Japan

Foreign tax credit

A Japanese corporation is subject to Japanese corporate income taxes on its worldwide income. However, to avoid double taxation of foreign-source income, Japanese corporations are allowed to claim a tax credit against corporation and inhabitant’s taxes for foreign income taxes paid directly.

Creditable foreign taxes are defined as taxes that (i) are incurred directly by the taxpayer; (ii) are levied by foreign governments and local authorities in accordance with local tax laws; (iii) are levied on corporate income; and (iv) have the same characteristics as Japanese income tax, corporation tax, and local income-based taxes. A tax for which a refund can be claimed optionally by the taxpayer after the tax payment, or a tax whose payment grace period can be decided by the taxpayer, is not regarded as a foreign tax.

In order to prevent the credit from reducing corporation tax on Japan-source income, certain limitations are set on the amount of foreign taxes that can actually be credited. The ceiling is currently 35% of the foreign taxes paid. The creditable foreign tax is calculated using the following formula:

Corporate tax liabilities x (Foreign source income / Worldwide income taxable in Japan)

Any excess amount over the ceiling is carried forward for three years.

A foreign tax credit is not applicable for enterprise tax purposes, although foreign branch income attributable to business conducted outside Japan is exempt from enterprise tax.

Generally speaking, the foreign tax credit system does not apply to the extent dividend income from a foreign subsidiary is subject to the dividend exemption system.

Foreign corporations with a PE in Japan should note that when the PE of a foreign corporation in Japan is subject to taxation in Japan as well as in another jurisdiction other than its country of residence, double taxation may arise. To alleviate any unfair tax burden, a foreign tax credit regime is also applicable to PEs in Japan similar to that which applies to Japanese corporations. However, foreign tax (including WHT) paid in the foreign corporation’s country of residence would not, in principle, be creditable.

Foreign taxes paid under the following circumstances are not creditable: (i) foreign taxes levied on payments between foreign corporations, on the grounds that such payments were deemed to have been made to the Japanese corporation, and (ii) foreign taxes levied on a payment from a foreign PE to its Japanese head office or another related party as a result of the foreign tax authorities disallowing a deduction at the level of the PE.

Innovation box

For patent rights or copyrights related to AI technology that a company has researched and developed itself in Japan, a new ’innovation box‘ will permit 30% of the ’qualified income‘ generated from that technology to be included as deductible expenses for the fiscal years beginning 1 April 2025 until 31 March 2032. To benefit from the innovation box, the revenue generated must arise from the assignment of the intellectual property (IP) rights to a Japanese individual tax resident or domestic corporation (excluding a related party) or from the loan of the IP rights to a third party, either resident or non-resident. To avoid ’double dipping‘ of the tax benefit, access to R&D credits for companies applying the innovation box will become more restrictive from 1 April 2026.

Tax credit for research and development (R&D) costs

R&D tax incentives (the R&D tax credit system) are available for expenditure on R&D where the intellectual property arising therefrom is owned by the Japanese taxpayer.

The R&D tax credit formula is shown in the following table:

As a result of the introduction of the innovation box regime, the R&D tax credit formula has been revised as follows:

The tax credit limitation for certain R&D is 20% of the corporate tax liability, with additional rate up to 10% added depending upon the movement in the R&D ratio. An additional R&D credit of up to 10% for open innovation is also available.

Salary increase tax credits

The salary increase tax credit is available for corporations filing 'blue form' tax returns that meet certain conditions relating to increased expenditure on salary and other employee-related expenses.

As a result of the 2024 Tax Reform Act, the application for this credit will be extended for three more years, the existing minimum tax credit will be reduced from 15% to 10%, and the maximum tax credit rate (the rate multiplied by the increased salary amount) will be increased from 30% to 35%, while the upper ceiling of the tax credit (20% of corporate tax payable) will remain unchanged. The eligibility requirements for the maximum rate will be tightened in some cases; however, the maximum rate will also be extended to new cases.

Tax credit for domestic production in strategic sectors

As a part of the 2024 Tax Reform Act, a tax credit designed to encourage domestic production in sectors considered strategically important by the government is established. Products that qualify for the tax credit include electric vehicles, green steel, green chemicals, sustainable aviation fuel (SAF), and semiconductors. The credit amount is based on either the quantity of goods produced and sold within ten years after the date of certification of an approved business plan under the Industrial Competitiveness Enhancement Act (ICEA) but before 31 March 2027 or the acquisition cost of qualified assets used for such production, whichever is smaller. The maximum tax credit in each year will be 40% (20% for semiconductor) of the corporate tax liability, with a carryover period of four years. In addition, a required level of either wage increase or capital investment must be met to be eligible for the benefit.

Incentives for the revitalisation of local ‘hubs’

A taxpayer may be eligible for tax incentives if it relates to or expands certain kinds of operations in local areas (generally other than Tokyo, Osaka, or Nagoya).

Local government contributions

As part of the Regional Revitalization Act, ‘blue form’ corporate tax filers who make donations to approved regional donation plans up until 31 March 2025 will be able to claim a tax credit against corporate, enterprise, and inhabitant’s taxes in addition to taking a deduction from the corporate tax. This is known as the corporate hometown tax, or furusato nozei system.