Under Japanese tax law, Japanese companies are taxed on their worldwide income while foreign companies are taxed only on their Japanese source income.
This article explains when a foreign company will suffer Japanese withholding tax or when it has an obligation to file a Japanese corporate tax return. In some circumstances a foreign company
can both suffer withholding tax and have a corporation tax filing obligation.
Factors determining Japanese taxes payable by a foreign company
Under Japanese domestic law the rate of tax applied and the method by which a foreign company is assessed to Japanese tax on its Japan source income will depend on the following factors:
whether or not the foreign company has a taxable presence (a ‘permanent establishment’ or ‘PE’) in Japan
if the foreign company does have a taxable presence in Japan, the nature of the foreign company’s taxable presence (whether a branch, an agent PE or a construction site PE)
the underlying nature of the Japan source income concerned
Tax treaties between Japan and the jurisdiction of residence of the foreign company concerned will of course modify the domestic law position.
Scope of Japanese tax for a foreign company
This article introduces a table that shows how the above factors work in combination to give rise to either a withholding tax on the foreign company, a corporation tax filing obligation or both withholding tax and corporate tax filing obligations for the foreign company concerned.
Understanding this table and its nuances is an excellent foundation for understanding the scope of Japanese tax payable by foreign companies.
Understanding the table
Below is a description of different items in the table and more detail on the scope of some of the underlying categories of income.
Foreign companies with a PE in Japan
Columns A to C refer to the status of the foreign company’s taxable presence in Japan. Columns A (branch or similar) and B (construction site, agent PE) cover companies that have PEs in Japan while column C is for a company that does not have a PE in Japan. Note that this refers to Japanese domestic law definitions of PE. Please see this article for the scope of PEs under Japan’s tax treaties.
The light blue areas (no shading) show sources of income where the foreign company is taxed on its net income through the filing of a tax return. Note that companies in Column A (branch or similar PE) are taxed on a “force of attraction” principle. In other words, taxed regardless of whether or not the income is attributable to the foreign company’s branch in Japan.
For example, a Cayman Company that had a branch carrying on business in Japan and also received royalty income from Japan would have to include the royalty income in its Japanese branch return even if the license giving rise to the royalties was held by the Cayman company’s head office and was in no way attributable to its Japan branch. Note that abandonment of this “force of attraction” principle is currently under discussion as a future tax reform item.
For light blue shaded areas, the foreign company is taxed on the income through the filing of a tax return but on an “attributable profits” principle rather than the above force of attraction principle.
Foreign companies without a PE in Japan – tax return filing
Looking at Column C shows that some foreign companies are required, under Japanese domestic law, to file a corporate tax return to pay taxes on some sources of income (light blue shading) even though the companies do not have a PE in Japan. In practice such a company would have to appoint a tax representative in Japan (typically a Japanese accounting firm or similar) in order to complete the tax filing.
In respect of income marked Note 1 (the income from the transfer of assets in Japan) a tax return has to be filed, although withholding tax does not apply. Tax treaties will often exempt Japanese tax on these items, although some tax treaties do not exempt a number of important categories of asset transfer from Japanese tax.
A list of assets that, when transferred, give rise to Japan source income is below. This is a summary and details will be covered in a later article.
Rights established in Japan through licensing, registration or similar procedures (i.e. typically patent, copyrights, trademark or similar intangibles).
The following marketable securities or financial assets:
- Those traded on exchanges in Japan.
- Those transacted through a place of business in Japan (i.e. typically sale through a Japanese securities brokerage)
- Transactions in marketable securities under a contract where prior to the transaction the relevant stock certificates were physically located in Japan.
The transfer of shares issued by a Japanese company in the following circumstances:
- Under certain arrangements for the concentrated purchase of shares (not discussed further here).
- On a “sale of shares resembling the sale of a business” (in Japanese `事業譲渡類似株式の譲渡’), briefly the sale of 5 per cent or more of the shares in a Japanese company where a shareholder or its defined related parties owns 25 per cent or more of the company.
- On the sale of shares in a company that resembles the sale of underlying real estate (in Japanese ‘不動産化体株式の譲渡’). Briefly, shares where 50 per cent or more of the assets comprise real estate in Japan.
The sale of certain golfing rights and shares with underlying golfing rights.
Certain deposits, savings and other rights regulated under the banking law held at a place of business in Japan.
Debts arising from the lending of funds to Japanese residents.
Rights to receive pension payments.
Debts arising from contracts based on mortgage certificates (in Japanese ‘抵当証券’).
The right to receive distributions under a tokumei kumiai agreement.
Goodwill arising from a business carried out in Japan.
Rights to use a golf course or other facilities in Japan.
Other assets that were physically located in Japan just prior to the obligation to transfer them, based on the contract concerned, arose (excluding inventory assets).
Foreign companies without a PE in Japan – withholding tax and tax return filing obligations
Note 2 flags two sources of income where both a withholding tax obligation arises and where the foreign company also has a obligation to file a tax return and pay tax on its net income. Fortunately, when filing such a tax return, the withholding tax is creditable.
A typical example of tax obligations arising here would be a Hong Kong company (that is, a non treaty protected company) dispatching staff to Japan to provide technical services or similar to a Japanese company. Withholding taxes would apply to the fees paid in respect of such services and the Hong Kong company has an obligation to file a Japanese tax return reporting such income even though its Japanese activity may not have risen to the level where it would form a PE.
Foreign companies without a PE in Japan – withholding tax is a final tax
The yellow areas indicate sources of income where Japanese withholding taxes suffered by the foreign company are a final tax.