Even corporation tax paid abroad,to the extent its rate is too high, foreign tax credit is ineligible for the foreign tax credit from the outset.This is the “high-rate tax portion.” But 35% is not the only threshold.Interest and similar income has separate rules with three levels.

Where is it prescribed?

In Article 69(1) of the Corporation Tax Act,inside the parenthesis.There arefour categoriesof exclusions.

... The amount of foreign corporation The foreign corporation tax amount, excluding:(1) The portion imposing a high burden on income,as prescribed by Cabinet Order;(2) Foreign corporation tax on income arising from transactions not considered ordinarily undertaken by a domestic corporation,as prescribed by Cabinet Order;(3) Foreign corporation tax imposed under foreign law on amounts not subject to corporation tax under laws applicable to the domestic corporation,as prescribed by Cabinet Order;(4) Other foreign corporation taxprescribed by Cabinet Order.which are excluded from this categoryThe remaining amount is referred to in this Article as“creditable foreign corporation tax.”That is the definition.

These are excluded from the definition of creditable foreign corporation tax.Deduction limit They are removed before the credit limit calculation,and cannot be carried forward under Article 69(2) and (3).

The 35% threshold: paragraph (1)

Article 142-2(1) of the Order for Enforcement of the Corporation Tax Act, titled “Foreign Corporation Tax Ineligible for Foreign Tax Credits.”

... The amount of the portion imposing a high burden on income,referred to in the following paragraph and paragraph (3)as “the high-rate tax portion,” is the portion of foreign corporation tax payable by a domestic corporation thatexceeds thirty-five percent of the taxable base used in the country or region imposing that tax.That excess is the excluded amount.

The denominator is the amount treated in the taxing country or region asthe taxable base.It is not Japanese taxable income.Use the local tax base.

Pay attention to these differences.At 35% or less, no high-rate portion arises under paragraph (1), but thisdoes not mean the entire amount is creditable.Exclusions (2), (3), and (4) apply separately. In particular,withholding tax imposed above a treaty maximum rateunder paragraph (8)(v) is a frequent exclusion in withholding practice.

Interest and similar income: three levels of 10%, 15%, or no high-rate exclusion under paragraph (2)

Paragraph (2) of the same Article.Reading only paragraph (1) can change the conclusion.

For domestic corporations listed in the following items,foreign corporation tax payable on foreign source income under Article 69(4),items (vi) and (viii),referred to asInterest and similar income“interest and similar income,” using the gross receipts as the taxable base,imposed by a method similar to withholding,excluding taxes creditable against other foreign corporation tax in the taxing jurisdiction,notwithstanding the preceding paragraph,the portion of that foreign corporation taxexceeding ten percent of the gross interest or similar incomeconstitutes the high-rate tax portion.However, where the domestic corporation's income ratio（……）exceeds ten percent but is no more than twenty percent,……fifteen percentthe portion exceeding the specified corresponding amount is the high-rate portion; where theincome ratio exceeds twenty percent,then, of that foreign corporation tax,there is deemed to be no high-rate tax portion.。

The “income ratio” is the fraction defined in each item, broadlyadjusted income for the payment fiscal year and fiscal years within the preceding two years, divided by total revenue and similar amounts for those years.The denominator differs by item.

Paragraph (2) applies only to four categories of domestic corporations

The items of paragraph (2).

(i)Financial business,including financial instruments business under Article 2(8) of the Financial Instruments and Exchange Act, as the principal business of a domestic corporation

(ii)Life insuranceas the principal business of a domestic corporation

(iii)Nonlife insuranceas the principal business of a domestic corporation

(iv) A domestic corporation principally engaged in a business other than the preceding three, limited to one for whichaggregate gross interest and similar incomefor the payment fiscal year and fiscal years within the preceding two years, divided by that total plusaggregate gross profitfor those fiscal years,at least twenty percent.reaches the prescribed ratio.

An ordinary operating company with an interest-income ratio below 20% is outside paragraph (2) entirely.It then returns to the 35% test in paragraph (1).

The parenthetical exclusion works the same way.Withholding tax creditable against other local foreign corporation tax falls outside paragraph (2) and is tested under paragraph (1)'s 35% rule.This does not mean it is ineligible for credit.

Paragraph (3) answers the relationship with tax sparing

Paragraph (3) of the same Article.

Where foreign corporation tax includesforeign corporation tax deemed paid,the high-rate portion of that foreign corporation taxis treated as consisting first of the deemed-paid foreign corporation tax.。

The high-rate portion is allocated first to the tax-sparing amount.The actually paid amount is not excluded first.

This system does not apply to individuals

Even reading all paragraphs of Article 222-2 of the Order for Enforcement of the Income Tax Act, Foreign Income Tax Ineligible for Foreign Tax Credits,there is no wording “high rate,” “thirty-five percent,” or “ten percent.”It instead covers nonordinary transactions, taxes on amounts not subject to income tax, and other exclusions such as amounts above treaty maximum rates.

The high-rate portion exclusion exists only on the corporation tax side.Do not apply it to individuals by analogy.

Points that require care in practice

• Thirty-five percent of what?The local taxable base, not Japanese income.
• Does the 10% rule apply to withholding on dividends or royalties?Paragraph (2) refers to Article 69(4)(vi), interest on bonds, deposits, investment trusts, and similar income, and item (viii), loan interest. Dividends under item (vii) and royalties under item (ix) are not included.
• How is the income ratio calculated?Use the fractions in the items of paragraph (2) and the definition of adjusted income in paragraph (4).
• Is the excluded portion deductible?That leads to the issue of choosing between a credit and a deduction.
• Tax was withheld above the treaty maximum rate.Paragraph (8)(v) excludes the excess from credit. First consider whether a refund can be claimed.

“Paid 40% abroad, so credit 40%” does not follow.Whether the destination has a high tax rate or withholding exceeds a treaty maximum, the Japanese credit may be smaller than expected. These issues matter when selecting an overseas location and filing withholding forms.

Legal basis

• Article 69(1) of the Corporation Tax Act (Foreign Tax Credits): parenthetical definition of creditable foreign corporation tax
• Article 142-2(1) through (8) of the Order for Enforcement of the Corporation Tax Act (Foreign Corporation Tax Ineligible for Foreign Tax Credits)
• Article 69(4)(vi) and (viii) of the Corporation Tax Act (Interest and Similar Foreign Source Income)
• Article 222-2 of the Order for Enforcement of the Income Tax Act (Foreign Income Tax Ineligible for Foreign Tax Credits)

This article does not cover details of adjusted income under Article 142-2(4) or all items in paragraphs (5) through (8). Individual determinations require review of the local taxable base and treaty.