A resident of Japan (other than a non-permanent resident — broadly, a “permanent resident” for tax purposes) is taxed on worldwide income. When overseas rent, dividends or interest is also taxed in your home country or in the country of investment, double taxation arises. The foreign tax credit is the mechanism that adjusts for it.
How the credit works
The mechanism is this: an amount corresponding to income tax paid abroad is credited against your Japanese income tax, up to a credit limit (the year’s income tax × foreign-source income ÷ total income). Foreign tax in excess of the limit can, within certain bounds, be credited against the special reconstruction surtax and resident (local) tax, and any amount still uncredited — together with unused credit capacity — can be carried forward for three years.
Treaty ceilings and procedures come first
In practice, the first point to watch is that tax withheld in excess of the treaty ceiling is not creditable. If, say, a treaty caps dividend withholding at 10% and the source country withholds 15%, the excess 5% is something to recover through a refund procedure in that country; it cannot be credited in Japan. Nor is the treaty rate applied automatically: before the dividend or other payment is made, it is usually necessary to submit a treaty-benefit application form, a certificate of residence or similar documents to the local payer or tax authority (the requirements vary by country).
Documents to keep
Second, claiming the credit requires keeping documents evidencing the name, amount and payment date of the foreign tax. Always retain the local tax payment certificates or the local equivalent of withholding statements.
Credit or expense deduction?
Third, as an alternative to the credit, foreign tax can instead be deducted as an expense; depending on your income position, it may be necessary to work out which treatment is more favourable.
The credit limit, with a worked example
Worked example (assumptions: Japanese income tax ¥1,000,000; total income ¥10,000,000, of which foreign-source income ¥2,000,000; foreign tax paid ¥250,000): the credit limit is ¥1,000,000 × ¥2,000,000 ÷ ¥10,000,000 = ¥200,000. That ¥200,000 is first credited against income tax; the remaining ¥50,000 is credited against the special reconstruction surtax and resident tax, and any amount still uncredited is carried forward to later years.
The foreign tax actually withheld abroad depends on whether the treaty procedures were carried out, and the Japanese credit is computed on the basis of foreign tax that was properly charged. The treaty procedures in the country of investment and the credit computation in Japan should therefore be considered together, as one continuous process.
Taxed twice on the same income?
We handle foreign tax credit claims and the related treaty procedures — by email.
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