The full text of the following tax treaty documents is available in Adobe PDF format. If you are unable to open the PDF file or view the pages, download the latest version of Adobe Acrobat Reader. More information on tax treaties is also available on the Department of Finance`s Tax Treaty Documents page. “. Where an agreement concluded by Japan for the avoidance of double taxation or the prevention of tax evasion contains provisions defining the scope of permanent establishments which are different from subsequent permanent establishments, permanent establishments shall be those designated as permanent establishments under this Agreement (limited to permanent establishments established in Japan) for a foreign company to which this Treaty applies. The main purpose of a tax treaty is to mitigate international double taxation through tax reductions or exemptions for certain types of income from residents of one Contracting Country from sources in the other Contracting Country. Since tax treaties often significantly alter the tax consequences in the United States and abroad, the relevant agreement must be considered in order to fully analyze the tax consequences of an outbound or inbound transaction. The United States currently has tax treaties with about 58 countries. This article discusses the implications of the U.S.-Japan tax treaty. There are several basic provisions of the conventions, such as permanent establishment provisions and reduced withholding tax rates, which are common to most income tax treaties to which the United States is a party. In many cases, these provisions are aligned with the model of the U.S.
Income Tax Convention, which reflects the original traditional or similar negotiating position. However, each tax treaty is negotiated separately and is therefore unique. Therefore, in order to determine the effects of contractual provisions in a given situation, it is necessary to analyse the applicable contract at issue. The U.S.-Japan tax treaty is no different. The treaty has its own unique definitions. We will now look at the key provisions of the U.S.-Japan Income Tax Convention and the impact on individuals who are trying to take advantage of the agreement. Defining a person`s country of residence is important because the contract only applies to residents of the United States and Japan. “U.S. resident” means: (1) a U.S.-incorporated business entity or (2) any other person (other than a corporation or legal entity treated as a corporation under U.S. law) who resides in the United States for U.S.
tax purposes, but in the case of an estate or trust only to the extent that: in which the income earned by that person is subject to U.S. tax, since the income of a resident. Section 7701(b) of the Internal Revenue Code treats a foreign person as a resident of the United States if that person is 1) legally admitted to permanent residence (26 C.F.R. Section 301.7701(b) -1(b)(1) “Green Card Test: A foreign national is a resident alien compared to a calendar year if the person is a lawful permanent resident at any time during the calendar year. A lawful permanent resident is a person who has legally obtained the privilege of permanently residing in the United States as an immigrant in accordance with immigration laws. Resident status is deemed to be maintained unless it is revoked or it is found that it has been abandoned administratively or judicially. “) (2) meets the significant presence test (A person passes the substantial presence test for a calendar year if (i) that person was present in the United States for at least thirty-one days during the calendar year, and (ii) the sum of the days that person was present in the United States during the current year and in the previous two calendar years (multiplied by the applicable multiplier): current year – 1, first previous year – 1/3, second previous year – 1/6) corresponds to or exceeds 183 days) or iii) makes a choice in the first year. Contrary to U.S. law, a person`s Japanese citizenship is not a tax base; instead, the place of residence is decisive. A natural person is considered a resident if he or she has been in Japan continuously for a year or more. People who have lived in Japan for less than a year and are not residents of Japan are considered non-residents and are only subject to certain income categories.
A company is considered to be located in Japan if its registered office or registered office is located in Japan. An individual established in both Contracting States shall be deemed to reside in the Contracting State in which he maintains his permanent residence. If he is permanently resident in both Contracting States or in either Contracting State, he shall be deemed to reside in the Contracting State with which his personal and economic relations are closest (centre of vital interests). While Article 2 of the Treaty examines the laws of each country to define the term “resident”, Article 4 of the Treaty limits who can benefit from the provisions of the Treaty – even if he can be classified as a resident of a State Party. In particular, Article 4 provides for a restriction on the use of fiscally transparent entities where an element of income is generated by an enterprise that is incompatible with the country of origin or residence. For example, a fiscally transparent partnership established in one state, which is taxed by the other state as a corporate tax payer, raises questions as to which person(s) are taxable on income and which persons are considered residents for contractual purposes. For example, suppose a royalty from Japan is paid to X, a unit organized in Chile, and the owners (or investors) of X are based in the United States. Neither the United States nor Japan has a tax treaty with Chile. Suppose X is an eligible corporation under U.S. entity classification regulations and chooses to be treated as a partnership for U.S. tax purposes.
Also, suppose X is considered a non-fiscally transparent Chilean company under Japanese law. Thus, the company is a so-called hybrid entity, as it is classified inconsistently by at least two countries with contentious claims of tax sovereignty over the income received. From a Japanese perspective, the royalty is paid to X Corporation, based in Chile, with which Japan has no tax treaty. Thus, Japan would levy its full withholding tax on royalty revenues. But because the U.S. views X as a fiscally transparent partnership, it would treat U.S.-based partners as if they were deducting revenue from royalties, whether distributed or not. Finally, assuming that Chile considers X to be a national company and does not exempt income from foreign sources, Chile would also tax X on receipt of royalty income. In the absence of specific contractual provisions dealing with how parties to a tax treaty must determine who is taxable on income in order to determine who is potentially eligible for contractual benefits, royalty income could be taxed three times. Not surprisingly, tax planners exploit conflicts in corporate classification laws by deliberately structuring cross-border transactions with hybrid companies to avoid paying taxes on income items in any country.
Suppose X is organized in a tax haven country, the Cayman Islands, and X chooses, under U.S. tax law, to be taxed as a tax-transparent partnership for U.S. tax purposes. Let us also assume that Japan considers the Caymanian entity to be a non-tax transparent corporate taxpayer. X`s shareholders are residents of Japan; the United States considers them to be taxable partners and Japan considers them to be resident shareholders of a foreign company. In the absence of specific rules for determining who is taxable on royalty income for the purposes of the Treaty, it would be for each Contracting State to apply its own classification rules, regardless of the inconsistent classification and treatment of the other Contracting State […].