Who Is Liable For Income Taxes in Japan
In Japan, the tax liability of individuals is determined by their residence status. Individual taxpayers are classified into the following three categories:
- A permanent resident is an individual who is a Japanese national or has been present in Japan for at least 5 years within the past 10 years.
- A nonpermanent resident is an individual of non-Japanese nationality who has not resided or maintained his or her domicile in Japan for more than 5 years within the past 10 years.
- A nonresident is an individual who does not meet the requirements for qualification as a permanent resident or a nonpermanent resident.
Foreign nationals arriving in Japan are considered to have established residence in Japan, unless employment contracts or other documents clearly indicate that they will stay in Japan for less than one year.
Permanent residents are subject to income tax on their worldwide income, regardless of source. Nonpermanent residents are subject to tax on income earned in Japan (for example, employment income from services performed in Japan, regardless of payroll location) plus any non-Japan source income that is paid in or remitted to Japan. Nonresidents are subject to tax on their Japanese-source income only.
Income subject to tax. The taxation of various types of income is described below. For a table outlining the taxability of income items.
Employment income and deductions. Individuals with employment income are subject to income tax. Employment income includes salaries, wages, directors’ fees, bonuses and other compensation of a similar nature. Benefits in kind provided by the employer, including the private use of an employer-provided auto mobile, tuition for dependent children, private medical insurance premiums and private pension contributions, are included in employment income.
However, certain employer-paid benefits, including moving expenses and home-leave expenses, are excluded from taxable income.
Favorable tax treatment is available for employer-provided housing if the following conditions are satisfied:
- The lease is in the employer’s name.
- The employer pays the rent directly to the landlord.
- The individual pays to the employer an amount equal to the “legal rent” for the premises from after-tax monies.
For purposes of the last condition above, the legal rent is computed using different formulas for directors and employees. For directors, the legal rent is the greater of one-half (35% if used for business) of the monthly rent paid by the employer or an amount computed by a formula involving the area and assessed value of the rented property. If the private living space exceeds 240 square meters, if amenities are located on the premises such as a swimming pool, tennis courts or other similar facilities, or if luxury amenities are provided that cater to the director’s personal tastes, the favorable tax treatment does not apply and the director’s housing is taxed at full value. For other employees, the legal rent equals one-half of an amount computed by a formula involving the area and assessed value of the rented property. Experience indicates that this amount is approximately 5% to 15% of the rent actually paid by the employer.
Investment income. Dividend income includes dividends and distributions of profits from corporations as well as distributions of earnings from securities investment trusts, except public and corporate debenture investment trusts. It also includes constructive dividends realized in the form of distributions of remaining assets on the liquidation of a company, distributions on the reduction of capital or distributions on the retirement of shares. Interest on borrowings for the acquisition of shares on which dividends were paid may be deducted from the gross amount of dividends.
Dividends from unlisted shares and dividends received by shareholders who own 5% or more of listed shares are included in taxable income and taxed at progressive rates. Dividends from listed shares are taxed at a flat rate of 20% (15% national tax plus 5% local inhabitant tax). A reduced tax rate of 10% (7% national tax plus 3% local inhabitant tax) applies until 31 December 2011. For dividends from listed shares that are received through a Japanese paying agent (securities company or trust company in Japan), a withholding tax is deducted by the Japanese paying agent. A taxpayer does not need to report the dividends as income on the tax return if the dividends are from listed shares and are received through a Japanese paying agent.
Interest income includes interest on public bonds, corporate debentures, deposits and postal savings, as well as interest on distributions of earnings of joint operation trusts, public bonds and debenture investment trusts. No deductions are allowed for expenses. Interest on public bonds and deposits paid in Japan is taxed separately from other income and is subject to a final 15% withholding tax (plus a final 5% local withholding tax) at source. Interest on public bonds and debentures issued overseas is subject to a 15% final withholding tax (plus a final 5% local withholding tax) if received through a paying agent in Japan. Otherwise, interest earned overseas is taxed at progressive rates.
Interest up to certain amounts on postal savings and deposits, public bonds and securities investment trusts is exempt from income tax if such income is received by qualified taxpayers.
Qualified taxpayers include spouses qualifying for survivors’ or widows’ annuities and handicapped persons. The following interest is exempt from tax:
- Interest on time deposits, public bonds, debentures and securities investment trusts, up to a maximum principal amount of ¥3.5 million
- Interest on national bonds, up to a maximum principal amount of ¥3.5 million
Under the workers’ savings program, interest on employees’ savings for pensions and for housing acquisitions is exempt from tax, up to a maximum principal amount of ¥5.5 million.
Directors’ fees. Directors’ fees paid by a Japanese corporation to nonresidents are considered Japanese-source income and are subject to tax in Japan, even if the services are performed outside Japan.
Capital gains. Capital gains from the sale of assets other than securities, land and buildings are divided into short-term and long-term gains and are then included in ordinary income and subject to tax at the normal income tax rates..
Gains derived from the disposal of property held longer than five years are considered long-term, and only one-half of the gains is taxable. A ¥500,000 deduction is available from the total of short-term and long-term gains.
Capital gains derived from the sale of shares are generally taxed at 20% (15% national tax plus 5% local inhabitant tax). If a taxpayer sells certain listed shares through a securities company or bank in Japan, a reduced tax rate of 10% (7% national tax plus 3% local inhabitant tax) applies until 31 December 2011.
Capital gains derived from the sale of land and buildings are taxed separately from other income and at different rates. Gains from the sale of land and buildings held for no longer than five years are considered short-term, and gains from the sale of similar assets held for longer than five years are treated as long-term gains. Long-term gains are defined as income from the transfer of land and buildings that have been owned for more than five years as of 1 January of the year of transfer.
Short-term gains are taxed at a rate of 30%, plus a 9% inhabitant tax on taxable gains. Long-term gains are taxed at a rate of 15%, plus a 5% inhabitant tax on taxable gains.
Gains derived from the sale of residential property held longer than 10 years are taxed at a rate of 10% (plus a 4% local inhabitant tax) on taxable gains of up to ¥60 million and at a rate of 15% (plus a 5% local inhabitant tax) on gains in excess of ¥60 million. This favorable treatment applies to sales of residential property that have been held for more than 10 years as of 1 January of the year of transfer. A special deduction of ¥30 million is available on gains from the sale of residential property if specified conditions are met.
Proceeds from the sale of land and buildings held by nonresidents are subject to a 10% withholding tax, unless the property is purchased by individuals for residential use and the sales value does not exceed ¥100 million.
Deductions
Deductible expenses. If the aggregate amount of specific employment-related expenditure incurred during a year exceeds the amount of the employment income deduction (see Employment income and deductions), the excess may be deducted in addition to the employment income deduction. Specifically allowed expenditure includes commuting expenses, moving expenses for a company transfer and training expenses for technical skills or knowledge directly required by employees for the performance of their duties. Expenditure must be documented and certified by the employer. The deduction of specific expenditure may be claimed only by filing a tax return.
Insurance premiums. Social insurance premiums are fully deductible. Life insurance premiums are deductible, up to a maximum of ¥50,000. Individual pension premiums are deductible, up to ¥50,000. For casualty insurance premiums, the maximum deductible amount is ¥50,000 for earthquake insurance contracts and ¥15,000 for long-term insurance contracts entered into by 31 December 2006. The maximum total deduction for earthquake and long-term casualty premiums is ¥50,000.
Contributions. Contributions to the government or local authorities, to institutions for educational, scientific or other public purposes designated by the Minister of Finance, and to institutions for scientific study or research specifically provided for in the tax law are deductible. The deductible amount is the lower of total contributions, or 40% of adjusted total income reduced by ¥2,000.
Rates. Individual income taxes consist of national income tax and local inhabitant tax. Individuals are also subject to a local enterprise tax on income derived from businesses or professions at rates ranging from 3% to 5%.
Normally, a 20% withholding tax is levied on nonresidents, with no deductions available; however, depending on the type of income, tax may be levied at progressive rates through self-assessment. Dividends and salaries paid by Japanese companies, interest income, annuities and prizes are subject to a 20% withholding tax if paid to nonresidents.
National individual income tax rates. National income tax rates are progressive. The rates range from 5% (on taxable income of up to ¥1.95 million) to 40% (on taxable income exceeding ¥18 million).
Local inhabitant tax rates (prefectural and municipal). Local inhabitant tax consists of prefectural tax (a flat rate of 4% plus ¥1,000 of per capita levy) and municipal tax (a flat rate of 6% plus ¥3,000 of per capita levy). Nonresidents are not subject to local inhabitant tax.
Relief for losses. Losses from rental, business and forestry activities may be used to offset income from other ordinary income categories. The portion of a rental loss equal to the ratio of interest expense on loans used to acquire the land, to total rental expenses, may not offset other income.
The net loss remaining after using all available losses to reduce income may be carried forward for three years by a taxpayer filing a blue form tax return (see Section D). A taxpayer who does not file a blue form tax return is allowed a carryforward of three years for certain losses, including the loss of business assets due to a natural disaster.
Losses from the sale of shares can offset only gains from the sale of shares. However, the losses from the sale of listed shares through a securities company or bank in Japan may offset dividend income from listed shares. The net loss remaining after using all available losses to reduce dividend income from listed shares may be carried forward for three years by a taxpayer filing a tax return.
B. Other taxes
Inheritance tax. Inheritance tax is levied on heirs and legatees who acquire properties by inheritance or bequest. An individual domiciled in Japan is subject to tax on all property, regardless of location. An individual not domiciled in Japan is, in principle, taxed only on property located in Japan at the time of the decedent’s death. However, a Japanese national not domiciled in Japan is subject to inheritance tax on all inherited properties, regardless of location.
Gifts made within three years before death are treated as inherited property and are included in taxable property for purposes of inheritance tax. Certain exemptions and allowances are permitted in the computation of total net taxable property. A basic exemption of ¥50 million, plus ¥10 million multiplied by the number of statutory heirs, is deductible from taxable properties. The inheritance tax is calculated separately for each statutory heir. The aggregate of the calculated tax is then prorated to those who actually receive the property.
Inheritance tax rates range from 10% to 50%, with a 20% surtax on transfers to heirs, other than the parents and children of the decedent, as shown in the following table.
Tax credits are allowed for surviving spouses, minors, gift taxes, and foreign estate and inheritance taxes paid on property located outside Japan. The credit for a spouse is the amount of inheritance tax payable on the spouse’s statutory share of the estate or on an estate of ¥160 million, whichever is higher.
Japan has entered into an estate tax treaty with the United States.
Gift tax. Gift tax is levied on individuals receiving gifts from other individuals. A donee domiciled in Japan is taxable on all gifts of property, regardless of their location. A donee not domiciled in Japan is, in principle, taxable only on gifts of property located in Japan at the time of the gift. However, a donee who has Japanese nationality and is not domiciled in Japan is subject to tax on all gifts of property, wherever located. An annual exemption of ¥1.1 million applies. Spouses are each entitled to a one-time exemption of up to ¥20 million on a gift of a residential house or land if the period of marriage is 20 years or longer.
C. Social security
Social security programs in Japan include health insurance, nursing care insurance (for employees 40 to 64 years of age), welfare pension insurance, unemployment insurance and workers’ accident compensation insurance. The rates described below are the applicable rates as of 1 April 2011.
The premium for health insurance is 9.32% of monthly remuneration and bonus, up to a maximum premium of ¥112,772 (bonus ceiling of ¥503,280 per year). The premium for nursing care insurance is 1.5% of monthly remuneration and bonus, up to a maximum premium of ¥18,150 (bonus ceiling of ¥81,000 per year). For welfare pensions, the premium is 16.058% of monthly remuneration and bonus, up to a maximum premium of ¥99,559 (bonus ceiling of ¥240,870 per year). Costs are borne equally by employers and employees for the types of insurance mentioned in this paragraph.
The premium for unemployment insurance is 1.55%, of which 0.95% is borne by the employer and 0.6% by the employee. The premium for workers’ accident compensation insurance is borne entirely by the employer at a rate of 0.3% of total compensation paid to employees.
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