Guide to Japan’s Foreign Tax Credit

[fabienne]

@kristhuy Great summary! This helped me a lot. I want to confirm my understanding of the "adjusted foreign income amount". I have a large capital loss carryover that offsets my cap gains and reduces my AGI by $3000. The foreign income I would show on the FTC form would include the cap gains as is. Is that correct?

Thanks.

 

[kristhuy]

@fabienne What do you mean by "AGI"? Do you mean the AGI on your US tax return? That is irrelevant to your "adjusted foreign income amount". What matters is the amount of foreign-source income you had according to Japanese tax law's definition of foreign-source income. And note that capital gains on anything other than real estate realized by a Japanese resident are not typically foreign-source.

 

[fabienne]

@kristhuy My capital gains are from US stock sales and US mutual fund cap gain distributions and would be included in the foreign source. As you said, the comment about cap loss carryover impact and AGI is only relevant to my US tax filing.

One other point to confirm: the foreign tax paid should be the portion of the US tax associated with foreign source income. I should remove the percentage of tax associated with Japan source income that is included on my US filing, right? For example, my wife's Nenkin payments are taxable by the US, but are not foreign source income for Japan.

 

[kristhuy]

@fabienne

US stock sales

US stock sales are not foreign source income, and the US has no right to tax them under the treaty, so it's not possible to claim a foreign tax credit in Japan with respect to US tax paid on US stock sales.

Instead, you have to claim a foreign tax credit in the US with respect to the Japanese tax you paid on them.

the foreign tax paid should be the portion of the US tax associated with foreign source income

Yep. But be careful about what counts as foreign source income.

 

[fabienne]

@kristhuy Thanks for your quick reply. I tried to read through all of the references included in your summary and references that I found along the way, but it is a bit overwhelming to say the least. Just to be clear: dividends for stocks I own in the US are foreign source and dividends/cap gains distributions for mutual funds I own in the US are foreign source. Sales of those stocks and mutual funds would not be included in foreign source.

Can you confirm that the following would also be considered foreign source? I am including some things that are on the near term horizon for me:

• Pension related: US Company Pension, Social Security, 401K distributions, IRA distributions
• Basic Interest from investment accounts

Edit to add: I was scanning through the references again and found that the example from tax accountant Kanayamais what left me with the impression that US stock sales would be included in foreign source.

 

[kristhuy]

@fabienne

dividends for stocks I own in the US are foreign source and dividends/cap gains distributions for mutual funds I own in the US are foreign source

Yep.

Sales of those stocks and mutual funds would not be included in foreign source.

That's right.

US Company Pension, Social Security, 401K distributions, IRA distributions

All of these are foreign source. Though it's worth noting that the US has no right to tax them under the US-Japan treaty, so you can't claim a foreign tax credit with respect to any US tax you pay on them (instead you have to claim a foreign tax credit in the US). They are still included in "foreign source income" for the purposes of calculating your foreign tax credit allowance though.

Basic Interest from investment accounts

Interest is generally sourced wherever the entity paying the interest is located, so interest paid by an overseas entity would be foreign source. The maximum rate at which the US can tax interest paid to Japanese residents is 10%, so you can claim a foreign tax credit in Japan with respect to any US tax on you pay on US-source interest up to a maximum of 10%. If you pay a higher rate than that in both countries, you must claim a foreign tax credit in the US with respect to the portion in excess of 10% paid in Japan.

example from tax accountant Kanayama

Yes, that example is a little strange. Capital gains generated by the sale of US stock can be foreign-source income in a few very specific circumstances (prescribed by Ordinance 255-4 of the regulations under the Income Tax Law), such as when the relevant company is a REIT, or when the sale is part of a corporate merger/acquisition. But in general the sale of listed US stock by a consumer investor doesn't generate foreign source income, as you can see from the ordinance linked above.

It's not hard to find examples of reputable tax accountants confirming this consequence of Ordinance 255-4 either (e.g., here and here). I suspect Kanayama just didn't give much thought to their example of foreign source income, since it's not relevant to the point of their article.

 

[fabienne]

@kristhuy Thanks again. That helped a lot. I spent some time wading through the Tax Treaty, Tax Treaty explanation and your various references. It is starting to make sense.

It looks like the only things that I can claim a foreign tax credit for are the interest and dividends. If my dividends have tax withheld at 10%, but my total income on the US side (say dividends + interest + pension) ends up being taxed at a rate of 9%, can I only claim 9% of dividend value for the foreign tax credit?

I still have to spend more time on Article 23 (Relief From Double Taxation). Is that what allows me claim a foreign tax credit for Pension? Even if I have no actual Japan Income, I am still able to identify the Pension income as Japan Source because Japan has the exclusive right to taxation of that income? (even though the Savings Clause allows the US to tax it anyway)

 

[kristhuy]

@fabienne

If my dividends have tax withheld at 10%

Are you a US citizen? US taxpayers shouldn't normally have US tax withheld from US-source dividends.

my total income on the US side (say dividends + interest + pension) ends up being taxed at a rate of 9%, can I only claim 9% of dividend value for the foreign tax credit?

Yes. If you only pay 9% tax, you can only claim a 9% foreign tax credit. The scenario you're describing doesn't normally occur though, because US taxpayers don't have US tax withheld from US-source dividends.

Is that what allows me claim a foreign tax credit for Pension?

Yeah Article 23(3) is the key provision. Articles 23(1) and 23(2) are just standard foreign tax credit provisions, but Article 23(3) is the provision that enables US citizens to "re-source" income for US tax purposes, so that they can claim a foreign tax credit with respect to Japanese tax they paid on the income. There is a decent explanation of this provision starting on page 92 of the US Treasury's Technical Explanation (PDF) accompanying the treaty.

 

[fabienne]

@kristhuy Thanks for your response. You are correct. I do not have tax being withheld on my US-source dividends. It was a poorly worded hypothetical scenario.

I appreciate you taking the time to share your expertise and answer my many questions. Hopefully the exchange will help someone else out in the future.

 

[ultrahyper]

@kristhuy Help! I went back and forth with the tax office today in Kyoto about how to tax US-based dividends. Since it is my FIRST year of dividends (FY2022), and I have not yet filed a US tax return (delayed waiting for rather late K-1's), I have not paid any taxes on the dividends. Ultimately, I couldn't find another solution but to let Japan levy their whole 20% tax on my dividends. I understand that next year I can use FY2022's US-based tax credits to offset dividend tax liability in Japan up to 10%, but does this mean I'll simply be double-taxed this year? (i.e. this will all be canceled out at some future date)?

 

[kristhuy]

@ultrahyper Yes, that is exactly what is described in the post above. US taxpayers must claim foreign tax credits on a one-year-delayed basis.

Over the long term it will all roughly even out, but for now all you can do is declare the foreign-source income on the foreign tax credit calculation form so that you can claim a foreign tax credit on next year's tax return, as described above.

 

[resjudicata]

@kristhuy Simple question on just income and income tax (No investments, dividends, property, etc)

Im moving to Japan and have a tax attorney lined up but im tying to estimate my tax liability before going through the process.

US Citizen Moving to Japan for 5 years for work. Income will be paid by Japanese Company in JPY.

Salary 30M JPY / yr... taxed at about 40% National / 10% Local

Since my US Tax rate is 35%... Am I understanding correctly that if I use FTC (and not FEIE) than I would pay 0$ US Tax, and even have a carry over of credit each year because I'm paying much more in foreign tax than if I were in the US?

 

[kristhuy]

@resjudicata

I would pay 0$ US Tax, and even have a carry over of credit each year because I'm paying much more in foreign tax than if I were in the US?

Yes, that is likely. But the Japanese tax burden on a salary of 30 million JPY is about 26% income tax and 9% residence tax, and the US tax burden on a salary of 30 million JPY is about 23%, so your estimates of your tax burden are a bit high.

 

[resjudicata]

@kristhuy Awesome, thanks for this. I’m tracking your comment on the percentages also. I’m closer to 40 than I am 30, but I definitely think I’m in that ballpark. Thanks again!

 

[zip66]

@kristhuy Great thread. Would you ever consider a step-by-step guide to filling out the form for both stock and dividend income? With something like this I think a lot of people would be comfortable submitting without an accountant

 

[kristhuy]

@zip66 By far the easiest way to generate an FTC Calculation Form is to use the NTA's online tax return preparation tool. And there are already quite a few step-by-step guides out there (e.g., here and here) explaining how to use that tool to claim a foreign tax credit.

The tool is updated every January, so current guides won't necessarily apply to the version of the tool that will apply to 2023 income, but a flurry of new guides will inevitably start to appear online in January 2024. Claiming a foreign tax credit with respect to dividend income is a very common procedure.

both stock and dividend income?

It is very rare for foreign tax paid on capital gains derived from the sale of stock to give rise to a foreign tax credit in Japan, because most of Japan's tax treaties give Japan primary taxation rights with respect to capital gains (derived from the sale of foreign stock) received by a Japanese tax resident.

Dividend income is a common source of foreign tax credits, though. Which is why there tend to be quite a few relevant guides available.

 

[zip66]

@kristhuy Ok thanks. I’m still a few years off from needing it but will take a look.

Just to get a basic idea for stock sales, you would claim an FTC on your American return (and not pay capital gains), and then file it in the year the sale was made on your kakutei shinkoku? And if you bought at multiple prices you would need to create a weighted average in Yen using the official exchange rate on the date you bought?

 

[kristhuy]

@zip66

you would claim an FTC on your American return (and not pay capital gains), and then file it in the year the sale was made on your kakutei shinkoku?

You would claim the FTC on your US tax return based on the amount of tax you already paid in Japan or the amount of tax you expect to pay in Japan with respect to the capital gains derived from the sale of stock.

if you bought at multiple prices you would need to create a weighted average in Yen using the official exchange rate on the date you bought?

Yes. And exchange rate fluctuations (among other things) may cause your taxable capital gain to be different for US purposes and Japanese purposes, which in turn may affect the extent to which the FTC can offset your US tax liability.