An Offshore Holdco Over Japanese Property: Dividends In and Shares Out Are Governed by Different Provisions

"I hold Japanese real estate through an offshore holding company. I'm told a tax treaty can bring the withholding tax on dividends back to my home country down to zero." We hear this constantly. As far as dividends go, and provided the conditions are met, the understanding is often correct. But in this kind of structure, the centre of gravity is not the entrance. It is the exit.

Start With the Domestic Default

Dividends of surplus paid by a Japanese corporation to a foreign corporation are Japan-source income under Article 161(1)(ix)(a) of the Income Tax Act, and are included in the tax base for income tax imposed on foreign corporations under Article 178. The payer bears a withholding obligation under Article 212(1), at a rate of 20% under Article 213(1)(i). On top of that, Article 28(1) and (2) of the Act on Special Measures for Securing Financial Resources for Reconstruction require the withholding agent to collect Special Income Tax for Reconstruction (2.1%) at the same time. The rate actually deducted is therefore 20.42%.

Article 9-3 of the Act on Special Measures Concerning Taxation substitutes 15% for 20% in the case of dividends on listed shares, but dividends from a privately held Japanese subsidiary do not fall within that relief. The starting point is 20.42%.

How a Treaty Displaces the Rate

Article 3-2(1) of the Act on Special Provisions for the Implementation of Tax Treaties provides that, where a treaty provision setting a maximum rate applies to the dividends, that maximum rate replaces the rate prescribed in Article 213(1) of the Income Tax Act and related provisions. Article 3-2(2) goes further: where a treaty provision granting exemption from income tax applies, Article 212(1) of the Income Tax Act and the related provisions simply do not apply at all.

"Going to zero," in other words, is not the rate falling to nil — it is the statutory basis for withholding ceasing to apply. The specific maximum rates, shareholding thresholds, holding-period requirements, and the content of any limitation-on-benefits and principal-purpose tests, however, differ from treaty to treaty. Treaty texts are outside the scope of Japan's statutory database, so this article cites neither treaty article numbers nor treaty figures. In practice, the treaty text itself, its protocol, and any applicable provisions of the BEPS Multilateral Instrument must be consulted directly.

Treaty Benefits Do Not Arrive Automatically

The procedural step is the one most often missed. Article 2 of the Ministerial Ordinance for the Implementation of the Act on Special Provisions requires a treaty-country resident seeking reduction or exemption to file an application form containing prescribed particulars — for each withholding agent, by the day before the day on which the payment is received, submitted through that withholding agent to the district director of the tax office having jurisdiction over the agent's place of tax payment.

Most cases of "we met every substantive treaty condition and were still charged 20.42%" trace back to this deadline, not to the treaty.

The Exit: Selling the Shares Does Not Necessarily Remove Japan's Taxing Right

"Don't sell the Japanese building — sell the shares of the Japanese company that owns it." Article 138(1)(iii) of the Corporation Tax Act treats as Japan-source income the income from the transfer of assets located in Japan as prescribed by Cabinet Order, and Article 178(1)(v) of the Order for Enforcement of the Corporation Tax Act places within that category "income from the transfer of shares in a corporation (limited to a real-estate-related corporation)."

### Identifying a Real-Estate-Related Corporation (Article 178(8))

A real-estate-related corporation is one in which, at any point during the period from the day 365 days before the date of the share transfer until immediately before that transfer, land and similar assets located in Japan (together with shares in certain lower-tier corporations) accounted for 50% or more of the total value of its assets.

The words "at any point" carry the weight. Reducing the property ratio shortly before the sale does not help: if the threshold was crossed even once in the preceding 365 days, the corporation still qualifies.

### Which Transfers Are Caught (Article 178(9) and (10))

"Specially related shareholders" means a shareholder of the corporation, persons in a prescribed special relationship with that shareholder, and persons treated as shareholders in respect of certain partnership property (Article 178(10)). The textbook structure — an offshore holding company owning 100% of a Japanese subsidiary — clears the 2% threshold by definition.

No Withholding Does Not Mean No Obligation

The Japan-source income that Article 212(1) of the Income Tax Act makes subject to withholding in the case of foreign corporations is that described in Article 161(1)(iv) through (xi) and (xiii) through (xvi). Income from the transfer of assets — Article 161(1)(iii) — is not on that list. Nobody deducts anything from the share sale proceeds.

What arises instead is a filing obligation. Under Article 141(ii) of the Corporation Tax Act, the tax base of a foreign corporation without a permanent establishment is the income attributable to the Japan-source income listed in Article 138(1)(ii) through (vi); and under Article 144-6(2), that corporation must file a final return within two months of the day following the last day of each fiscal year — unless it has no such Japan-source income, or corporation tax is not imposed by virtue of a treaty provision or other prescribed rule.

By contrast, where a corporation sells Japanese land or buildings directly, the consideration is Japan-source income under Article 161(1)(v) of the Income Tax Act and the buyer withholds 10% under Article 213(1)(ii) — 10.21% including the reconstruction surtax. Sell the building and the tax is deducted for you; sell the shares and it is not. That asymmetry is precisely what produces unfiled returns on the share side.

A Treaty May Not Protect the Exit

Many modern tax treaties reserve source-country taxing rights over gains on shares in companies whose value is derived principally from immovable property situated in that country. Which treaty contains such a clause, and on what conditions it operates, varies by treaty and must be confirmed against the treaty text itself. The sound starting assumptions for structuring are two: without a treaty, domestic law applies in full; and with a treaty, the exit taxing right has most likely been reserved anyway.

Put Entry, Holding, and Exit on One Drawing

• Entry — the acquiring entity, the funding route, the shareholding percentage
• Holding — the withholding rate on dividends, and control of the application-form deadline
• Exit — real-estate-related corporation status (the 365-day rule), the shareholding threshold, and where the filing obligation sits

A design that brings 20.42% on dividends down belongs on the same sheet of paper as the share-transfer gain that may be taxed at exit. A structure optimised only at the entrance reveals the absence of design at the exit.

This article provides general information on tax systems and does not constitute individual tax consultation. Specific filings and tax computations are handled by licensed partner tax accountants whom we introduce.