Foreign Income Tax Credit for US/Japan

[ClearAsMud]

You do not get any tax credit in Japan for any State Taxes paid in the US.

For what it's worth, my accountants and local 税務署 don't agree. They have filed tax credits for US state taxes every year for me and that survived a very detailed audit.

I think I've seen the same argument in reverse somewhere in the forum: Japanese residence tax doesn't qualify for the US Foreign Tax Credit. The basic reasoning seems to be that a residence tax doesn't technically qualify as an income tax. Also, in the case of the IRS, the stated position is "You can claim a credit only for foreign taxes that are imposed on you by a foreign country or U.S. possession." So one might say that because residence tax is imposed by the municipality rather than the country, it doesn't apply.

The trouble is, first, that except for a flat fee of a few thousand yen, residence tax IS based on income even though it doesn't call itself an "income tax." Second, the IRS explicitly defines "foreign country" as follows (same web page): "A foreign country includes any foreign state and its political subdivisions. Income, war profits, and excess profits taxes paid or accrued to a foreign city or province qualify for the foreign tax credit."

It's hard to interpret this definition as not applying to Japanese prefectures and municipalities, which are obviously political subdivisions of the state. As a result, I believe that (many? most?) expat accountants routinely include residence tax in the FTC, although because of the way residence tax is collected, they have to work with accrued rather than paid taxes. They may be wrong, of course, but still...

By the same logic, U.S. state (and city) taxes would seem to qualify for the Japanese version of the foreign tax credit. On the other hand, I've never had to substantiate that position officially, so YMMV, although TokyoWart's experience is suggestive.

[TokyoWart]

I think I've seen the same argument in reverse somewhere in the forum: Japanese residence tax doesn't qualify for the US Foreign Tax Credit. The basic reasoning seems to be that a residence tax doesn't technically qualify as an income tax. Also, in the case of the IRS, the stated position is "You can claim a credit only for foreign taxes that are imposed on you by a foreign country or U.S. possession." So one might say that because residence tax is imposed by the municipality rather than the country, it doesn't apply.

The trouble is, first, that except for a flat fee of a few thousand yen, residence tax IS based on income even though it doesn't call itself an "income tax." Second, the IRS explicitly defines "foreign country" as follows (same web page): "A foreign country includes any foreign state and its political subdivisions. Income, war profits, and excess profits taxes paid or accrued to a foreign city or province qualify for the foreign tax credit."

I think Japan similarly understands "foreign country" to include local governments within that country. From one of the English guidance pages note the use of "or its local authorities" (https://www.nta.go.jp/english/taxes/ind ... 2007-2.htm):

“Foreign income tax” means a tax that is imposed on income of an individual as a tax base under foreign the law and regulations by a foreign government or its local authorities, including the following:

(1) An excess income tax or a similar tax that is imposed on a specific part of income of an individual as a tax base.
(2) A surtax that is imposed on the whole or specific part of income of an individual as a tax base.
(3) A tax that is imposed on the amount of earnings or its equivalent instead of the amount of income as a tax base, with regard to the specific type of income of an individual, for the convenience of tax collection, which is categorized in the same kind of tax that is imposed on income of an individual as a tax base.
(4) A tax that is imposed on the amount of earnings or its equivalent with regard to the specific type of income of an individual as a tax base, which is substituted for the tax that is imposed on the income as a tax base.

[emikami]

Hello everyone. I hope that someone can help me with a Foreign Income Tax Credit question. I need to file a US tax return and a Japanese tax return, as always. This year in the US, I had a large amount of US savings bonds come due, which I cashed all together in September. The estimated tax on the interest was thought to be about 17,000 dollars, which I prepaid while I was in the US. I hope to use the foreign income tax credit in Japan so that I don't have to pay the same amount of tax here.

My understanding of the latest US Japan Tax treaty is that because such interest income is normally taxed only in Japan if you were a Japanese Citizen and living in Japan, Japan has zero obligation to give any foreign tax credit. However, the tax treaty allows re-sourcing such income as if it were foreign source on the U.S. tax return to claim foreign tax credit. Since no foreign tax credit is given by Japan and the only reason you are taxed in the U.S. is because you are a U.S. Citizen, the entire U.S. interest can be claimed in Form 1116 as "certain income re-sourced by treaty" category.

From U.S.'s standpoint, by tax code, foreign income tax includes Shotoku zei (Japanese National Personal Income Tax) and Shotoku wari (income proportional portion) of jyumin zei (local inhabitant tax). However, what's not completely clear is that that the U.S. Japan Tax treaty is limited to Shotoku zei (Japanese National personal income tax) and Hojin zei (corporate income tax). Jyumin zei (local inhabitant tax) is not covered by the treaty. Because the treaty is what is allowing the re-sourcing of the income, it is not clear if you can claim U.S. foreign tax credit against the inhabitant tax portion.