How do I calculate foreign tax credits for dividend income from US bond ETFs?

[spamdetector]

For simplicity, let's assume the USD/JPY exchange rate is constant, and interest is distributed at the end of the year. (I am not a US national.)

I buy $100 of a bond ETF with a 10% yield on January 1st.

At the end of the year, I receive $10 in dividends.

According to my Japanese broker, the withheld taxes are as follows:

• US tax withholding:

  10% * $10 = $1

• JP income tax withholding:

  15% * $9 = $1.35

• JP local tax withholding:

  5% * $9 = $0.45

Total tax withheld:

$1 + $1.35 + $0.45 = $2.80

(or 28%)

How do I calculate these credits?

• A. It is the amount of US tax withheld:

  $1 (Effective tax: (1.35 + 0.45)/10 = 18.0%)

• B. It is the difference between the amount of taxes I should have paid in Japan, and what I actually paid:

  $2.80 - $2 = $0.80 (Effective tax: 20%)

• C. I can reclaim this money from the US government, and pay the difference between what was withheld and what should have been paid to achieve 20% in taxes:

  $2.80 - $1 - $2 = -$0.20 (Effective tax: 20%)

• D. It is the amount of US tax withheld

  $1

  but pay

  $0.20

  after filing the tax return. (Effective tax: 20%)

 

[kristhuy]

@spamdetector

How do I calculate these credits?

The short answer is: none of the above. See this post for a discussion of how the value of foreign tax credits is determined under Japanese tax law. As you will see, the value of foreign tax credits depends on your total taxable income (not just the income that is subject to foreign tax).

 

[spamdetector]

@kristhuy I want to completely disregard the limit in my problem. (Assuming my total taxable income is high enough so I don't bump in those limits)

Reading your link, my case should be in the case of double-taxation adjustment system (二重課税調整制度). (Dividend from bond ETF)

I will double check if it is done properly. It was my impression, when I did the math on my brokerage statement, that there didn't seem to have automatic adjustment...

However, for the sake of the argument, if this wasn't an ETF, and instead let's say profit from US stock.

Then, my brokerage says:

In general, U.S. stocks dividends will be subject to withholding tax in the U.S. at the rate of 10% based on the Japan-U.S. tax treaty, and an income tax of 15.315% (plus an additional 5% inhabitant tax for Japanese residents ) will be withheld in Japan on the remaining amount.

In this case, checking the FTC calculation form (disregarding limits and allowance), it seems to be

A.

. (though I may be wrong, my japanese skill are lacking to understand their form on the detail of the calculation)

 

[kristhuy]

@spamdetector

my case should be in the case of double-taxation adjustment system (二重課税調整制度)

The list of ETFs subject to that system is available here. If the ETF you hold is subject to that system, then you can't claim a foreign tax credit. The brokerage will automatically deduct the foreign tax the ETF paid from your Japanese tax liability, leaving your combined tax liability at 20.315%.

checking the FTC calculation form (disregarding limits and allowance), it seems to be A

I can't quite work out what your question is. The uncapped value of the foreign tax credit is equal to the foreign tax you paid. But if you claim a foreign tax credit, you will owe Japanese tax on the gross dividend. You also need to ensure you do the tax calculations in JPY (the math won't be right if you use USD).

In simple terms, your US tax liability on a 1000 yen dividend will be:

1000 x 10% = 100 yen

And your Japanese tax liability on the same dividend (ignoring foreign tax credit limits) will be:

1000 x 20.315% - 100 yen foreign tax credit = 103.15 yen

So your combined tax liability, in this "ideal" scenario, is 20.315% (10% to the US and 10.315% to Japan).

 

[spamdetector]

@kristhuy Thank you this make sense, so it's the

D.

case.

From my example, I would get

$1

of tax credits, but need to pay JP taxes

$2

on the whole dividend. Given that

$1.35 + $0.45 = $1.80

has already been withheld by the broker, after the tax return filing, I'll need to pay

$0.20

more.

I know I assumed many things that aren't true (no limit, allowance), constant rate, and that this is the only withheld tax I have for the whole year. This was to isolate my question on the specific point I wanted a clarification.

My ETFs aren't part of the list, so I'll need to claim the credits.

 

[kristhuy]

@spamdetector

Given that

$1.35 + $0.45 = $1.80

has already been withheld by the broker, after the tax return filing, I'll need to pay

$0.20

more.

It makes a lot more sense to do the calculations in JPY, but in USD terms: if your total combined tax liability on the dividend is $2, and you file a tax return claiming a foreign tax credit, you will receive a refund of $0.80. You won't have to pay anything extra. Because $2 total liability minus $1 foreign tax credit minus $1.80 tax already withheld = -$0.80.

 

[spamdetector]

@kristhuy Thank you this make sense.

D.

was calculating that I have

1$

of credit, and pay

$0.20

after filing the tax return. But that wasn't well formulated, because since I have this credit, effectively mean I will get back 1$ as well... (so I get back

1-0.20 = 0.80

, as you said)