Kon'nichiwa, Nihon! Baker McKenzie breaks down the Key Legislation of the Island Nation
From its fascinating culture, to driven workforce and technological aptitude, Japan has truly marked itself out as a prolific presence on the global stage, with foreigners looking to the nation to seek out both business and domestic opportunities alike. For those looking to operate in the island nation, Baker McKenzie’s Edwin Whatley and Akihiro Kawasaki offer an expansive guide to key legislation, ranging across the likes of inheritance law, spousal residence legislation, to CRS, inheritance tax and gifting, and even the likes of cryptocurrency and Covid-19 legislation, amongst other points of note, offering comprehensive insights into the legislation that interested parties may need to know.
By Edwin Whatley, Partner and Head of Tax Practice Group – Tokyo, Baker McKenzie, and Akihiro Kawasaki, Associate in Tax Practice Group – Tokyo, Baker McKenzie
1. Reform of Inheritance Law
To solve issues related to inheritance, the Civil Code stipulates basic rules, including on who will be the heir, what will be the legacy, and how the rights and obligations of the decedent will be succeeded. The part in the Civil Code that contains these provisions is referred to as the “Inheritance Law” (or “Sozoku Ho”).
There has been no major reform to the Inheritance Law since 1980. Recently, the law was amended for the first time in order to address issues related to the aging population in Japan and other changes in social circumstances.
The main elements of this amendment to the Inheritance Law are as follows:
- The new spousal residence right;
- Relaxation of the requirement to write by hand the assets lists attached to a holograph will;
- Retention of holograph wills by the Legal Affairs Bureau; and
- Compensation for family members who contributed to the care or nursing of the decedent.
a. Spousal residence right (effective from April 1, 2020)
The spousal residence right allows the spouse of the deceased to use a house owned by the deceased free of charge for the spouse's entire life or for a certain period of time, if the spouse was living in the house at the time of the death of the deceased.
Where there is more than one heir with regard to a house, the regime enables a spouse to acquire the spousal residence right and an heir other than the spouse to acquire onerous ownership rights at the time of division of the estate. The spousal residence right does not give rise to full ownership rights; the spouse will not have a right to dispose the house or lend the house to others at his/her discretion. As the value of a spousal residence right is lower than that of a full ownership right, the spouse may be entitled to more assets at the time of division of the estate, ensuring his/her subsequent financial stability.
b. Relaxation of the requirement to write by hand the assets lists for holograph wills (effective from January 13, 2019)
Previously, for a holograph will, it was necessary for the testator to prepare the assets list in handwriting. The assets list may now be prepared in other ways, (for e.g., using a personal computer or attaching a copy of a bankbook).
c. Retention of holographic wills at the Legal Affairs Bureau (effective from July 10, 2020)
Holograph wills are often kept at home, where they may be lost, abandoned, or rewritten. In order to prevent inheritance disputes arising from these problems and make it easier to use holograph wills, the Legal Affairs Bureau will be retaining holograph wills.
d. Compensation for family members who contributed to the care or nursing of the decedent (effective from July 1, 2019)
In some cases, non-heir relatives (e.g., a spouse of a child) may have been involved in taking care of or nursing the decedent. Before the reform of the Inheritance Law, it was not possible to distribute inherited property to such non-heir relatives.
In order to eliminate such inequities, non-heir relatives can now claim compensation from the heirs if the non-heir relatives contributed to the care and nursing of the decedent free of charge or made a special contribution to the maintenance or increase in value of the decedent's property.
2. Implementation of CRS and information exchange in Japan
Japan passed legislation giving effect to Common Reporting Standards (CRS") in 2015, under which certain financial institutions operating in Japan are obligated to report certain financial account information regarding account holders to the Japanese tax authorities. The CRS system came into effect in Japan on January 1, 2017, and the first reports were due to be submitted by the financial institutions by April 20, 2018.
According to an announcement from Japan's National Tax Agency (NTA) the NTA had gathered information on 1,891,040 foreign accounts held by Japanese residents, from 85 countries, primarily in Asia and Europe, by November 31, 2019. The NTA had provided information on about 473,657 accounts held in Japan to 64 countries and regions by the end of November, 2019. Compared with a paltry 9,961 filings made in 2018 in compliance with Japan's overseas asset requirement, under which individuals holding assets with a value of JPY50 million or more (USD462,000), including assets held in trusts, are required to report information regarding such assets with the tax return, this data may be a sign that there were many assets that Japanese residents had failed to properly declare.
It still remains to be seen precisely how the Japanese tax authorities will use the data collected from information exchange under the CRS during audits. The first case of criminal accusation occurred on May 2019. In this case, the taxpayer did not declare income tax on sales proceeds that were remitted to the overseas bank accounts of the taxpayer (as well as bank accounts where the nominees were not the taxpayer). Although there was a considerable amount of cash in the overseas bank accounts, exceeding the reporting threshold of USD462,000, the taxpayer failed to submit the overseas assets report (or Kokugai Zaisan Chosho) by the due date, without a justifiable reason. As such, the tax authority-imposed penalties on the taxpayer for non-compliance with the overseas assets report requirement.
Additionally, the NTA has publicly announced through its website that it is focusing on undertaking audits of high net worth individuals and their international transactions. Given the consequences of non-compliance, there is clearly an incentive now for Japanese resident persons to comply with the Japanese overseas asset reporting requirements (and for non-residents holding assets in Japan to comply with their local country's asset reporting requirements).
3. Japanese gift and inheritance tax rules
In 2017, Japanese inheritance tax rules were amended such that, where a foreign national who had lived in Japan for 10 years (in the aggregate) out of the last 15 years died outside of Japan, the foreigner national's heirs would be subject to Japanese inheritance tax on the foreign national's assets located both in Japan and elsewhere (a similar rule also applies for gift tax purposes). This rule resulted in a situation where Japanese inheritance tax may still apply to a foreign national's worldwide assets even if the foreign national had left Japan, for up to five years after the expatriation. The fact that Japanese inheritance tax could "follow" a foreign national for up to five years after he/she left Japan caused great concern among Japan's expatriate community, and threatened to derail the Japanese government's efforts to attract successful foreign talents to live and work in Japan.
In Japan's 2018 Tax Reform, the Japanese government abolished the above rule applying to foreign nationals, subject to certain anti-avoidance measures in the context of gift tax. This change applies to inheritance taxable events that occurs on or after April 1, 2018.
4. Japanese exit tax (effective in 2020)
Under Japan's 2015 tax legislation, which was passed by Japan's Diet and promulgated on March 31, 2015, a new "exit tax" came into effect. Under the new tax regime, which applies to both expatriating Japanese nationals and certain long-term foreign residents, an individual subject to the exit tax must pay tax on the deemed gain realised on the sale of assets at applicable individual income tax rates. The exit tax applies where: (a) the individual has financial assets with a total aggregate value of JPY 100 million or more; and (b) the individual has maintained his place of residence or place of abode in Japan for 5 years or more during the 10-year period immediately prior to departure from Japan.
In order to determine whether the JPY100 million threshold is met, the law considers assets such as certain securities, as defined under the Income Tax Law (including foreign stocks and bonds and stock option certificates), interests held in a silent partnership (i.e., a Tokumei Kumiai or “TK”) contract, unsettled credit transactions or when-issued transactions, and unsettled derivatives.
With respect to foreign nationals, the five-year period does not include time spent in Japan under a visa status specified under Table 1 of the Immigration Control and Refugee Recognition Act which includes work status visas, such as intra-company transferee visas or business investor/manager visas, under which expatriate employees are typically assigned to Japan. It will apply to non-Japanese persons present in Japan under a visa status specified under Table 2 of the Immigration Control and Refugee Recognition Act, including permanent residents and spouses of Japanese nationals.
The persons subject to the above law include those who (a) own certain assets with a combined value of JPY100 million at the time of the inheritance, and (b) have had a principal place of residence (jusho) or temporary place of residence (kyosho) in Japan for at least 5 out of the last 10 years, as of the date before the inheritance.
It should be noted that the Japanese Exit Tax and Inheritance Tax work in tandem at the time of the death of a person, where applicable. Specifically, where certain residents of Japan have certain assets at the time of their passing worth JPY100 million or more (i.e., they are subject to the Exit Tax), and a non-resident receives through inheritance all or some of such assets, the assets will be deemed to have been transferred as of the inheritance date, and the decedent will be assessed for income tax on any built in gain in such assets. Thus, the estate of the decedent would be subject to Exit Tax on the expatriation, and the recipient subject to Inheritance Tax on the same assets.
The law was promulgated with respect to non-Japanese nationals to apply prospectively; thus, the five-year count for foreign nationals began in July 2015, such that the five-year period will not come into effect until (at the earliest) July 2020, for foreign nationals resident in Japan with a permanent resident or similar visa status. As a practical matter, the prospect of being taxed on capital gains on securities and similar assets has caused a number of long-term residents to expatriate from Japan prior to the effective date of the exit tax. Likewise, another strategy to avoid the effect of the tax is for an expatriate currently in Japan on a "permanent resident" or spousal visa to relinquish such visa status and switch to a work visa.
In any event, the upcoming effective date of the law as it applies to non -Japanese national should be considered with respect to any Japan expatriation planning going forward, and should be considered prior to a move to Japan by either a Japanese national or non-national.
5. Inheritance and gift tax rates – unchanged from 2018
a. Japanese gift tax
Japanese gift tax rates, imposed at progressive rates ranging up to 55%, has remained the same since 2018. Gift tax is assessed on the total value of gifts received annually. For this purpose, gifts from all donors are aggregated subject to an annual exemption of JPY 1.1 million. Rates can be summarised as follows:
Note that special gift tax rates apply to gifts made from lineal ascendants including parents and grandparents to their lineal descendants, including children or grandchildren who are 20 years old or older as of January 1 of the year in which the gift is made.
b. Japanese inheritance tax
As with gift tax, the taxpayer for inheritance taxes is the individual who acquired property by inheritance or by bequest.
Inheritance tax rates and available deductions in effect in 2019 are as shown in the following table:
As briefly discussed in section 2, the analysis to determine whether heirs will be subject to inheritance tax on domestic assets, foreign assets, or both, can be complex, and in the case of a non-national, will depend on the length of time such person has resided in Japan.
6. Individual income tax rates – unchanged from 2018
Japanese individual income tax rates are summarised below. Note that a 2.1% surtax is levied on the national income tax until 2037, thus the maximum marginal rate is 55.945%. The following tax rates are applicable to the aggregate income of the taxpayer.
7. Other changes
a. MLI has come into effect with respect to Japanese treaties
Japan signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) in June 2017, and the document was ratified by Japan 's Diet on May 18, 2018. The MLI has already come into effect with respect to 24 Japan's bilateral tax treaties (including the UK, New Zealand, Australia, Sweden and others) as of June 2020. Some of the provisions to which Japan has "opted in" that are particularly notable are Articles 12 and 13, involving permanent establishment (PE), and Article 7, which incorporates the principal purpose test (PPT). Where the PPT applies, taxpayers should consider whether this will potentially affect their entitlement to the benefits of the treaty.
Articles 12 and 13 of the MLI expand the scope of a PE to more broadly encompass activities undertaken by a commissionaire (toiya), and prevent taxpayers from relying on multiple specific activity exemptions in order to avoid a PE. It remains unclear at this time how the Japanese tax authorities will apply these provisions in practice, and whether the tax authorities will broaden the scope of structures that they challenge in audits. Currently, Japan has tended to rely on transfer pricing provisions to challenge transactions, but the Japanese tax authorities may treat the implementation of the MLI as an opportunity to also challenge structures from a PE perspective going forward.
b. Changes to Japanese earnings stripping rules
Japan first introduced earnings stripping rules in 2012. Under the rules, net interest payments by a Japanese company to an offshore related person in excess of 50% of the Japanese company's adjusted taxable income is disallowed for tax purposes.
Under the 2019 Tax Reform, the headline threshold beyond which interest payments would be non-deductible to the Japanese company was reduced from 50% to 20%. This tax reform is effective from the fiscal year started (or starting) on or after April 1, 2020.
Further, the scope of interest subject to the rule has been increased. Previously, a company was exempted from the scope of the earnings stripping rule if interest paid to an offshore related party that was not otherwise subject to Japanese corporate income tax in the hands of the recipient,9 did not exceed 50% of total adjusted taxable income of the Japanese company. Under the revision to the rule, interest payments to any party (including an unrelated party) that is not otherwise subject to Japanese corporate income tax in the hands of the recipient, in excess of 20% of the adjusted taxable income of the Japanese company, will be non-deductible to the Japanese company.
The calculation of "adjusted taxable income" for purposes of the earnings stripping rules has also been changed. These changes will be applicable to persons with companies in Japan that are highly leveraged.
c. Changes to Japanese cryptocurrency rules
The Financial Action Task Force ("FATF") amended FATF Recommendations in October 2018. As a result of the amendments, crypto assets exchangers, custodians of crypto assets, etc. will be required to implement anti-money laundering and countering the financing of terrorism controls. Amendments to the Payment Service Act were made in May 1, 2020, which takes into account such FATF Recommendations.
The main elements of the amendments to the Payment Service Act are as follows:
- Characterising cryptocurrencies as "crypto assets" rather than "virtual currencies" in light of the fact that most crypto assets are not used as currencies, and restricting advertisements for "speculative investments" in the cryptocurrency space.
- Provisions concerning the in-advance notification, etc., have been prescribed, which pertain to applications for registration of a crypto asset exchanger, the name of the crypto assets to be handled by crypto asset exchangers, and changes to the business of the crypto asset exchangers.
- Provisions concerning the service of crypto assets exchangers have been prescribed, such as the method for displaying advertisements of crypto assets exchangers, prohibited activities, provision of information to users and other measures for ensuring user protection, and methods for managing users' monetary and crypto assets.
- Provisions concerning the transaction of Financial Instruments Service Operators, etc., which engage in derivative transactions using crypto assets and fund-raising transactions in the course of trade have been prescribed. These include the development of business management systems, methods for displaying advertisements, provision of information to customers, prohibited acts, and methods for managing rights to transfer electronic records of customers, etc., for Financial Instruments Service Operators.
While the amendments to the Payment Service Act are not directly related to tax, it is hoped that new tax regulations will also be implemented with respect to cryptocurrency. For example, currently individuals are taxed at regular individual tax rates on gains arising from the sale of crypto assets; if more favourable rates were implemented, this may encourage further development in the area and promote Japan as a digital asset "hub" in Asia.
d. Covid-19 related tax measures
New tax measures with regard to the emergency economic measures warranted by the COVID-19 situation came into effect on April 30, 2020. These include tax measures related to individual tax, gift tax and inheritance tax:
- Filing and payment deadlines for individual tax and gift tax have been extended to April 16, 2020 (for FY2019). For individuals who are affected by COVID-19 and cannot meet the filing deadlines due to certain reasons, e.g., remaining indoors due to feeling unwell, filing and payment deadlines for the returns are further extended until they are able to file the return.
- Filing and payment deadlines for inheritance tax are generally within 10 month after the decedent passes away. If the heirs or their tax advisors are affected by COVID-19 and cannot meet the filing deadlines due to certain reasons, e.g., remaining indoors due to feeling unwell, filing and payment deadlines for the returns are further extended until they are able to file the return.
 The Act on Special Provisions of the Income Tax Act, the Corporation Tax Act and the Local Tax Act Incidental to Enforcement of Tax Treaties (the “Act on Special Provisions”).
 Although the heirs of a foreign national who had resided in Japan long-term are no longer subject to inheritance tax with respect to non-Japan situs assets after the non-resident leaves Japan under the 2018 tax proposal, the rules does not eliminate gift or inheritance tax in those circumstances with respect to Japan-situs assets.
 The specific rate at which tax will be owed depends on the tax category of the income realised; Japan's
individual income tax is made up of several income categories, with varying rates. For example, capital gain
arising on the transfer of listed or non-listed stocks is generally subject to tax at a flat 15.315%.
 Article 21-5, Inheritance Tax Law, Article 70-2, Special Tax Measures Law.
 The Local Tax Rate is the sum of prefectural and municipal taxes.
 Specifically, "net interest payments" refers to interest payments to related persons less interest income relating to interest payments received from related persons.
 For purposes of the rules, an "interest payment to a related person" does not include interest payments under a repo transaction, or interest payments that are subject to Japanese tax in the hands of the recipient.
 Note that there was no change in the previously applicable carry forward rule with regard to disallowed interest amounts (i.e., interest amounts incurred in the previous seven years and disallowed in such previous years under the dividend stripping rules are deductible in the current fiscal year).