Individual tax – calculating taxable income

July 18, 2010  |  Individual

A fan with the letters in the Japanese cursive hiragana script just visible

The early focus of this site is corporate and international tax issues. However for the benefit of expat using this site we will be posting on tax topics that may be of interest to non-Japanese citizens resident in Japan.

Below is an overview of the process behind filing a Japanese individual tax return along with a helpful diagram illustrating this process. Readers can e-mail the editor with any individual tax topics where they would like to see some posts in future.

The Japanese Individual Income Tax System

Income tax flowchart

In Japan individual income tax is assessed on a calendar year basis with final tax returns due in mid March. Japan operates a withholding tax system similar to UK PAYE to deduct tax throughout the year from employee wages with a yearend adjustment process. For many employed individuals earning only the average salary then a further tax filing is not required.

The flowchart linked here and to the picture above describes the overall tax calculation process, which can be broken down into the following steps:

Step 1: Calculate income for each income source

Allocating a particular type of income to a particular source (e.g. income from employment, real-estate income etc) is critical step given that the rates of tax and basis of tax and rules around offset of losses will vary depending on the source of the income. In particular a key difference is that some sources of income are aggregated and taxed at marginal rates (i.e. subject to Comprehensive Taxation or sougou kazei/総合課税) while others are subject to taxation not at marginal rates but tax rates specific to the type of income concerned (i.e. subject to Separate Taxation or bunri kazei/分離課税).

To make things more complicated for some sources of income subject to Separate Taxation and withholding tax suffered can be a final tax (, while for others the income must still be reported on the tax return even though treated as subject to Separate Taxation and not combined with other income subject to Comprehensive Taxation for tax purposes. In the area of dividends, interest and transactions in marketable securities this becomes more complicated still as related income may be included under various different sources and accordingly treated differently. The table below summarizes the different sources of Japanese income and please see later posts relating to each source of income.

Type of incomeOutline of incomeMethod of calculationComprehensive or Separate Taxation
Interest income/rishi shotokuInterest from public bonds, deposits, distributions from public bond trusts and similar.Amount of incomeIn principle Separate Taxation with exceptions
Dividend income/haitou shotokuDistributions of surplus or profit from companies, income from certain stock or other fundsAmount of income less some deduction for funding costs unless election not to report on tax return is madeComprehensive Taxation (with election not to include)
Business income/jigyou shotokuIncome from agriculture, fishing, retail, service provision and other businessTotal income less necessary expensesComprehensive Taxation
Income from real estate/fudousan shotokuIncome from real estate, rights over real estate, ships, aircraftTotal income less necessary expensesComprehensive Taxation
Salary income/kyouyo shotokuSalaries, wages, bonuses and amounts having a similar natureTotal income less deduction allowed for salary expensesComprehensive Taxation
Miscellaneous income/zasshotokuIncome other than the other types of income above - a default for any remaining incomeComprehensive Taxation
One time income/ichiji shotokuFor income other than business income, income that does not arise from continuing activities that have profit as a purpose and that does not have the nature of being consideration for either labor or the transfer of assets - a very limited category, but receiving a favorable tax rate.Total income less expenses for acquring such income less a special deductionComprehensive Taxation
Gains from disposals/jouto shotokuIncome from the transfer of assets (exlcuding continuous transfers having the nature of a business)Total income less acquisition costs less expenses of disposalComprehensive or Separate Taxtion depending on asset, circumstances
Forestry and mountain incomeIncome from lumber or similar or disposal of related assets or from disposal of related land (held over 5 years)Total income less costs of forest, lumber less special deduction taxed at only 20% of incomeSeparate Taxation
Retirement incomePayments for retirement or payments having a similar character.Total retirement income less special deduction times 50%Separate Taxation

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Step 2: Net down losses where applicable

The net down of losses across different sources of Japanese income is a further key step with tax planning implications. However there are restrictions in the order of offset and the order in which loss set off occurs. For example, losses on real estate income, business income, forestry and mountain income and from disposals can be offset on gains from certain other sorts of income while losses on other income sources cannot. Also there are some restrictions on the nature of loss that can be set off for some income sources – for example interest paid to purchase land cannot be included in real estate used to offset other sources of income. Please see related posts for more details.
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Step 3: Carry forward and deduct prior year losses

For certain sources of income (income from real estate, business income, gains (losses) from disposals and forestry and mountain income losses) that cannot be set off against other sources of income in the current year can, under certain circumstances, be carried forward by a Japanese resident and set off against other sources of income for up to three years. However such unrestricted carry forward of losses is only available to “blue form” tax filers (i.e. who have to have applied to the tax authorities for such status and who are required to meet certain criteria such as maintaining appropriate records). However in some special cases – such as for income from businesses that can be highly variable (certain artistic pursuits, certain fishing businesses etc) and business losses through natural disaster – losses can be carried forward without a blue form filing. Continual filing of a tax return through the carry forward period is also a requirement.

For some other sources of income losses can also be carried forward for generally up to three years but not for offset more generally against other, different sources of income. An example is losses on listed shares under certain circumstances. Please see related posts for more details.
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Step 4: Calculation of total income

The amount of total income – soushotoku no kingaku/ – is simply the total of the categories of income subject to Comprehensive Taxation after set of losses and similar.
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Step 5: Claim tax deductions

Common with other tax systems Japan has a number of tax deductions based on public policy or similar as shown on the flowchart. Besides the very standard deductions for spouses or dependents useful ones to note are deductions for medical expenses, sundry losses (e.g. through theft of certain non business assets other than those used for daily life), certain insurance payments and certain donations.
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Step 6: Calculate taxable income

Total income less tax deductions gives taxable income. As shown on the flowchart, Taxable Total Income
– kazei soushotoku – refers to the total across the sources of income subject to Comprehensive Taxation. Sources of income subject to Separate Taxation will also each have their total amounts income amounts.
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Step 7: Apply tax rates according to income type

Taxable Total Income is taxed on a progressive basis with in 2009 the highest rate being 40% for JPY18m or more (this rate does not include local taxes).

Income from sources subject to Separate taxation are then taxed at the rate that applies to the source concerned which may be different from the marginal tax rate. For example, short term capital gains are taxed at 30%, long term capital gains are taxed at 15% and gains from the transfer of stocks and similar the tax rate is until 31 December 2011 7% for listed shares and 15% for other shares.
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Step 8: Apply tax credits and file tax return

Tax credits are available for foreign taxes and also for income tax withheld at source.
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