Private Wealth in Japan

Japan is home to many wealthy individuals, including owners of large public and private companies, heirs of multi-generational family wealth, and senior foreign executives and investment fund managers employed in APAC regional roles.

These individuals and persons who inherit from them face significant tax burdens due to Japan's high income, gift and inheritance tax rates, which exceed those of other countries; wealthy individuals face top marginal ordinary income, gift and inheritance tax rates of 55%. Without proper planning, these wealthy individuals and those who inherit from them risk losing substantial wealth to Japanese taxes.

Tax

Japan's national tax regime is enforced by the Japan National Tax Agency (the NTA). While Japan's tax system shares many characteristics with those of other developed nations, certain aspects are unique and complex.

Japanese income tax

Under Japanese income tax law, individuals are taxed primarily based on their residency. Japan categorises individuals as residents or non-residents for income tax purposes. A person is treated as a resident if they are domiciled in Japan or have resided continuously in Japan for more than one year.

A person is domiciled in Japan if their centre of living is in Japan, rather than in another country. Relevant factors to consider in determining a person's centre of living are based upon objective facts, which include but are not limited to:

• the location of homes and days spent in Japan and other countries during the year;
• the location of businesses and job contracts;
• the location of the place of living of family members;
• the location of assets such as bank accounts, investments, etc; and
• any other relevant factors, such as tax residency in other countries, the presence or absence of a registered residential address in Japan, etc.

Residents

If a person's centre of living is in Japan, they are considered a resident for income tax purposes. Residents are classified as either permanent residents or non-permanent residents.

• Permanent residents: Japan citizens residing in Japan and non-Japan citizens who have resided in Japan for more than five out of the last ten years are permanent residents. Permanent residents are taxed on worldwide income up to a top marginal rate of 55.945% and on capital gains under a separate taxation system (eg, for securities) at a fixed rate of 20.315%, regardless of the source of the income or gain.
• Non-permanent residents non-Japan citizens who are residents of Japan and have resided in Japan for less than five out of the last ten years are non-permanent residents. Non-permanent residents are generally taxed on a worldwide basis, except for foreign source income (as defined under Japanese tax law) not remitted into Japan. With this scope of taxation, capital gains on the sale of non-listed securities that are not taxed at the source in a foreign country, Japanese listed securities and foreign listed securities acquired after becoming a non-permanent resident may be taxable. If subject to tax based on the categories listed above, non-permanent residents are taxed at the same rates as permanent residents.

Non-residents

If a person's centre of living is outside of Japan and they have not resided continuously in Japan for one year or more, they are considered non-residents. Non-residents are taxed on Japan-source income and are generally subject to withholding, usually at a flat rate of 20.42% or 15.315%, depending on the type of income.

Japan exit tax

Due to the high income tax rates in Japan, individuals may wish to consider relocating to live abroad. However, Japan imposes an exit tax on those who:

• were resident in Japan for more than five out of the last ten years before leaving; and
• hold assets subject to exit tax worth JPY100 million or more on the date of exit.

The assets that are subject to exit tax generally include securities such as stocks and bonds. Notably, real estate and personal items such as art are not subject to exit tax. In addition, the five-year period excludes any period of time residing in Japan on a Table 1 visa (eg, a work visa), but includes any period of time residing in Japan on a Table 2 visa (eg, a spouse or permanent resident visa).

If an individual is subject to exit tax, the assets that are subject to this taxation are deemed to be sold on the date of their exit, and for any appreciation in their securities the tax would beat a flat rate of 15.315%.

Japan gift and inheritance tax

In addition to income tax, Japan also imposes gift and inheritance tax on a worldwide basis. Japanese assets such as real property located in Japan and stock in Japanese companies are subject to gift and inheritance tax up to a top marginal rate of 55%. The applicability of these taxes to non-Japanese assets generally depends on the citizenship and residency status of the donor and donee.

An individual who gives a gift or inheritance (a “donor”) is treated as a Japan Person if they are:

• a Japan citizen currently domiciled in Japan or who had been domiciled in Japan at any time during the last ten years; or
• a non-Japan citizen currently domiciled in Japan on a Table 2 visa.

An individual who receives a gift or inheritance (a “donee”) is treated as a Japan Person if they are:

• a Japan citizen currently domiciled in Japan or who had been domiciled in Japan at any time during the last ten years;
• a non-Japan citizen currently domiciled in Japan on a Table 2 visa; or
• a non-Japan citizen currently domiciled in Japan for more than ten of the last 15 years on a Table 1 visa.

If either the donor or the donee is a Japan Person at the time of the gift or inheritance, Japan gift or inheritance tax will apply on a worldwide basis. Basic allowances include:

• for gifts: JPY1.1 million per donee per year; and
• for inheritances: JPY30 million plus JPY6 million for each surviving statutory heir (generally close family members).

A spousal credit, which is generally the surviving spouse's statutory share (commonly 50%), may reduce the inheritance tax due.

Wealth Structuring

There are several wealth planning approaches to increase Japanese tax efficiency and tax optimisation on succession. The most commonly used structures involve the use of offshore trusts and offshore companies.

Trusts

Trusts may be used by individuals to pass on wealth to future generations in a tax-efficient manner.

Although trusts are recognised in Japan under Japanese law, personal trusts are not commonly used in Japan, primarily because of the differences between the legal system from which trust law developed and Japan's legal system, which did not originally have trusts. Since the succession of assets in Japan is generally a simple process that does not require probate, there is no need to create trusts to avoid it. As a method of estate planning for wealthy individuals, trusts are still far less commonly used in Japan than in other jurisdictions, like the United States and the United Kingdom.

Individuals with ties to Japan may still use offshore trusts to hold their assets for future generations in a tax-efficient manner. A careful analysis of the citizenship and residency status of the settlor (ie, the person who creates and funds the trust) and the beneficiaries, and whether they are Japan Persons or not, would be required to determine whether an offshore trust may be used in a tax-efficient manner.

Japan tax treatment of offshore trusts

With little familiarity in the area of offshore trusts, most tax practitioners and authorities in Japan take a default position that all trusts are passthrough to either the settlor or the beneficiaries (meaning that the settlor or the beneficiaries are treated as owning the trust assets). However, not all trusts should be categorised as passthrough for Japan tax purposes. Trusts that are treated as non-passthrough for tax purposes are useful in a number of tax beneficial ways.

Passthrough trusts

If a trust is treated for Japan tax purposes as passthrough to a beneficiary, and the beneficiary did not pay the settlor fair market value consideration corresponding to their beneficial interest in the trust, the beneficiary is deemed to receive a gift from the settlor at the time the trust is funded. If either the settlor or the beneficiary is a Japan Person at the time the trust is funded (or if any of the assets funded into the trust are Japanese assets), Japan gift tax up to a top marginal rate of 55% should apply.

Classification as a passthrough trust

Based on the above, it is important to determine when a trust should be treated as passthrough to a beneficiary for Japan tax purposes. Under Japanese law, a trust should generally be treated as passthrough if it has a beneficiary for Japan tax purposes. A beneficiary is defined for Japan tax purposes as:

• a person who has a current beneficial right (a “Current Beneficiary”); or
• a person who can amend the trust and can potentially receive trust assets (a “Deemed Beneficiary”).

The guidance on what constitutes a Current Beneficiary is contained in an example set forth in a Japanese inheritance tax basic circular interpreting the trust taxation rules. Based on the example in the circular, if there is a condition precedent that must be met in order to receive any beneficial interest in a trust, a beneficiary should not be treated as a Current Beneficiary in the trust assets until the condition is fulfilled.

With regard to the second category above, the ability to amend the trust for Japanese tax purposes includes, for example, the power to appoint or remove trustees, the power to add or remove beneficiaries or the power to consent to certain substantial decisions made by the trustee. Therefore, an individual given these types of powers should generally be considered a Deemed Beneficiary if they can potentially receive trust assets in any way.

Non-passthrough trusts

If a trust is instead treated as not passthrough to any of the beneficiaries, although the trustee would be deemed to receive a gift, there should generally be no Japan gift tax applicable to potential beneficiaries upon funding the trust, provided that the settlor and trustee are not Japan Persons. If the trust is also not passthrough to the settlor, no Japan inheritance tax should apply to the trust assets upon the settlor's passing, even if the settlor or any of the beneficiaries are Japan Person, because the trustee is treated as the owner of the trust assets.

Classification as a non-passthrough trust

To potentially be classified as a non-passthrough trust, the following criteria should generally be considered:

• the trust is irrevocable;
• the trustee is an independent, third-party trustee;
• there is a condition precedent to the beneficiaries receiving any distributions;
• the settlor has no powers over the trust, the trustee or the trust assets;
• there is no beneficiary for Japanese tax purposes; and
• no potential beneficiary has any powers over the trust, the trustee or the trust assets.

If a trust is a non-passthrough trust, under Japanese tax law it should be treated as a corporation, and the trustee is treated as the taxpayer regarding the income of the trust.

When the settlor contributes assets into a non-passthrough trust, the settlor is deemed to sell the assets for income tax purposes, and the trust recognises donation income.

If the office of the trustee is located outside of Japan, the trust should be treated as a foreign corporation, and only Japan source income should be subject to Japanese corporation tax (non-Japan source income should not be subject to Japanese tax).

Furthermore, if the beneficiaries of a non-passthrough trust include a relative of the settlor with six degrees of blood relation, the trustee is deemed to receive a gift from the settlor. However, no Japan gift tax should be applicable if neither the settlor nor the trustee are Japan Persons, and the trust does not hold Japanese assets.

Based on the favourable tax benefits of non-passthrough trusts, the option to create such trusts is beneficial to wealthy individuals who have ties to Japan, and in particular to foreigners living in Japan.

Offshore companies

Offshore companies may also be used to hold assets for future generations in a tax-efficient manner. As explained above, even if neither a decedent nor a person inheriting a decedent's assets are Japan Persons, any Japanese assets transferred by the decedent at death are subject to Japan inheritance tax. However, if the Japanese assets are owned by an offshore company during the decedent's lifetime, they are not subject to Japan inheritance tax. Each individuals' particular situation should be analysed by Japan tax counsel to determine the tax implications of the transfer of the Japanese asset to the offshore company.

Japan Tax Updates for 2024

A significant change to the Japanese tax law came into effect on 1 January 2024, which will greatly affect gift planning for wealthy individuals.

Gifts made within seven years of passing includible in estate

Prior to the start of 2024, gifts made by a decedent within three years of their passing were brought back into their estate and made subject to Japan inheritance tax (ie, a three-year “clawback”). However, as of 1 January 2024, this three-year period has been extended to seven years. This means that if a person made a gift on 1 January 2024 and passes away, for example, in December 2030, the value of the gift at the time it was made will be added back to the decedent's estate and the corresponding gift tax paid is credited in computing the inheritance tax due.

Although the value of the gift may have declined since the time it was given, there is no reduction in the value of the gift based on depreciation or the passage of time when it is added back to the decedent's estate. There is also a JPY1 million deduction for gifts made between three and seven years prior to the donor's passing.

Notably, the clawback rule should apply only to gifts that were subject to the calculation of Japan gift tax at the time of the gift. Therefore, if the donee was not a gift taxpayer with respect to non-Japanese assets, the value of the gift should not be added back into the donor's estate.

This new seven-year clawback rule will greatly affect gift planning for those looking to reduce the value of their taxable estate, particularly those who are elderly or are otherwise not expected to live for more than seven years.

This article was first published in Chambers and Partners here.