Can an LLP be considered as a pass-through entity?

There were some arguments whether a Delaware Limited Liability Partnership (LLP) should be treated as a pass-through entity or not. If it is regarded as a pass-through entity, income or loss made through an LLP has to be included in Japanese taxable income.

As of today (May 2018), it is regarded as a pass-through entity.

There have been several contradicting rulings by Japanese courts but recently in 2017, Japanese Supreme Court gave the decisive ruling that sent many in Japanese and US tax community in panic.

デラウェア州LPSの法人該当性が争われた事案~平成27年7月17日最高裁判決

Japanese Supreme Court rules that a Delaware limited partnership is a corporation

Then, after strong criticism and the change in the tax law that limits loss from partnership for passive members, the National Tax Agency announced a memo in “English” saying that
a Delaware limited partnership is fiscally transparent. (It is rare to make its official announcement not in Japanese. Some people think that it is too embarrassing for Supreme Court if NTA denies their ruling in Japanese.)

Now we have the conclusion here. An LLP can be treated as a pass-through entity.

It affects your tax situation if you do business or invest into something through an LLP. If you are an active partner, your loss in the partnership can be offset against your Japanese loss.

There is a rumor that the tax authority is considering revision on overseas property depreciation

I have not confirmed the source yet but there is a talking in tax community that the tax authority is considering to limit deductible depreciation expenses on overseas properties.

As you may know that second handed houses can be expensed over relatively shorter period. The depreciation expense are allowed to use the 20% of the original life year if it is older than the original life year.

For example, the life year defined for a wooden house by the tax law is 22 years. If you buy a wooden house which is older than 22 years, you are allowed to expense the cost of the house (except the land price portion) over 4 years through depreciation calculation (22 years * 20%).

If you buy a house of 60 million yen and if the house portion and the land portion can be split into 50:50, you can claim depreciation expense of 7.5 million yen (60 million * 0.5 / 4 years) per year over the next 4 years.

Because your rent income usually is much lower than this amount (let’s presume it will be 2.4 million yen a year), and you also have other expenses (let’s say 1 million yen), your loss will be 6.1 million yen (2.4M – 1M – 7.5M) that can be offset against other income (e.g. salary).

As you can see, it has huge impact to reduce your tax. On top of this, when you sell it, the tax rate on capital gain is only 20%. So, if you are in the higher tax bracket, say 50%), you save the income tax of 50% by the amount of loss, and when you sell it, you only have to pay 20%. It surely sounds like a very good deal, no?

The tax authority knows this and is said to be considering to stop this type of practice because this does not sound fair.

If it comes soon, the new restriction will come in by January 1, 2018. If you are thinking of buying a property because of the tax benefit, you may want to consider more on financial elements such as your future return on investment.

Exit Tax

Exit Tax came to place

Exit Tax is an important topic for foreigners living in Japan, especially for those who have their saving in stocks. This tax is newly introduced from 2016 to punish wealthy Japanese nationals moving overseas.

According to the newly introduced taxation, if you have stocks with unrealized gain, no matter which country those stocks belong to, you are taxable on those stocks when you move back to home country even though you have not sold them. It should probably sound very harsh based on a common concept among us that assets are not taxable until they are sold.

The Exit Tax was introduced because you would not be taxed by Japanese tax if you move to a country such as New Zealand, HK and Singapore and sell your stocks.

The below is the summary of the important points about Exit Tax:

Unrealized capital gain on stocks are to be taxed when a resident turns to be a non-resident (Properties are not subject yet).

To prevent a loop hole, gift and inheritance of stocks with unrealized capital gain will be taxable.

Tax can be suspended by an application for those who do not have cash to pay the tax.

Scope

(1) Person with her total assets in stock, derivatives etc over 100 million yen, and
(2) person who has been in Japan more than 5 years in the past 10 years (excluding a spouse of a permanent resident or Japanese national).

Tax rate

15.315 percent

Exception/ Exempt

This taxation seems to target mainly Japanese nationals moving out of the country after they made fortune, to avoid capital gain tax.

Foreign nationals with Japanese spouse seem to be exempt since June 2020. We have to follow any changes in regulation very closely not to miss anything.

Reporting requirement of foreign asset

If you have assets of more than 50 million yen in value overseas, you are required to reports them to the authority together with your tax return.

Tax saving – basics things better than sexy ones

I recently had a meeting with one of our clients. The client company is doing very well and, naturally, they wanted to talk about how to minimize their tax as their year-end is getting nearer. We knew that tax saving would be a major subject in the meeting but partly because I was occupied with other things, I did not spend enough time for my home work.

As expected, the president of the company asked me, as CPA, to to provide some advice on reducing their tax. I could not give realistic or feasible ones but mentioned only those general things like buying properties, insurance policies or buying things that can be expensed immediately. Frankly, I have to admit I failed spectacularly to convince the president what I had to propose.

The CEO knew much more about in and out of the company, of course. One of their director was retiring. They were waiting to pay his retirement money until the refund of one of their insurance policy would come from the insurance company. I knew that, too! The president asked if the company could pay the retirement money before the refund comes. Of course, the answer is YES!.

Then he asked if they could write off some of their bad debt that have been on their book for some time. Again, the answer was yes.

With his suggestions, the taxable income became almost as half at it was originally presented. And those items are all basic. Paying expenses that have to be paid anyway, writing off accounts receivable that are now broke or bankrupt, or writing off inventories or things are not in use any more. They are really basic things. I should not have missed them.

I think I realized again the importance of know-your-clients rule. If you want to save income tax of you clients, you need to know your client very well, including things that are happening very recently too. And you need to stare the balance sheet. There must be a hint.