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To reduce or eliminate double taxation, taxpayers who have overseas sources of income—and overseas income tax liabilities— often make use of foreign tax credits. However, in our experience, the use of such credits when it comes to inheritance tax is not as well understood.

During a recent seminar that we held on Japan’s inheritance and gift taxes, a number of attendees were surprised by the scope and mechanism for claiming a foreign tax credit against liability for inheritance tax in Japan. A credit is available for foreign tax paid in the jurisdiction where the asset is located. As with income tax credits, a cap is applied so that the credit available is the lower of the Japan liability and the overseas tax paid. As a result, if the tax paid overseas is greater than the Japan liability, the liability is reduced to zero.

A key point to note is the location of the asset. In most cases, the location of an asset is where you might think it would be—real estate is located in its physical location, bank deposits in the location of the bank. A couple of quirks are the locations of loans and insurance policies. These are treated as being at the location of the borrower and the head office of the insurer, respectively.

For estates that span multiple jurisdictions, where the maximum foreign tax credit is further restricted, the credit for tax paid in each jurisdiction is capped at an amount determined by the following formula:

Japan inheritance tax due x (Property received located in the overseas jurisdiction / Total property received)
To understand how this works in practice, consider the estate of a UK decedent whose daughter in Japan meets the criteria to be subject to inheritance tax on worldwide assets. At the time of passing, the decedent owned a holiday home in France, valued at ¥100 million, and a main home in London, valued at ¥200 million. All assets were left to the daughter.

In the UK, both properties would be subject to inheritance tax. For the sake of this example, let’s assume that the tax due in the UK is ¥100 million, no tax is due in France, and the inheritance tax due in Japan is ¥80 million. If the holiday home were located in the UK rather than France, a credit of ¥80 million—the lower of the UK and Japan taxes—would have been available to offset the Japan liability, reducing it to zero.

But as the inheritance tax on the France property is paid in the UK, the credit is restricted. It can be calculated using this formula:

Maximum credit = 80 million x 200 million/300 million = ¥53.3 million
Applying this credit would leave a final amount to be paid in Japan of ¥26.7 million.

As can be seen in the chart below, even in this simple example spanning only two jurisdictions the dilution of the foreign tax credit can significantly increase the inheritance tax liability in Japan—as well as the total inheritance tax—paid in both countries.

Although Japan has tax treaties with many countries to prevent double taxation, only its agreement with the United States covers inheritance tax. The treaty contains provisions to prevent the dilution of the tax credit that occurs when an estate spans two or more jurisdictions. However, in most other cases, advance planning is required to ensure estates are structured to reduce unnecessary double taxation.

In today’s age, where estates covering multiple jurisdictions are not unusual, it is important for residents of Japan to be aware of not only their liability to inheritance tax, but also the small details that can give rise to additional tax and an unwanted surprise in the future.

Adrian Castelino-Prabhu
is a principal at Grant Thornton specializing in international inheritance/gift taxation for high-net-worth individuals as well as tax advice for corporations looking to enter the Japan market.



Eiji Miura
is a partner at Grant Thornton Japan specializing in succession planning and international inheritance/gift taxation for high-net-worth individuals.




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