A Publication of Pepper Hamilton LLP
Client Alert
Guidance on Japanese Withholding Taxes Under New U.S.-Japanese Tax Treaty - Effective July 1, 2004
Monday, July 19, 2004
The new U.S.-Japan tax treaty makes sweeping changes to the imposition of withholding taxes on cross-border payments of interest, royalties and dividends, and the July 1, 2004 effective date may apply to previously accrued income.
- Royalties paid to a U.S. resident by a Japanese company are no longer subject to a Japanese withholding tax. This resolves the vexing problem of withholding on the sale of computer software into Japan
- Interest payments are free of Japanese withholding tax if made to a U.S.:
(i) bank (including an investment bank)
(ii) insurance company
(iii) registered securities dealer
(iv) enterprise, provided that in the three taxable years preceding the taxable year in which the interest is paid, the enterprise derives more than 50 percent of its liabilities from the issuance of bonds in the financial markets or from taking deposits at interest, and more than 50 percent of the assets of the enterprise consist of debt claims against unrelated persons
(v) pension fund that is a resident in the U.S., provided that such interest is not derived from the carrying on of a business, directly or indirectly, by the pension fund.
- Dividends may be free of Japanese withholding taxes, based on the percentage of the payor that the shareholder owns.
The changes affect items that are taxable, as defined by Japanese tax law, after July 1, 2004. In Announcement 2004-60, issued on July 15, 2004, the following examples were released to describe when income that economically accrued before July 1, 2004 is deemed to be taxable for purposes of applying the tax treaty.
Royalties
Japanese company has an obligation to pay royalties to U.S. company. Under the license agreement, royalties are determined based on sales over six-month periods ending June 30 and December 31, and are payable within 15 days after the close of each six-month period. The royalties for the six-month period ending June 30, 2004 are paid on July 5, 2004. The income is deemed taxable on July 5, 2004 and the treaty may be claimed to preclude the Japanese tax.
Interest
Japanese company has an obligation to pay a U.S. financial institution interest on a debt claim. The interest is payable in installments three times a year, at the end of April, August and December. In accordance with the terms of the debt claim, the interest for the period May – August 2004 is payable on August 31, 2004. The interest is deemed taxable on August 31, 2004 and the treaty may be claimed to preclude Japanese tax on the income.
Joan C. Arnold
