Tax knowledge is essential for corporate management. The most troublesome thing about taxes is when you have profits overseas. If I make a profit overseas, how will it be taxed?
a taxation system that changes according to the way a company goes abroad
When you work abroad, you always need to think about which country’s laws and tax systems apply. Therefore, the form of establishment of an overseas corporation is important. Overseas expansion can be broadly divided into two types: overseas branches and overseas subsidiaries.
In the case of an overseas branch, profits at the overseas branch are taxed according to the country in which the branch is located. In addition, in the case of an overseas branch, it is treated as the same company as the head office in Japan even though it is located overseas. Therefore, profits from overseas branches are taxed in Japan.
However, with this method of taxation, both Japan and countries with overseas branches impose double taxation. That’s how the foreign tax credit system came into being. Under this system, the profits and losses of the head office and overseas branches in Japan are combined, and if there is a loss at an overseas branch, the loss is combined with the profit at the Japan branch. As a result, taxes on the company as a whole can be reduced and balanced.
Overseas subsidiaries, on the other hand, have a different corporate status from that of the parent company in Japan. Profits earned by overseas subsidiaries are not combined with profits earned by the head office in Japan. Therefore, in principle, no tax is levied in Japan after taxes are levied in the countries in which the overseas subsidiaries are located.
When a parent company in Japan receives dividends from a subsidiary, the parent company can use the system of exclusion of dividends from gross profits. Therefore, if certain conditions are met, 95% of dividends from overseas subsidiaries are not included in the income of the Japanese parent company.
In general, there are many cases in which local subsidiaries are established to expand overseas. Also, because the permission for establishment of a corporation differs from country to country, there are cases that only subsidiaries, not branches, can establish a corporation due to the laws and regulations of that country.
What is a foreign tax credit?
For people living in Japan, the money earned by companies with their head offices in Japan, whether earned in Japan or abroad, is taxed in Japan. However, if you are already taxed in a foreign country, you may be taxed twice on the same income. There is a system called foreign tax credit to remove this double taxation.
For example, you can deduct taxes paid by overseas branches directly from taxes paid in Japan. However, it does not mean that you can deduct the whole amount of tax paid abroad. The foreign tax credit limit can be calculated by multiplying the amount of corporation tax for the year by foreign income for the year/worldwide income for the year.
Foreign taxes exceeding this limit cannot be deducted from taxes paid in Japan. However, it can be carried over for 3 years from the next year as the amount exceeding the deduction limit, so it can be used without waste.
What is a tax haven?
Money earned overseas is taxed overseas. Therefore, the tax rate and tax system of the foreign countries are very important. Japan’s corporate tax rate is by no means a low rate in the world. Many neighboring Asian countries and OECD countries have lower tax rates. Looking around the world, some countries attract foreign companies by lowering corporate taxes to an extremely low level. These countries are used by many companies and wealthy people to save taxes. These countries are called tax havens. A tax haven is a tax haven, which literally means a tax haven.
There are many companies and wealthy people who avoid paying their own taxes by establishing overseas corporations in tax havens from countries with relatively high tax rates like Japan. Major tax havens include the Cayman Islands, a British overseas territory, and the British Virgin Islands.
However, in Japan, there is a tax haven tax system to prevent tax evasion by using tax havens. Any foreign subsidiaries deemed to be tax avoidance are taxed in Japan when combined with the profits of the parent company. Of course, there may be cases where an overseas corporation is established for purely business purposes, not tax avoidance purposes. If there is a reason for an establishment not for tax avoidance in a tax haven, it is not subject to the tax haven tax system.
Overseas expansion has various purposes such as expanding sales channels and reducing production costs. Another strategy is to use overseas tax systems to save taxes by expanding overseas. When you expand overseas, I recommend you to investigate the tax system and the laws of the foreign country in advance.
Like the corporate tax rate cut in the United States, countries that used to have high tax rates have started to cut tax rates in order to keep their industries in the country. Tax cut competition is expected to continue, and future trends will be closely watched. If you establish an overseas corporation only for the tax system, the tax system itself may change, so you should be careful.