Offsetting individual tax losses – example

June 4, 2012  |  Individual

The Japanese one thousand yen note includes a view of Mount Fuji from one of its five nearby lakes.

The ability to offset tax losses arising from one source of income against taxable profits arising from another is often critical for tax planning purposes, for example through ensuring that a taxpayer is taxed on his overall economic gain.

The Japanese individual tax system has a rules that govern such loss offset which are discussed in this article. Below is a worked example of how these rules apply in practice so it is helpful to read it together with the earlier referenced article.


 

A practical example

For the purposes of this example suppose a taxpayer has the following sources of income and loss:

  1. JPY400,000 Dividend Income where an election has been made for Taxation at Marginal Rates (in Japanese 総合課税所得 sougou kazei sentaku). See this article for more details of dividend taxation for individuals.

  2. JPY2,800,000 Real Estate Income

  3. JPY loss (1,500,000) from Business Income

  4. JPY3,000,000 Employment Income

  5. JPY loss of (500,000) from Miscellaneous Income subject to Taxation at Marginal Rates

  6. Capital gains

    • JPY loss (2,000,000) Capital Gains subject to Taxation at Marginal Rates

    • JPY loss (9,000,000) Capital Gains on Land, Buildings and Similar

  7. JPY1,200,000 Occasional Income

  8. JPY loss (4,000,000) from Mountain and Forestry Income,

  9. JPY5,000,000 Retirement Income

The above figures suggest the taxpayer is an an employed individual running a loss making side business who may have positive rental income from a property but where the property was sold at a loss during the year.

Ideally the individual would want to offset the loss from Business Income and an overall Capital Loss from property against his other income. The steps below show how this works out in practice.

Loss set off

The individual’s overall taxable income after loss set off is as calculated below. The Steps referred to below are those indicated in the post explaining overall principals of loss set off here.

  • Step 1: Real Estate and Business Losses vs Ordinary Income

    First calculate Ordinary Income from the total of Dividend Income, Real Estate Income and Employment Income above as JPY(400,000 + 2,800,000 + 3,000,000) = JPY6,200,000. Then offset Business Losses of JPY(1,500,000) to give net income after loss offset of JPY4,700,000.

    Note that the loss of JPY(500,000) of Miscellaneous Income is not included in the above calculation of Ordinary Income.

    If this amount had been income rather than a loss it could have been added into the total amount of Ordinary Income and then offset by the Business Loss.

  • Step 2: Capital Losses vs Occasional Income

    JPY(2,000,000) of Capital Losses subject to taxation at Marginal Rates can offset the JPY1,200,000 of Occasional Income leaving a JPY(800,000) of excess Capital Loss that can then be used in Step 4 below.

  • Step 4: Residual Capital Losses vs Ordinary Income

    The residual Capital Loss of JPY(800,000) un-relieved after Step 2 above can be used to offset the net Ordinary Income above of JPY4,700,000 (after the offset of Business Income in Step 1 above) to give a net JPY(4,700,000 – 800,000) = JPY3,900,000.

    Note that Business Losses have already been offset in Step 1 and there are no Real Estate Losses so “Step 3: Real Estate, Business Losses vs Capital Gains, Occasional Income” is not required here.

  • Step 6: Mountain and Forestry Income

    The loss of JPY(4,000,000) Mountain and Forestry Income can first be set off against the residual Ordinary Income of JPY3,900,000 from Step 4 above to give a net unrelieved loss of JPY(100,000) Mountain and Forestry Income.

    The JPY(100,000) unreleived loss on Mountain and Forestry Income can then be offset against the JPY5,000,000 of Retirement Income to give an overall amount of taxable Retirement Income of JPY4,900,000.

Overall position

Looking at the overall position the individual has offset the loss on his Business Income against Employment Income, Real Estate Income and Dividends subject to Taxation at Marginal Rates (his “Ordinary Income”). His Capital Loss subject to Taxation at Marginal Rates was also offset against Occasional Income first and then the amount of Capital Loss remaining against Ordinary Income.

As a final step the loss on Mountain and Forestry Income could also be used against Ordinary Income reducing it to zero and the remainder then against Retirement Income.

Generally speaking Retirement Income is subject to a favorable taxation regime in any case, so an important planning point for this taxpayer may have been considering when the timing of realisation of a Capital Loss and whether it would be set against Ordinary Income or Retirement Income.

The taxpayer in this example was not able to relieve the loss on his Miscellaneous Income nor the Capital Loss on Land, Buildings and similar that was not subject to Taxation at Marginal Rates.

Except for certain important exemptions around residential property, Capital Losses on Land, Buildings and Similar cannot be treated as Taxed at Marginal Rates and hence cannot set off other categories of income discussed above.


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