In income tax and corporation tax law arena, there are situations where different tax rules are applied by distinguishing natural persons from a “resident” and a “nonresident”, corporations from a “domestic corporation” and a “foreign corporation”.
Why is that?
Actually, the range of income taxed in Japan can be different.
This time I will outline how scope of taxable income will differ.
First, “resident” is an individual who has an address or domicile in Japan for more than one year until now (Income Tax Law (hereinafter referred to as “ITL”) Article 2 Item 3).
A domicile is a meaning of a base of living other than an address.
For example, a house or a hotel where people who is not registered as resident lives in is degraded as a domicile.
It is consistent with the provision of the Civil Code (Article 23 Para 2) that “a domicile of a person who does not have an address in Japan is deemed as the address of that person, regardless of whether the person is a Japanese or a foreigner”.
It should be noted that individuals who do not have Japanese nationality and who have an address or domicile for 5 year or less in total within the recent 10 years are classified as “non-permanent residents.
Non-permanent residents are subject to special rules differently from permanent residents. (ITL Article 2 Item 4).
Those who have Japanese nationality are treated as “residents” as soon as they return to Japan even if they are away from the country for decades.
However foreign nationals are regarded as “residents but non-permanent residents” until “5 years in the recent 10 years”.
If you lived in Japan for more than “5 years in total within the recent 10 years”, you foreign national also will make it for(?) a plain “resident”.
“Nonresident” means an individual other than a resident (ITL Article 2 Item 5).
In other words, everyone who is neither a resident nor a non-permanent resident is a “non-resident”.
Nationality is irrelevant here.
respite the facts you lived in Japan and regardless of Japanese or foreigner, you will be a “non-resident” as soon as you surrender your address or domicile in Japan.
Therefore, not only foreigners who have never stepped on Japanese soil, as well as those who have moved abroad are nonresident.
A corporation having a head office or a principal office in Japan (ITL Article 2 Item 6).
“Head office” is the principal office of the company (the registered main office).
“Principle office” is the principal office of a corporation other than the company (e.g., Incorporated Association, Incorporated Foundation corporation, Unincorporated association etc.).
It is a corporation other than a domestic corporation (ITL Article 2 Item 7).
Whatever income you earn, all of it will be taxable for income tax in Japan (ITL Article 7 Para 1 Item 1).
For example, a resident leasing real estate to others is subject to Japanese income tax for rent income regardless of location of the real estate, Japan or abroad.
(2) Non-permanent resident
① Income other than ‘foreign source income’
② “Domestic source income” that was paid domestically or remitted from overseas
Two types of income are taxable (Article 7 Para 1 Item 2 of the law).
Conversely, the part which is not taxed is “foreign source income” which is paid outside of the country and has not been remitted to the country.
The term “foreign source income” referred to here means, in a nutshell, the income derived from conduct of business abroad, possession and transfer of assets outside Japan.
For example, if a foreigner who has just moved to Japan leases a house in his/her home country to someone else, the rent will be foreign source income.
When the rent is remitted to Japan, it falls under ② above and taxed in Japan.
However if it is paid in his/her offshore bank account, it will not be taxed because it does not fall under ① or ②.
As long as you are a non-permanent resident, you better not to bring unnecessary money into Japan.
A portion of “domestic source income” is taxed.
“Domestic source income” is almost reversed of “foreign source income”, it is income derived from domestic business, possession and transfer of domestic assets.
In the case of non-residents, foreign source income is not taxed at all.
Taxable base is also limited for domestic source income (ITL Article 7 Para 1 Item 3), roughly limited to the following two kinds of income.
① Income of a business conducted through domestic “permanent establishment” (ITL Article 164 Para 1).
② Income earned relatively easily without domestic “permanent establishment” (capital gain, rent of domestic real estate, dividend of domestic stock, interest of government and corporate bonds etc. ITL Article 164 Para 2).
“Permanent Establishment” means fixed place of business such as a branch, factory, construction site, workshop and certain “agent”.
It is abbreviated in “PE”.
It is “agent” that needs attention here.
Although it is easy to understand that physical facilities for carrying out business such as branch office fall under PE, natural persons and corporations who are given the authority to conclude contracts for the sake of non-residents also can be PE.
If there is PE in Japan, both ① and ② above are subject to Japanese income tax.
If not, only a part of ② will be taxed in Japan.
The majority of income tax on ② is taxed at source upon its payment (ITL Article 212 Para 1).
It is so-called “withholding” (please refer to the blog “Japanese withholding tax (1)” for details).
Please note that ② also includes consideration for usage of intellectual property rights such as patent, know-how, trademark right, design rights (so-called royalties).
(4) Domestic corporation
Only certain income paid in Japan is taxed (ITL Article 7 Para 1 Item 4).
Specifically, income tax is imposed only on passive income such as interest, coupon and dividend (ITL Article 174).
It is interesting that “horse race prize paid to a horse owner” is subject to income tax (Article 10 Item 10).
Does this imply that there are many racehorses owned by corporations?
The taxing method for domestic corporations is withholding tax (ITL Article 212 Para 3).
As corporation tax is imposed on income of corporations, withholding income tax on domestic corporations is a kind of “back-up”.
The double taxation of income tax and corporation tax will be adjusted through tax return filing of corporation tax.
Therefore, domestic corporations do not have to file tax return of income tax.
(5) Foreign corporation
Part of “domestic source income” is taxed (ITL Article 7 Para 1 Item 5).
Although the scope of taxation is slightly wider than that of domestic corporations, they are mainly passive income such as capital gain and rent of domestic real estate, interest, coupon, dividend of domestic securities and so on.
Taxing method is withholding tax (ITL Article 212 Para 1).
As same to the case of non-residents, please note that royalties are also subject to withholding tax.
Among the income subject to withholding tax, withholding tax may be exempted under certain conditions (ITL Article 180) for those paid to domestic PE of a foreign corporation.
Taxing on non-residents and foreign corporations without PE is totally relying on withholding tax.
Therefore, the tax office always pay attention to withholding agents (income payer).
In addition, withholding tax rate may be reduced or exempted for payment to non-residents and foreign corporations under applicable tax treaty, if any.
However if they do not meet the procedure requirements, the tax authority will not accept application of the tax treaty (please see blog “Japanese withholding tax (3) “).
Please make sure if any withholding tax is required upon your payment to non-residents and foreign corporations.