and such shares have been held for six months or more then 95% of the related dividends or distributions can be excluded from taxable income. Note that if a tax treaty with Japan prescribes a holding requirement below 25% then this lower ratio can apply – for example the rate in the treaties Japan has with the US, Australia and Brazil is 10% and France 15%.
The above system will run in parallel with the earlier tax + credit system for a transitional period of three years. Please see further posts for more details. Back to top
Can Japanese companies get a credit for non Japanese taxes?
Japanese tax law includes a credit for certain defined foreign taxes whether suffered directly (for example, through withholding on interest or dividends) or indirectly, for example for foreign taxes imposed on the income of foreign subsidiaries of a Japanese parent. Please see the FAQ on dividends from foreign subsidiaries to see important changes in the law in this area. Back to top
Does Japan have something similar to US Subpart F or UK CFC legislation?
Yes. Japan has anti tax haven legislation that very broadly captures entities that are 50% or more owned in jurisdictions where the tax rate is 25% or less. Such companies may be subject to current taxation on their income at the Japan parent level in accounting periods prior to their making a distribution with a tax credit also available. Provided distributions are made within a specified period then to prevent double taxation the dividends are taxed at that time and the previously taxed income can be treated as deductible.
However this system is also impacted by the major change in 2009 referred to in the FAQ on taxation of dividends moving to an exemption system. Dividends when received are now treated as excluded following the treatment described in the FAQ concerned. Back to top