The application of tax treaties to TK Distributions is obviously a matter of major concern to foreign TK Investors.
For foreign corporations or individuals that do not have an permanent establishment in Japan then, assuming the TK Investor qualifies for benefits under the relevant tax treaty concerned, the process to determine the impact of the tax treaty is to first decide the classification of the TK Distribution for treaty purposes and then apply the terms of the treaty article relevant to that classification. Most of Japan’s tax treaties do not have specific terms applying to TK Distributions and also such distributions are generally not thought to be “business income” or “interest”. Therefore it is common for TK Distributions to be treated as “other income” for tax treaty purposes. However not all tax treaties directly address the taxation of “other income” – so the treatment for such tax treaties also has to be considered. These issues are looked at further below:
Treaties under which taxation is only in the country of residence
The Netherlands/Japan tax treaty is on an often quoted example in looking at the taxation of TK Distributions. Under the Netherlands/Japan treaty there is no article clearly applied to TK Distributions so the catch all “other income” article is used. Under this article taxation of other income is only allowed in the country of residence of the earner of the income concerned. Accordingly Japan, as the country of source of the TK Distribution, would not be able to impose tax on the TK Distribution. The Swiss/Japan tax treaty is similar. For both countries attention should be paid as to whether the treaties may be re-negotiated in future and the Japanese tax authorities are currently litigation a Netherlands/Japan treaty case concerning the taxation of TK Distributions.
Note that a treaty claim form is required to apply the benefits under the Netherlands/Japan or other tax treaties. Also, given the 20% withholding tax that now applies to TK Distributions that would have to be exempted under the treaty the submission of the treaty claim will give the authorities an opportunity to examine the arrangements concerned.
Treaties under which taxation is allowed in the country of source
In contrast to the Netherlands/Japan treaty some tax treaties, such as Canada, Singapore and Sweden/Japan, allow taxation in the country of source in respect of TK Distributions. Accordingly current Japanese domestic law would apply, with a 20% withholding tax on TK Distributions.
Under the US/Japan treaty there is also an “other income clause” but the protocol (giteisho/議定書) makes it clear that Japan reserves the right to tax TK Distributions. Furthermore under the protocol, for the US the TK Contract is not treated as a resident of Japan. Also, income from the TK Contract is not treated as income of the participants in the TK Contract. The implication of this is that even in a case where you have a TK Contract with TK Investors and a TK Operator who are both Japan residents who are normally able to claim the benefits of the US/Japan treaty, if they realise US source income through a TK Business under a TK Contract such income cannot apply the benefits of the US/Japan treaty.
Under the UK, France and Italy/Japan tax treaties it is also clear that taxation on TK Distributions occurs in the country of source – i.e. Japan with currently the 20% withholding tax applying.
Germany/Japan is one of the few treaties that have for a long time referred explicitly to the taxation of TK Distributions, reflecting the historical parallels in the countries’ legal systems. Under article 10(8) (the dividends article) taxation of TK distributions is allowed in the source country, so in the case of Japan currently applying the 20% withholding tax under Japanese tax law.
Treaties with no other income article or no set rule
For treaties where there is not rule specifically addressing sourcing or taxation of TK Distributions and where there is no “other income” article the normal interpretation is that domestic law applies – i.e. currently 20% withholding tax in Japan. New Zealand/Japan is an example.