Japanese tax structuring

 

The new US-Japan tax treaty

10.  the new US-Japan tax treaty

Despite my comments regarding 'tax conduits' in the previous section on the tokumei kumiai 'tk', doing business in Japan became more profitable for US companies, especially software vendors, due to the new US-Japan tax treaty which was signed on November 6, 2003 and took effect in 2005.

Withholding tax on royalties is eliminated.

The new US-Japan tax treaty eliminated withholding tax on royalties paid by Japanese customers to a US company, including payments from a Japanese subsidiary to its US parent. This is very good news for US software vendors doing business in Japan.

Be aware that a 5% withholding tax will be levied on any royalties paid between a Japanese subsidiary and its US parent (or any other payments on which withholding tax has been eliminated) if the payment exceeds the arm's-length amount determined by the Japanese tax authorities.

Withholding tax on dividends is eliminated or reduced.

Withholding taxes on dividends paid by a Japanese subsidiary to its US parent (assuming the parent has owned 50% or more of the subsidiary's voting stock during the previous 12-months) was eliminated in the new US-Japan tax treaty. The withholding tax on dividends paid to corporate shareholders that own 10% - 50% of the subsidiary's voting stock was reduced from 10% to 5%. Withholding tax on all other dividends was reduced from 15% to 10%.

This change makes the kabushiki kaisha a more tax efficient structure than was previously the case but it still cannot compare with a tokurei yugen kaisha properly structured as a check-the-box entity.

Withholding tax on certain interest payments is eliminated.

Withholding taxes on interest paid to financial institutions were eliminated in the new US-Japan tax treaty but the current 10% withholding tax still applies to interest paid by a Japanese subsidiary its US parent.

Treatment of pass-through entities

The new treaty provides explicit rules to determine whether treaty benefits are available to an entity or its owners, generally depending on which of them (entity or owner) is taxable on the entity's income and where the entity is organized. The rules are consistent with the US treatment of 'hybrid' entities (entities classified as a corporation in one country and as a pass-through entity in the other country).

There are also provisions to deny treaty benefits to payments in "conduit financing arrangements" where financing is structured to route the economic benefit of the new US-Japan tax treaty's reduced or eliminated withholding tax provisions to persons in other countries that have less favorable withholding tax rates on payments from Japan.

Related party transactions.

Transfer pricing provisions are extended to allow Japan to tax the profits of a US company's Japanese subsidiary using an 'arm's-length' standard. Transfer pricing examinations and application evaluations for advance pricing agreements will be made in accordance with OECD Transfer Pricing Guidelines.

New US-Japan tax treaty benefits eligibility.

The new US-Japan tax treaty includes provisions to limit benefits to persons having a sufficient nexus to Japan or the US. The US may deny treaty benefits to a tokumei kumiai 'silent partnership' and research needs to be completed to understand how this will affect the usefulness of the tokumei kumiai to US companies doing business in Japan. Also the Japanese tax authorities, who are clearly becoming sensitive to what they believe to be abuses of the tokumei kumiai, maintain the right to levy withholding tax on deductible payments from them to US silent partners.

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Japanese tax structuring

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