This article is the first in a series that outlines the structure, target income and administration of the Japanese withholding tax system. These articles will form a foundation for understanding more complex Japanese withholding tax issues arising in an international context.
Japan has an extensive system of withholding taxes (‘WHT’) imposed on different types of income. In theory this system is supplementary to the obligation to file a tax return reporting the income concerned and Japanese individuals, domestic companies or Japanese branches of foreign companies that suffer Japanese WHT are able to credit it against the corresponding tax liability when they report it on their tax returns. In practice however a substantial proportion of Japan’s tax revenue is collected through withholding taxes, especially on employment income.
Issues for foreign investors
For foreign investors withholding taxes on interest, dividends and royalties tend to be of particular concern although there are a wide range of withholding taxes on other sources of income such as rental payments or distributions from Japanese tokumei kumiai agreements.
Practical problems also arise for foreign investors from the need to involve the person with the obligation to withhold the taxes (typically a Japanese company) in any process to either file a tax treaty exemption application or in the tax reclaim process if taxes are over-withheld.
Structure of Japanese withholding tax
The Japanese withholding tax system adopts a structure common in many countries. Withholding taxes are imposed on the payee of the income but the obligation to collect the tax is on the payor of the income.
Where the payor of the income fails in his obligation to collect taxes he is liable to fines and or penalties but has a legal right to recover the taxes (but not penalties or interest) from the payee. However if the payor has agreed to “gross up” payments of income under a contract with the payee then the payor has effectively agreed to bear an additional cost sufficient to meet the payee’s financial burden arising from the WHT concerned.
Below are references to the relevant law and definitions of persons or other items concerned in the above process:
1. Japanese law defines parties to the process of assessing withholding taxes – the Payor (源泉徴収義務者) and the Payee (受給者) in the Tax Principles Law (below, TPL and in Japanese 国税通則法) Article 2-5.
2. The TPL imposes an obligation on the Payor to collect taxes and remit them to the authorities (the ‘Tax Collection Obligation’ or (納税義務)). TPL 15
3. The Tax Collection Obligation arises at the time to pay the income is established – the WHT Obligation Date (支払時). TPL 15-2
4. The Tax Collection Obligation arises on the Payor at the WHT Obligation Datet automatically, without any additional action required by the tax authorities. TPL 15-3
5. The Payor is entitled to collect the WHT due according to the relevant regulations and is obliged to remit the taxes so collected to the tax authorities within the WHT Remittance Deadline (納期限). ITL 181
6. If the Payor fails to remit the WHT to the authorities by the WHT Remittance Deadline, the tax authorities can assess the Payor for the tax concerned through the issue of a WHT Collection Notice (納税告知). ITL 221
7. Where the Payor has been issued with a WHT Collection Notice he is required to pay it within the specified period but is also entitled to deduct the amount of tax concerned from further payments to the Payee or to require repayment of the taxes from the Payee. ITL 222.
8. The Payee is entitled to credit WHT suffered against a tax obligation arising on the filing of his tax return including the income concerned. ITL120.
9. Where the Payor has collected WHT then, regardless of whether or not it has been remitted to the tax authorities, the amount is deemed to have been paid on the due date and suffered by the Payor. ITL 223
Scope of Payor
ITL Article 6 defines the scope of the Payor(s) on whom a Tax Collecting Obligation can arise. This scope is, unsurprisingly, very broad, being the “…person who pays benefits and similar…” (in Japanese 「…給付等の支払いをする者…」). Person in this context can include companies (Japanese and foreign), co-operative associations, individuals, un-incorporated associations and including government bodies.
One little known exception from the scope of Payor is a person who pays normally two or less persons employment income for assistance with household duties (i.e. payments to a maid or similar household helper) – ITL article 184.
Place of withholding tax payment
Under ITL Article 17 in principle WHTs once withheld are due to the tax office having jurisdiction over the location of the office or place of business of the person making the payment. As a practical matter this means that if a branch office is arranging the payment of salaries or other payments on which WHT applies then the tax is paid to the tax office covering the local branch rather than the tax office responsible for the head office of the Payor.
There are some exceptions to the above general principle. For example, WHT on dividends and other shareholder distributions, bond coupon and bond discount are paid at to the tax office having jurisdiction over the location of the head or main office of the Payor entity. Additional special rules relating to location of WHT payment apply to domestic source income paid overseas, WHT on distributions made by trusts taxable as corporations and certain other trusts, coupon paid by foreign companies attributable to their branches and some other items not discussed further here.
Following articles will consider the scope of Japanese withholding tax and issues in determining when it is paid.