First, two famous quotes:
“I hate paying taxes. But I love the civilization they give me”
—Oliver Wendell Holmes Jr. (jurist, former Associate Justice of the Supreme Court of the United States of America)
“I like to pay taxes. With them, I buy civilization.”
—Also Oliver Wendell Holmes Jr.
Seems like he couldn’t seem to make up his mind about the enjoy-ability of paying taxes. However, one consistent thing was that he acknowledged that they make civilization possible. Roads, police, courts, militaries, safety nets… Japan is a civilization with over 126 million citizens and 2.83 million foreign residents. Certainly it needs revenue, and one way in which it makes sure it gets it is via withholding tax.
What is withholding tax?
You can think of withholding tax as a kind of “security deposit” to the government that ensures you’ll really pay your taxes for people who do not live in Japan- i.e non-residents and people living overseas. Withholding tax is a certain amount of money that a person or company takes out of a payment (wage/salary, capital gains, rental income, etc.) and gives to the government to hold onto. However, the person(s) or company doesn’t yet necessarily know exactly how much the taxes will be for the year. Therefore, they make regular payments based on estimates or withholding tax tables. Hopefully for the taxpayer, some of this will come back after the tax year is complete. On the other hand, occasionally, the taxpayer will have underpaid, and will owe the government more money.
Oversimplified Example of Withholding Tax on real estate income
For instance, Mr. Smith lives in Singapore and receives approximately ¥250,000 per month in income from Japanese real estate, sometimes less, sometimes more (~¥3,000,000 yearly). As a result, he’s not really sure how much he’ll pay in taxes this year. Each month, he pays 20% in withholding tax. Hence, by the end of the year, he has paid ¥600,000 in withholding tax. Finally, in the late winter of the following year, he files his Blue Tax Form (青色申告, Ao Iro Shinkoku). Good news—the government owes him money! For the reason that his personal income tax liability was actually only ¥400,000. A few weeks later, the government transfers ¥200,000 back into his bank account. Mr. Smith rejoices about his windfall. He uses a small portion of it to treat his family to a day at Disneyland and a nice dinner, and invests the rest.
Why does withholding tax exist?
The purpose of withholding tax is twofold. First, to avoid the following situation at tax time: The taxpayer has already spent all the money and stresses over coming up with enough to pay taxes. Second, to make sure the government gets paid. What if tax time rolled around and the taxpayer “disappeared” under mysterious circumstances? Withholding tax protects both the taxpayer and the government from these scenarios.
Who pays it, and how much do they pay?
People and companies in a wide variety of situations pay withholding tax. The rules about who and how much are very complicated. For now, let’s just discuss real estate investors (not complicated at all).
Real estate investors who live in Japan don’t need to pay withholding tax. They’re physically present in Japan. Therefore, Japan’s government trusts them enough to wait until tax season to collect taxes from them.
Overseas investors, on the other hand, pay withholding tax. When selling a property, the amount is 10.21% for withholding tax. When collecting rental income, the amount is 20.42%. Who takes care of this? The answer is “your property manager” or accountant.
Especially if you’re just starting out as a real estate investor in Japan, you’ll very likely get some of the withholding tax back the next year. Here’s one example:
You decide to dip your toes into the vast ocean of Japanese real estate investment. You buy a small studio apartment in western Tokyo to rent out, spending only a couple million yen on it. The rent is ¥30,000 per month, and you immediately find a good, reliable tenant. How much will you pay in withholding taxes? How much will the government refund you the following year?
withholding taxes for the year = ¥30,000 in rental income × 12 months in a year × 20.42% = ¥73,512 paid in withholding taxes
The next year, you file your income tax return:
¥360,000 in income – personal exemption of ¥380,000 = ¥0 in taxable income
With ¥0 in taxable income, your income tax is ¥0. Therefore, the ¥73,512 that you paid all comes back. This is great news for investors who are just starting out.
Of course, the more property/properties you have, the less that withholding tax will cover the income, because some of the higher tax brackets are above 20.42%. The marginal tax rate increases from 20% to 23% at the ¥6.95 million taxable income mark. At this point:
- Congratulations on achieving what many would consider total financial independence. You’ve built your own real estate empire.
- Your withholding tax on the highest tax bracket is no longer covering your tax liability. Start setting some money aside in case the government asks you for more when you file your tax return.
Important Dates to Be Aware of and Who Helps You Meet Them
- The tax year in Japan is January 1-December 31.
- The tax season (when you file your Ao Iro Shinkoku tax return) is from February 16-March 15 of the following year. Your tax representative can help you with this. A tax representative is either a family member or a tax accountant located in Japan.
- Receiving your refund takes a few weeks. A tax representative will help you get your refund. Either it’ll end up in your Japanese bank account, or your tax representative will figure out a way to send it to you.
Withholding tax comes out of your income at regular intervals if you’re an overseas investor. Foreign residents of Japan need not pay withholding tax (but they’re still liable for income tax). The government hangs onto withholding tax—at least until the following year. They do this to make sure you don’t just run off without paying taxes. If your income tax liability ended up being lower than the withholding tax amount, you get something back. This is common for fledgling investors in Japanese real estate. If the two amounts were miraculously exactly the same, neither party will owe the other anything. If your withholding tax ended up being less than your income tax liability, you pay the government. Note that this only happens when you’re making a substantial income from either renting out or selling, though.
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