Say a US Citizen, after filing in Japan and then of course also in the US ends up incurring a tax payment to the IRS, for any combination of income exceeding the US Foreign Earned Income Exclusion limit, income attributed to years past (e.g. vested RSU's grant date), or income from time worked on US soil (e.g. business trip). Is the basic principle of Japan's Foreign Tax Credit for Residents in the Japan-US Tax Treaty essentially to cover this double taxation, and therefore one could just later claim this US tax payment as a deduction on their Japanese taxes?
The principle is to avoid double-taxation but in my experience it doesn't fully do so. Here is what happens:
1. When you complete the Foreign Tax Credit part of your Japanese return (外国税額控除に関する明細書) you will have an entry for dividends from the US and you automatically enter a 10% tax credit for them on part 1 of the worksheet. (You can't enter more or less since its per the treaty, even though actual tax rate ranges from 0-23.8% for those dividends in the US).
2. That gets combined with any US taxes you actually paid for other things (salary, etc.) but the actual amount of foreign tax credit you get to exclude is determined in a section of the form called 所得税の控除限度額の計算. The way that calculation works you can never get a credit for more than the tax you paid, but your actual allowable credit is limited by the overall effective tax rate you are paying in Japan as applied to what is counting as "foreign taxed income" (salary taxed by the US plus dividends taxed by the US, etc.). For instance, if your effective tax rate was 30% in the US but it's only 15% in Japan you wind up only getting a credit for half (15%) of the US taxes you paid.
3. The US dividends you pay taxes on when filing in 2021 are the dividends you received in 2020 and you may be asked to give evidence such as your 1099-div forms to prove that was the amount. However, the salary that is appearing in that form with the actual US tax you paid will be from the prior year (e.g. 2019) because you don't know how much tax you'll pay on it yet. At least, this is how the calculation worked in my case when I was allowed to claim a credit for US taxes paid on salary (if you are a director of a Japanese company you are not allowed to do so.)
Now I've also been learning that it's generally in the best interest for a US Citizen to keep any investments based in the US (e.g. mutual funds), as the US tax code essentially treats them as a PFIC, and taxes at a higher rate. However, if any excess tax payments to the US incur on these investments, using the logic above could one not also then claim a tax credit in Japan for them to cover the excess (double?) tax? Or is this what basically makes foreign-domiciled investing as an American more complicated? So, while not impossible, likely just more messy than it's worth?
Yes, you definitely don't want to hold a mutual fund that is not based in the US (could be a Vanguard international fund, but not a Nomura or Daiwa mutual fund even if it only holds US stocks) because the PFIC handling is complicated and punitive. However, the US taxes you paid on investments is handled as I mentioned above (start with 10% assumed tax payment). I have seen comments here at RetireJapan saying some accountants say the foreign tax credit only applies to stock dividends not mutual funds here in Japan but that is not what my accountant says and I have no interest in challenging that opinion.
Is it worth it? Depends on how much you're getting in US dividends and how your salary is taxed in the US (it of course gets taxed more in the US if you have State tax liability or spend working days in the US). For my return this credit winds up helping offset at least 2 million yen in Japanese taxes each year but that amount is a lot less than what I am actually paying in additional US taxes.