The US-Japan tax treaty
Doing business in Japan has traditionally been very profitable for US companies, and the US IRS and Japanese National Tax Agency have tended to revise and improve the US – Japan Tax Treaty more often than has happened with many of Japan’s other trading partners. Changes over the past decade, in 2005 and 2013, have made it much more profitable and tax efficient for US companies, especially software vendors, to do business in Japan. In fact, the effects of some of the changes might make it beneficial for many non-US companies starting business in Japan through a wholly owned subsidiary, to do so using a US parent to own it (but be aware of the treaty’s anti-conduit provisions).
The US-Japan tax treaty eliminates withholding tax on royalties that Japanese customers pay to a US company, including payments from a Japanese subsidiary to its US parent. Be aware that the Japanese tax office charges 5% withholding tax on any royalties paid between a Japanese subsidiary and its US parent (or any other withholding tax exempt payments) if the payment exceeds the arm’s-length amount the Japanese tax office sets.
The US – Japan tax treaty eliminates withholding taxes on dividends paid by a Japanese subsidiary to its US parent if the parent has owned 50% or more of the subsidiary’s voting stock during the preceding 6-months. The withholding tax on dividends paid to corporate shareholders that own 10% – 50% of the subsidiary’s voting stock is 5%. Withholding tax on all other dividends is 10%.
This makes the KK kabushiki kaisha a tax efficient structure for US parents, but it still cannot compete with a GK godo kaisha structured as a check-the-box entity.
The US – Japan tax treaty eliminates withholding tax on interest paid to a US lender.
The US – Japan tax treaty provides explicit rules to decide whether treaty benefits are available to an entity or its owners, generally depending on each’s country of residence and which (entity or owner) has liability for taxes on the entity’s income. 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”. In such schemes, recipients in countries that have less favorable withholding tax rates on payments from Japan, route such payments through a US entity to receive the US-Japan tax treaty’s reduced or eliminated withholding tax provisions.
Extended transfer pricing provisions 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 generally follow OECD Transfer Pricing Guidelines.