FAQs - 2. Taxation-related matters
2-7) Please tell us more about bilateral tax agreements.
Bilateral tax agreements are agreements concluded between countries with the objective of eliminating double taxation. In order to prevent double taxation with countries that have different taxation regulations to Japan, bilateral tax agreements contain provisions to determine residence status and taxation rates.In Japan, the application of bilateral agreements takes priority over domestic law.
Purpose of bilateral tax agreements
As economic transactions develop, so too does the cross-border movement of people, items, money, and services. This can cause problems of double taxation between the country of residence and the country of origin. One approach to taxation suggests that a state should keep track of the places of residence of its citizens(for individuals, their place of residence or domicile ; for corporations, the location of their head office) and should attempt to levy tax on profits earned anywhere in the world (worldwide income taxation). On the other hand, another approach suggests that a state should attempt to tax those profits earned within the range of its own sovereignty, even when taxed citizen does not possess a residence in the home country, for example.
Since both the country of residence and the country of origin are mutually sovereign states, it is no simple matter to criticize the policies of the other state ; however, if the issue of double taxation is not addressed simply for the sake of securing short-term taxation income, this can present obstacles to cross-border economic transactions and thus generate losses for the state in the long term.
Double taxation can be eliminated to a certain extent by establishing a foreign tax credit system under domestic law or by abolishing the worldwide taxation approach and taxing only domestic source income(foreign income exemption). However, this procedure is highly complicated and troublesome, and it is also technically difficult to completely eliminate double taxation. Accordingly, bilateral tax agreements enable mutual concession of taxation rights and provide for distribution of taxation rights in order to eliminate double taxation. This effectively allows reduction or exemption of taxation for residents of the other country.
