An individual’s taxable Japanese real estate income is the total of “revenue from real estate” less “necessary expenses” less a deduction available for individuals filing a blue form real estate tax return.
This article looks in more detail at how to calculate the first of these amounts, revenue from real estate for Japanese tax purposes. A key issue here is the timing of when rental or other real estate income is subject to Japanese tax.
Please also refer to this article which examines threshold issues which are relevant to whether or not an individual’s real estate income is subject to Japanese tax, such as the impact of Japanese tax residence or whether capital gain is being earned rather than income. The article also includes an English translation of the non blue form tax return schedule used for reporting Japanese real estate income.
Revenue recognition – principles
Real estate income is not simply recognized as taxable on a “cash received” or “accounting accruals” basis for Japanese tax purposes. Instead a number of different rules define different days (referred to below as the ‘Income Recognition Day’) on which different types of real estate income are treated as income for Japanese tax purposes.
If the Income Recognition Day falls within a particular calendar year then the related income has to be reported as real estate income for that calendar year. The English translation of the tax return schedule shows (on the left of the front page in orange) the different boxes used to report different types of taxable real estate revenue.
Note that while the above Income Recognition Day approach is applied in a number of different circumstances, in some cases different approaches such as an accruals approach (where a payment of income is spread over the period to which it relates), can apply instead as discussed further below.
Business Scale Real Estate Income
Note that the rules for calculating an individual’s taxable real estate income also depend on whether or not they are carrying on the activity concerned on a scale sufficient for it to be regarded as a real estate business. As explained in more detail in this article, such a scale is typically renting out ten or more apartments or five or more individual houses.
The discussion of revenue recognition for real estate below assumes, unless otherwise indicated, that the individual is not earning income from a real estate business, referred to below as ‘Business Scale Real Estate Income’.
Revenue recognition for rental income
Where the date of payment of rental income is decided under contract or by custom to be a particular day then the Income Recognition Day is the day so specified in the contract or by custom.
For real estate income not due on a particular day by contract or custom but due on demand (for example, when due on the issue of an invoice) then the Income Recognition Day is the day on which the demand is made.
For any other rental income, the Income Recognition Day is the day on which the payment is received.
Accrual basis for Business Scale Real Estate rental income
An accruals basis can be applied Business Scale Real Estate Income provided that the three conditions specified below are met. If accrual treatment is applied such income is taxable based on apportionment on a time basis to the period in which the payment is made rather than based on the Income Recognition Day principles outlined elsewhere. (See Income Tax Instruction (‘ITI’) 36-5 (1)). The three conditions are:
books of account are maintained that are used and updated on an continuous basis
the accounts are used as a basis for calculating the real estate income;
For all the rental income, on a continuous basis, the amount corresponding to the taxable year concerned is used as a basis for calculating taxable real estate income and prepaid or accrued but not yet paid rental income is properly accounted for.
Special case for rental income payment covering less than a year
As a special case an individual who is not earning Business Scale Real Estate Income (the normal case for most expatriates renting out a single family home) the accruals basis can be applied when a rental payment covers a period of one year or less and the first two conditions noted in the paragraph above, that are required in order to apply accrual accounting to Business Scale Rental Income, are also met.
If this special rule is applied then the rental income may be apportioned between the two different tax years to which the payment relates, despite the payment being received in the earlier year.
Revenue recognition for key money, occasional payments
Japanese rental contracts traditionally include a number of one off payments that are relatively rare outside Japan, typically due at the start of the rental contract, when renewed or on other events occuring. Examples of such payments are ‘rights money’ ( 権利金or ‘kenrikin’ in Japanese) , ‘fee for change of name’ ( 名義賞換料or ‘meigisho kaeryou’ in Japanese) or ‘renewal fees’ ( 更新料or ‘koushinryoutou’ in Japanese). These are referred to below collectively as ‘Ad Hoc Payments’.
For Ad Hoc Payments that are due under the contract on the time that the rental property is made available to the lessee, then the Income Recognition Day is the day that the property is made available.
For amounts that do not require the property to be made available to the lessee to become payable, the Income Recognition Day is the day on which the contract becomes valid.
Special treatment of Ad Hoc Payments as occasional income
Where a contract has been entered into to rent real estate for three years or more and where the Ad Hoc Payments exceed the annual rental by a factor of two or more then – except for circumstances where the payments concerned may be treated as giving rise to a capital gain on disposal of the property – such payments are treated as ‘occasional income’ (臨時所得 or ‘rinjishotoku’) for Japanese tax purposes and can be subjected to a defined averaging of the income concerned over more than one year (ITL 2(1) 24, 33(1, 90, ITLEO8, 79).
The averaging treatment here is intended to prevent a disproportionate amount of Ad Hoc Payments being taxed at a higher rate of tax in a single year. However, given the expected rarity of this treatment it is not discussed further here. A qualified Japanese tax accounting should be consulted if this situation may apply.
Revenue recognition – guarantee and other amounts no longer refundable
Revenue recognition rules also apply to amounts initially received on the basis that they are refundable but which, owing to the occurance of a contingency, are no longer repayable.
Payment of such amounts (referred to below as ‘Contingent Receipts’ and the date on which the obligation of the landlord to return them is extinguished referred to as the ‘Contingent Claim Day’) often will not depend on the length of term of the rental contract.
An example of such a payment may be a guarantee deposit that was forfeit in whole or in part if property was vacated early or to compensate for damage to the apartment.
If the Contingent Claim Day is the day the property is made available to the lessee or the day the rental contract becomes effective then the same rule applied to Ad Hoc Payments noted above applies – i.e. the Income Recognition Day is either the day the property is so made available or the day that the contract becomes valid.
If the Contingent Claim Day is otherwise specified in the contract then the day so specified is the Income Recognition Day. This may include, for example, the final day of the contract if the amount can be claimed by the landlord on that day (ITL TI 36-7).
Arbitration and similar payments
Where amounts of rent have been in dispute and subject to judicial proceedings, arbitration or other similar process then the Income Recognition Date for any income awarded under such process (including interest for late payment and similar amounts) is the day on which the arbitration is determined. However if amounts are placed into escrow the rules normally applied to rental income described above are applied. (ITI 36-6)