This post is an introduction to the taxation of Japanese trusts. Japanese trust taxation is a confusing area because of the large number of different trust forms which have a range of similar sounding names. An understanding of Japanese trusts and their taxation is, however, useful when understanding many of the different financial products available in the Japanese market and their treatment for Japanese individual tax purposes. Furthermore, transactions involving the use of trusts created for securitisation or similar financing purposes are gaining in popularity in the Japanese capital markets. Examples include the March 2010 Mitsubish Sumitomo Bank loan securitisation or Softbank’s use of trusts in whole business securitisations . This is a promising area for the future.
One clue to unravelling the complexities of Japanese trust taxation is to understand that, in addition to “generic” Japanese trusts defined under Japanese trust law, a number of other Japanese laws (for example pensions law) define different types of trust. These trusts are based on the “generic” Japanese trust law but may require certain specified terms or trust objectives to be included in the trust deed consistent with the purpose of the law governing the trust’s formation.
Japanese tax law itself defines different categories of trust with a different treatment for Japanese tax purposes and trusts created by the trust law or by other Japanese laws then have to fit within the categories created by the tax law. This is made more complicated by the tax law itself cross referring to different types of non-tax trust or even to other tax law definitions of a trust as well as referring to criteria uniquely required for tax purposes. Unless you are very familiar with this definitional structure it is often difficult to tell whether a particular term is referring to a tax category of trust or a type of trust arising from other, non-tax law. The name of the trust itself will often not give much clue.
Given the above this first post outlines the basics of Japanese trust taxation while the following post will diagram out the different definitions underlying Japanese trusts and trust taxation.
Taxation of trust income
There are in principal three ways in which income from trust assets can be taxed for Japanese tax purposes.
- Taxation on the beneficiary at the time the income accrues (‘Trusts Taxable on the Beneficiary’). This is the default method of trust taxation.
- Taxation on the beneficiary at the time the income is distributed to the beneficiary (‘Trusts Taxable at Distribution’). This is an important exception to the above default taxation and includes certain collective investment schemes and pension and retirement arrangements taking trust form.
- Taxation as a corporation at the time the income accrues to the trustee (‘Trusts Taxable as Corporations’). This includes an important category – trusts which are allowed to issues beneficiary rights in the form of securities but which do not meet certain criteria around public offering and other matters.
A summary of different types of trust and their taxation is given in this excel spreadsheet.
For Trusts Taxable on the Beneficiary the assets and liabilities of the trust (‘Trust Wealth’) have legally been transferred to the Trustee. However from a tax point of view the assets, liabilities and income and expenses attributable to the Trust Wealth are deemed to be directly those of the beneficiary and hence at the time related income accrues are treated as taxed on the beneficiary. For example, if the assets of the trust include leased real estate then the beneficiary of the trust would be taxed on rents from the real estate in the year such rent accrued for tax purposes regardless of whether the income had been received by the beneficiary from the trustee.
Japanese Trust tax law also defines the scope of beneficiaries who may be taxable on income from the Trust Wealth to include persons who have rights to change important terms of the trust and hence receive benefits from the trust. Such “Deemed Trust Beneficiaries” may also be taxed on trust income or gains. The trust law itself also recognises a similar concept – Specified Trustors i.e. persons who have a right to change important terms of the trust and receive trust benefits.
It is also possible in Japan for a trust to exist without known beneficiaries. For example, if a trust is formed under a will with a defined purpose but there are currently no beneficiaries that would receive income further to such purpose, then – assuming there are no Deemed Trust Beneficiaries (being persons with the right to change the terms of the trust and benefit thereon) – the trust would likely be taxed as a Trust Taxable as a Corporation at the time of its establishment.
When, at the time a trust becomes effective, the beneficiary of the trust is a person other than the trustor, then the trustor is deemed to have made a gift to the beneficiary concerned of the right to receive income and other benefits as defined by the trust at that time. If the beneficiary received such rights as a result of the death of the trustor then they would be deemed to be received as a result of inheritance.
Treatment on addition of or replacement of beneficiaries
In a trust that has existing beneficiaries, then when a new beneficiary is added to the trust or takes the place of an existing beneficiary in the trust then the new beneficiary of the trust is deemed to have received a gift from the beneficiaries of the trust existing immediately prior to such change in beneficiary composition. (If such change is made further to the death of a beneficiary, then by inheritance rather than gift). To give an example, Article 91 of the Trust Law defines ‘Successor Will Trusts’ and Article 89 of the Trust Law allows the creation in a person of the right to define the beneficiaries of a trust. In these circumstances the first beneficiary may be treated as receiving a gift of the Trust Wealth on the creation of the trust and then if that initial beneficiary passes away or if a right was exercised to appoint a different beneficiary under the trust then on the death of the beneficary or exercise of the right to designate a new beneficiary the Trust Wealth is treated as being gifted from the initial beneficiary to the new inheriting or designated beneficiary.
Treatment on ending of trust
At the end of a trust where a person other than the beneficiary has a right to receive the benefits of the trust assets (i.e. has a Reversionary Interest) then that person will be treated as having received a gift of the relevant trust assets.
Trust Taxtion Summary
The excel spreadsheet attached here lists up a variety of different Japanese trusts under the three tax classifications referred to above.