[h4]Disclaimer and sources[/h4]
The information in this post is provided solely for discussion and entertainment purposes. It is no substitute for professional advice and should not be relied upon. The post is based on a wide range of sources, but the sources I found most useful were:
A foreign tax credit (FTC) uses foreign income tax payments to reduce a person's Japanese tax liability. The theory is that the amount of Japanese tax a person owes on their income should be reduced by the amount of foreign tax they paid on the same income. Though the reality is more complicated.
As discussed in detail below, the maximum amount of foreign tax that can be credited against a person's Japanese tax liability for any given year is determined by their "effective income tax rate" multiplied by 1.321 multiplied by the amount of "foreign-source income" (FSI) they received during that year. A person's “effective income tax rate” is the amount of income tax they owe as a percentage of their total net income.
For example, if you have an annual salary of 5 million yen and you received 100,000 yen worth of foreign dividends, then your net income (after the employee's expenses allowance) will be 3.66 million yen, and your annual income tax liability (assuming shakai hoken and minimum deductions) will be ~153,000 yen, resulting in an effective income tax rate of ~4.2%. The maximum amount of foreign tax that could be credited against such a person's Japanese tax liability would be ~4.2% x 1.321 = ~5.5% of the amount of FSI they received.
Since foreign tax is often withheld from foreign dividends and rental income at rates of 10-20%, it is common for people to pay a higher rate of foreign tax on their FSI than their effective income tax rate x 1.321, meaning that not all the foreign tax they paid will be credited against their Japanese tax liability. However, this is less likely to happen to people earning higher incomes, since their effective income tax rate will be higher. (Depending on deductions, a taxpayer’s “effective income tax rate x 1.321” is likely to reach 10% when their annual salary exceeds 8-10 million yen, and 20% when their annual salary exceeds 15-17 million yen.)
Residents who pay foreign income tax can claim an FTC. However, some types of foreign income taxes don’t qualify for the FTC, such as:
Most foreign taxation of Japanese residents is "withholding-based", in which case the timing of the FTC claim is straightforward. If you received a dividend during 2021 and 10% foreign tax was withheld from that dividend at the time it was paid, you can use that foreign tax to claim an FTC when you file your 2021 tax return.
However, sometimes Japanese residents file foreign tax returns (US taxpayers are the obvious example here). In those cases, it is the due date for filing the return (if the return is filed on time) that is deemed to be the date on which the relevant foreign tax is imposed for FTC purposes. This creates a mismatch between the year in which income was generated and the year in which the foreign tax on that income can be used to claim an FTC.
For example, if a Japan-resident US taxpayer received a dividend from a US company during 2021 and no US tax was withheld from the dividend, it is not possible to use the US tax liability on that dividend to claim an FTC on a 2021 Japanese tax return, even though the dividend itself must be declared on the 2021 return and Japanese tax paid on it at that time. Since the US tax on that dividend will end up being imposed via a tax return due in 2022, it is deemed to be a foreign tax imposed during 2022, meaning that it can only be used to claim an FTC on a 2022 Japanese tax return. (See here and here for commentary by Japanese tax accountants on this issue.)
As discussed below, it is possible to claim a Japanese FTC based on FSI earned in previous years, which means that the mismatch described above should not typically cause US taxpayers to end up paying more tax overall. However, it does make the calculations that US taxpayers need to perform, and the documents they need to submit, significantly more complicated.
[sup]1[/sup] There is an exception to these dates for people who elect to claim an FTC based on the date they actually pay their foreign tax liability rather than the date on which the tax is "imposed". This option is only available with respect to regular and consistent sources of foreign income.
[h4]Foreign taxes paid by investment funds[/h4]
In some countries, taxpayers are able to claim a personal FTC for foreign taxes that were paid by funds (ETFs, mutual funds, REITs, etc.) on their behalf. However, Japan does not provide an FTC for foreign taxes paid by funds. Instead, since 2020 Japan has had a double-taxation adjustment system (二重課税調整制度) that allows brokerages to take into account foreign taxes paid by Japan-domiciled funds when calculating the amount of Japanese income tax to withhold from distributions paid to Japanese residents.
This system does provide investors with a type of "foreign tax credit", but it has almost nothing to do with the FTC being discussed in this post. Foreign taxes subject to the double-taxation adjustment system cannot be used to claim a normal FTC and taxpayers can benefit from the double-taxation adjustment system without filing a tax return.
The key to claiming an FTC is the preparation of an FTC Calculation Form (外国税額控除に係る証明書). This document (blank version here (PDF)) identifies the amount of FSI received by the taxpayer, and shows all the steps necessary to calculate the exact value of the FTC for any given year.
The value of the FTC shown on this form is the value that must be entered in the “外国税額控除等” row of the “税金の計算” section of the taxpayer’s Japanese income tax return. It is also the document that the taxpayer's municipality will use to apply foreign tax credits to the taxpayer's residence tax bill.
If you use the NTA’s online tax return preparation tool to prepare your income tax return, you can ask the tool to generate an FTC Calculation Form automatically for you. But you still need to enter all the relevant information. It is only the calculations that are done automatically.
I have resisted the temptation to walk through the FTC Calculation Form (or its online equivalent) box-by-box in this post, but if anyone has a specific question about how to complete the form, feel free to post your question as a comment below.
In addition to an FTC Calculation Form, taxpayers claiming an FTC are supposed to attach evidence that the foreign tax was imposed (e.g., foreign tax return, withholding summary produced by a brokerage) and an explanation of how the declared amount of FSI was calculated. My understanding, however, is that these documents can probably be omitted when submitting a tax return electronically.
And with respect to paper submissions, it appears that different NTA branch offices have slightly different expectations regarding the documents that must be attached when claiming an FTC, so most people recommend consulting your local tax office directly to find out what they require, or just erring on the side of caution and attaching as much relevant documentation as possible.
Note that it is not possible to claim an FTC without filing a tax return. My understanding is that it is also not possible to claim an FTC for residence tax purposes only (i.e., it is necessary to file an income tax return in order to apply foreign tax credits to a residence tax liability), though there may be some variation between municipalities on this point.
To claim an FTC, it is necessary to accurately calculate the amount of FSI received by the taxpayer during the relevant year. In simple terms, FSI is income generated by assets located overseas or activities taking place overseas. The classic examples of FSI are dividends paid by foreign companies, interest paid on foreign bank deposits, and rental income/capital gains generated by overseas real estate. However, for a full list of all 17 types of FSI, refer to Article 95 of the Income Tax Law. The NTA also has an English version of the list here. A particularly important category of FSI is “income that a tax treaty gives another country the right to tax”. This means that a particular type of income may be FSI if it arises in one country and not if it arises in another (due to differences between Japan’s tax treaties with those countries).
The FSI figure used when claiming an FTC is referred to as ”調整国外所得金額” (adjusted foreign income amount). It is an “adjusted” amount in the sense that it does not include losses carried forward from previous years, it cannot exceed the taxpayer’s total net income, and losses incurred within different categories of income are not offset against gains in other categories (so if you had a 3 million yen loss on foreign real estate but received 200,000 yen worth of foreign dividends, you still had 200,000 yen worth of FSI). And note that whether you paid foreign tax on FSI is irrelevant to whether it is included in the calculation.
If you are preparing an FTC Calculation Form, the adjusted foreign income amount goes in box 4 (調整国外所得金額) in section 3. If you are using the online tax return preparation tool, the amount goes in section 2 (調整国外所得の計算) of the FTC page. When I refer to FSI in this post I am always referring to this amount.
As mentioned above, the amount of Japanese tax that can be offset by foreign tax using an FTC is capped by the taxpayer’s “effective income tax rate”. This rate is calculated by dividing the taxpayer’s final Japanese income tax liability (after applying all other credits, and not including SITR[sup]2[/sup] or residence tax) by their total net income (including declared income subject to separate taxation and excluding carried-forward losses). It gives the following limits:
[sup]2[/sup] SITR = Special Income Tax for Reconstruction, the 2.1% loading applied to income tax liabilities until the end of 2037.
When the amount of foreign tax imposed in a given year is less than the sum of the three allowances listed above, it is necessary to check whether the taxpayer has any “foreign tax carried forward” (see below) that can be included in the FTC calculations. If there is foreign tax carried forward, the taxpayer should complete section 4 of the FTC Calculation Form (section 3 of the FTC section if preparing the return online) so that they can receive a credit for the foreign tax they were unable to receive a credit for in the preceding three years.
If there is no foreign tax carried forward or the sum of the three allowances has still not been reached after applying the foreign tax carried forward, the unused portion/s of the income tax and residence tax allowances will become “excess credit allowance” (控除余裕額). This amount will be added to any other excess credit allowances from the past two years and the total amount will be carried forward to the next year as “credit allowance carried forward” (繰越控除限度額).
When the amount of foreign tax imposed in a given year is more than the sum of the three allowances listed above, it is necessary to check whether the taxpayer has any “credit allowance carried forward” (see above) that can be included in the FTC calculations. If there is credit allowance carried forward, the taxpayer will need to complete section 4 of the FTC Calculation Form (section 3 of the FTC section if preparing the return online) to increase the amount of foreign tax that can be credited against their Japanese tax liability.
If there is no credit allowance carried forward or there is still foreign tax in excess of all available credit allowances, the foreign tax that was unable to be credited will become “excess foreign tax” (控除限度超過額). This amount will be added to any other excess foreign tax from the past two years and the total amount carried forward to the next year as “foreign tax carried forward” (繰越外国所得税額).
To successfully carry credit allowance or foreign tax from one year to a future tax year, it is necessary to submit an FTC Calculation Form together with your tax return (or equivalent, if submitting electronically) for the year from which the allowance/tax is being carried forward and all subsequent years. This is true even if you paid no foreign tax in the relevant year.
When it comes time to apply your credit allowance or foreign tax carried forward, you are supposed to use copies of the FTC Calculation Forms you submitted in previous years to show the carried-forward amounts. If you did not submit FTC Calculation Forms previously, you would need to file amended tax returns to attach those forms. And as discussed here, if income that was not required to be declared was not originally declared (such as dividends paid via a domestic brokerage), it is not possible to later declare that income via an amended tax return in order to generate excess credit allowance for FTC purposes. So it is important to carefully consider the FTC consequences of not declaring FSI before filing a tax return (as discussed in this previous thread).
Sometimes a foreign tax liability is recalculated after it has been imposed. (For example, you may amend a foreign tax return that you filed a few years ago.) In that case, it is necessary to declare the recalculation on an FTC Calculation Form.
If the amount of foreign tax is recalculated upwards, the difference between the original amount and the new amount is treated as foreign tax imposed in the year of the recalculation. But if the amount of foreign tax is recalculated downwards (i.e., you receive a refund), the refunded foreign tax must be deducted from the amount of foreign tax imposed (for FTC purposes) in the year of the refund, or (if there is insufficient foreign tax in that year to accommodate the refund) from foreign income tax carried forward, or (if there is insufficient foreign income tax carried forward) declared as miscellaneous income. Though note that taxpayers can ignore refunds issued more than seven years after the year in which the original tax was imposed.
The information in this post is provided solely for discussion and entertainment purposes. It is no substitute for professional advice and should not be relied upon. The post is based on a wide range of sources, but the sources I found most useful were:
- NTA’s explanation of the FTC
- NTA’s instructions for completing an FTC Calculation Form (PDF)
- NTA’s instructions for claiming an FTC using their tax return preparation tool
- This guide to Japan’s foreign tax credit
- These guides to claiming a foreign tax credit with respect to foreign dividends
What is a foreign tax credit?
A foreign tax credit (FTC) uses foreign income tax payments to reduce a person's Japanese tax liability. The theory is that the amount of Japanese tax a person owes on their income should be reduced by the amount of foreign tax they paid on the same income. Though the reality is more complicated.
As discussed in detail below, the maximum amount of foreign tax that can be credited against a person's Japanese tax liability for any given year is determined by their "effective income tax rate" multiplied by 1.321 multiplied by the amount of "foreign-source income" (FSI) they received during that year. A person's “effective income tax rate” is the amount of income tax they owe as a percentage of their total net income.
For example, if you have an annual salary of 5 million yen and you received 100,000 yen worth of foreign dividends, then your net income (after the employee's expenses allowance) will be 3.66 million yen, and your annual income tax liability (assuming shakai hoken and minimum deductions) will be ~153,000 yen, resulting in an effective income tax rate of ~4.2%. The maximum amount of foreign tax that could be credited against such a person's Japanese tax liability would be ~4.2% x 1.321 = ~5.5% of the amount of FSI they received.
Since foreign tax is often withheld from foreign dividends and rental income at rates of 10-20%, it is common for people to pay a higher rate of foreign tax on their FSI than their effective income tax rate x 1.321, meaning that not all the foreign tax they paid will be credited against their Japanese tax liability. However, this is less likely to happen to people earning higher incomes, since their effective income tax rate will be higher. (Depending on deductions, a taxpayer’s “effective income tax rate x 1.321” is likely to reach 10% when their annual salary exceeds 8-10 million yen, and 20% when their annual salary exceeds 15-17 million yen.)
Who can claim an FTC?
Residents who pay foreign income tax can claim an FTC. However, some types of foreign income taxes don’t qualify for the FTC, such as:
- Taxes that are optional, refundable, or have no meaningful due date.
- Taxes that are charged at a rate negotiated by the taxpayer.
- Taxes on income generated while the taxpayer was not a Japanese tax resident.
- Taxes that the taxpayer could have avoided paying (e.g., by asserting their rights under a tax treaty).
- Taxes that violate a tax treaty or are explicitly excluded by a tax treaty (e.g., by Article 23(3) of the US-Japan treaty).
- Taxes on income received within tax-advantaged investment wrappers (NISA, iDeCo/DC pension, etc.)
- Declaration-based taxation: the date on which the tax return is filed or the deadline for filing the tax return, whichever is later.
- Notification-based taxation: the date of the notice sent to the taxpayer or the due date for the payment of each instalment.
- Withholding-based taxation: the date on which the taxpayer received the income from which the tax was withheld.
Most foreign taxation of Japanese residents is "withholding-based", in which case the timing of the FTC claim is straightforward. If you received a dividend during 2021 and 10% foreign tax was withheld from that dividend at the time it was paid, you can use that foreign tax to claim an FTC when you file your 2021 tax return.
However, sometimes Japanese residents file foreign tax returns (US taxpayers are the obvious example here). In those cases, it is the due date for filing the return (if the return is filed on time) that is deemed to be the date on which the relevant foreign tax is imposed for FTC purposes. This creates a mismatch between the year in which income was generated and the year in which the foreign tax on that income can be used to claim an FTC.
For example, if a Japan-resident US taxpayer received a dividend from a US company during 2021 and no US tax was withheld from the dividend, it is not possible to use the US tax liability on that dividend to claim an FTC on a 2021 Japanese tax return, even though the dividend itself must be declared on the 2021 return and Japanese tax paid on it at that time. Since the US tax on that dividend will end up being imposed via a tax return due in 2022, it is deemed to be a foreign tax imposed during 2022, meaning that it can only be used to claim an FTC on a 2022 Japanese tax return. (See here and here for commentary by Japanese tax accountants on this issue.)
As discussed below, it is possible to claim a Japanese FTC based on FSI earned in previous years, which means that the mismatch described above should not typically cause US taxpayers to end up paying more tax overall. However, it does make the calculations that US taxpayers need to perform, and the documents they need to submit, significantly more complicated.
[sup]1[/sup] There is an exception to these dates for people who elect to claim an FTC based on the date they actually pay their foreign tax liability rather than the date on which the tax is "imposed". This option is only available with respect to regular and consistent sources of foreign income.
[h4]Foreign taxes paid by investment funds[/h4]
In some countries, taxpayers are able to claim a personal FTC for foreign taxes that were paid by funds (ETFs, mutual funds, REITs, etc.) on their behalf. However, Japan does not provide an FTC for foreign taxes paid by funds. Instead, since 2020 Japan has had a double-taxation adjustment system (二重課税調整制度) that allows brokerages to take into account foreign taxes paid by Japan-domiciled funds when calculating the amount of Japanese income tax to withhold from distributions paid to Japanese residents.
This system does provide investors with a type of "foreign tax credit", but it has almost nothing to do with the FTC being discussed in this post. Foreign taxes subject to the double-taxation adjustment system cannot be used to claim a normal FTC and taxpayers can benefit from the double-taxation adjustment system without filing a tax return.
How do I claim an FTC?
The key to claiming an FTC is the preparation of an FTC Calculation Form (外国税額控除に係る証明書). This document (blank version here (PDF)) identifies the amount of FSI received by the taxpayer, and shows all the steps necessary to calculate the exact value of the FTC for any given year.
The value of the FTC shown on this form is the value that must be entered in the “外国税額控除等” row of the “税金の計算” section of the taxpayer’s Japanese income tax return. It is also the document that the taxpayer's municipality will use to apply foreign tax credits to the taxpayer's residence tax bill.
If you use the NTA’s online tax return preparation tool to prepare your income tax return, you can ask the tool to generate an FTC Calculation Form automatically for you. But you still need to enter all the relevant information. It is only the calculations that are done automatically.
I have resisted the temptation to walk through the FTC Calculation Form (or its online equivalent) box-by-box in this post, but if anyone has a specific question about how to complete the form, feel free to post your question as a comment below.
In addition to an FTC Calculation Form, taxpayers claiming an FTC are supposed to attach evidence that the foreign tax was imposed (e.g., foreign tax return, withholding summary produced by a brokerage) and an explanation of how the declared amount of FSI was calculated. My understanding, however, is that these documents can probably be omitted when submitting a tax return electronically.
And with respect to paper submissions, it appears that different NTA branch offices have slightly different expectations regarding the documents that must be attached when claiming an FTC, so most people recommend consulting your local tax office directly to find out what they require, or just erring on the side of caution and attaching as much relevant documentation as possible.
Note that it is not possible to claim an FTC without filing a tax return. My understanding is that it is also not possible to claim an FTC for residence tax purposes only (i.e., it is necessary to file an income tax return in order to apply foreign tax credits to a residence tax liability), though there may be some variation between municipalities on this point.
Foreign-source income
To claim an FTC, it is necessary to accurately calculate the amount of FSI received by the taxpayer during the relevant year. In simple terms, FSI is income generated by assets located overseas or activities taking place overseas. The classic examples of FSI are dividends paid by foreign companies, interest paid on foreign bank deposits, and rental income/capital gains generated by overseas real estate. However, for a full list of all 17 types of FSI, refer to Article 95 of the Income Tax Law. The NTA also has an English version of the list here. A particularly important category of FSI is “income that a tax treaty gives another country the right to tax”. This means that a particular type of income may be FSI if it arises in one country and not if it arises in another (due to differences between Japan’s tax treaties with those countries).
The FSI figure used when claiming an FTC is referred to as ”調整国外所得金額” (adjusted foreign income amount). It is an “adjusted” amount in the sense that it does not include losses carried forward from previous years, it cannot exceed the taxpayer’s total net income, and losses incurred within different categories of income are not offset against gains in other categories (so if you had a 3 million yen loss on foreign real estate but received 200,000 yen worth of foreign dividends, you still had 200,000 yen worth of FSI). And note that whether you paid foreign tax on FSI is irrelevant to whether it is included in the calculation.
If you are preparing an FTC Calculation Form, the adjusted foreign income amount goes in box 4 (調整国外所得金額) in section 3. If you are using the online tax return preparation tool, the amount goes in section 2 (調整国外所得の計算) of the FTC page. When I refer to FSI in this post I am always referring to this amount.
FTC limits
As mentioned above, the amount of Japanese tax that can be offset by foreign tax using an FTC is capped by the taxpayer’s “effective income tax rate”. This rate is calculated by dividing the taxpayer’s final Japanese income tax liability (after applying all other credits, and not including SITR[sup]2[/sup] or residence tax) by their total net income (including declared income subject to separate taxation and excluding carried-forward losses). It gives the following limits:
- Income tax credit allowance (所得税の控除限度額): effective income tax rate multiplied by FSI
- SITR credit allowance (復興特別所得税の控除限度額): income tax credit allowance multiplied by 2.1%
- Residence tax credit allowance (地方税の控除限度額): income tax credit allowance multiplied by 30%
[sup]2[/sup] SITR = Special Income Tax for Reconstruction, the 2.1% loading applied to income tax liabilities until the end of 2037.
Credit allowance carried forward
When the amount of foreign tax imposed in a given year is less than the sum of the three allowances listed above, it is necessary to check whether the taxpayer has any “foreign tax carried forward” (see below) that can be included in the FTC calculations. If there is foreign tax carried forward, the taxpayer should complete section 4 of the FTC Calculation Form (section 3 of the FTC section if preparing the return online) so that they can receive a credit for the foreign tax they were unable to receive a credit for in the preceding three years.
If there is no foreign tax carried forward or the sum of the three allowances has still not been reached after applying the foreign tax carried forward, the unused portion/s of the income tax and residence tax allowances will become “excess credit allowance” (控除余裕額). This amount will be added to any other excess credit allowances from the past two years and the total amount will be carried forward to the next year as “credit allowance carried forward” (繰越控除限度額).
Foreign tax carried forward
When the amount of foreign tax imposed in a given year is more than the sum of the three allowances listed above, it is necessary to check whether the taxpayer has any “credit allowance carried forward” (see above) that can be included in the FTC calculations. If there is credit allowance carried forward, the taxpayer will need to complete section 4 of the FTC Calculation Form (section 3 of the FTC section if preparing the return online) to increase the amount of foreign tax that can be credited against their Japanese tax liability.
If there is no credit allowance carried forward or there is still foreign tax in excess of all available credit allowances, the foreign tax that was unable to be credited will become “excess foreign tax” (控除限度超過額). This amount will be added to any other excess foreign tax from the past two years and the total amount carried forward to the next year as “foreign tax carried forward” (繰越外国所得税額).
Carry-forward requirements
To successfully carry credit allowance or foreign tax from one year to a future tax year, it is necessary to submit an FTC Calculation Form together with your tax return (or equivalent, if submitting electronically) for the year from which the allowance/tax is being carried forward and all subsequent years. This is true even if you paid no foreign tax in the relevant year.
When it comes time to apply your credit allowance or foreign tax carried forward, you are supposed to use copies of the FTC Calculation Forms you submitted in previous years to show the carried-forward amounts. If you did not submit FTC Calculation Forms previously, you would need to file amended tax returns to attach those forms. And as discussed here, if income that was not required to be declared was not originally declared (such as dividends paid via a domestic brokerage), it is not possible to later declare that income via an amended tax return in order to generate excess credit allowance for FTC purposes. So it is important to carefully consider the FTC consequences of not declaring FSI before filing a tax return (as discussed in this previous thread).
When foreign taxes are recalculated
Sometimes a foreign tax liability is recalculated after it has been imposed. (For example, you may amend a foreign tax return that you filed a few years ago.) In that case, it is necessary to declare the recalculation on an FTC Calculation Form.
If the amount of foreign tax is recalculated upwards, the difference between the original amount and the new amount is treated as foreign tax imposed in the year of the recalculation. But if the amount of foreign tax is recalculated downwards (i.e., you receive a refund), the refunded foreign tax must be deducted from the amount of foreign tax imposed (for FTC purposes) in the year of the refund, or (if there is insufficient foreign tax in that year to accommodate the refund) from foreign income tax carried forward, or (if there is insufficient foreign income tax carried forward) declared as miscellaneous income. Though note that taxpayers can ignore refunds issued more than seven years after the year in which the original tax was imposed.
TL;DR
- If you’re not a US taxpayer, claiming an FTC is relatively simple, but if your total income is below 8-10 million yen/year, you may not be able to fully alleviate double-taxation.
- If you’re a US taxpayer, your FSI and foreign tax calculations will be out-of-sync, due to you paying US tax via a tax return rather than via withholding. Be prepared for complex calculations.
- US taxpayers (and many others) should submit an FTC Calculation Form for any years in which they have FSI, even if they have paid no foreign tax on that income, to ensure that their credit allowance is carried forward for use in future years.
- If you have any questions about how to complete the FTC Calculation Form (or its online equivalent) please ask them in this thread and I'll try to answer them.
