Japanese Pension Income Under US/Japan Tax Treaty

Japanese Pension Income Under US/Japan Tax Treaty

Japanese Pension Income 

Japanese Pension Income Under US/Japan Taxation Treaty: When it comes to the United States and the international tax treaties, one of the main purposes behind the tax treaty is to help Taxpayers identify how certain income will be taxed by the IRS or Japan National Tax Agency — depending on if the income is sourced. Pension is a key ingredient in any tax treaty. In general, the United States taxes individuals on their worldwide income — and Pension in general is a taxable category of income (domestic and foreign pension). In addition, how the pension interacts with the saving clause is also crucial — because what may sound wonderful on first glance does not really mean what it purports to mean when it is taken in accordance with the saving clause. Stated another way, while US Persons may initially believe they are entitled to some great benefits under the Japan/US Tax Treaty for pension payments, once the treaty is read as a whole — the benefits are not so wonderful. Let’s take a look at how the US and Japan tax treaty impacts pension.

Saving Clause

      • (a) Except to the extent provided in paragraph 5, this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4) and, in the case of the United States, its citizens.

      • (b) Notwithstanding the other provisions of this Convention, a former citizen or long-term resident of the United States may, for the period of ten years following the loss of such status, be taxed in accordance with the laws of the United States, if the loss of such status had as one of its principal purposes the avoidance of tax (as defined under the laws of the United States).

What does this Mean?

Paragraph four (4) of article one (1) refers to the infamous Saving Clause. The saving clause is in present in nearly all treaties and provides that despite any benefits that may be afforded under the tax treaty, each country reserves the right to still tax the way they want in accordance with their own country’s tax rules  — aside from any limitations identified in the paragraph below (Article 1, Paragraph 5). In other words, the tax treaty provides certain benefits — the saving clause restricts the application of those benefits  — and paragraph 5 below is an exception to the saving clause so that the treaty law should trump non-treaty law.

Saving Clause Exemptions

      • The provisions of paragraph 4 shall not affect the benefits conferred by a Contracting State under paragraphs 2 and 3 of Article 9, paragraph 3 of Article 17, and Articles 18, 19, 23, 24, 25 and 28, but in the case of benefits conferred by the United States under Articles 18 and 19 only if the individuals claiming the benefits are neither citizens of, nor have been lawfully admitted for permanent residence in, the United States.”

What does this Mean?

It means that despite the restriction and limitation on benefits under the treaty by way of the saving clause, the provisions identified in paragraph five (5) of article one (1) limit the application of the saving clause so that the treaty should still hold as to the benefits provided in the treaty.

ARTICLE 17 Pension – Step 2

      • Subject to the provisions of paragraph 2 of Article 18, pensions and other similar remuneration, including social security payments, beneficially owned by a resident of a Contracting State shall be taxable only in that Contracting State.

      • Annuities derived and beneficially owned by an individual who is a resident of a Contracting State shall be taxable only in that Contracting State. The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during the life of the individual, or during a specified or ascertainable period of time, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

      • Periodic payments, made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support, including payments for the support of a child, paid by a resident of a Contracting State to a resident of the other Contracting State shall be taxable only in the first-mentioned Contracting State. However, such payments shall not be taxable in either Contracting State if the individual making such payments is not entitled to a deduction for such payments in computing taxable income in the first-mentioned Contracting State.

What does this Mean?

It means that subject to article 18 paragraph 2, that when pensions and other Social Security is paid to a resident of one country, it will only be taxable in that country. For example, Denise is a US Citizen who resides in Japan. Therefore, any pension she receives as a resident in Japan, should only be taxed in Japan. Thus, if Japan does not necessarily tax that type of pension, then Denise could escape the US tax — if it wasn’t for the Saving Clause.

The Saving Clause allows the United states to reserve the right to continue taxing Denise’s pension — because this saving clause limits the application of treaty benefits unless the type/category of income is excluded from the Saving Clause.

Article 17 is not excluded from the saving clause other than paragraph 3 — which is not applicable to Denise’s pension.

ARTICLE 18  Government/Public – Step 3

    • 1. (a) Salaries, wages and other similar remuneration, other than a pension and other similar remuneration, paid by a Contracting State or a political subdivision or local authority thereof to an individual in respect of services rendered to that Contracting State or political subdivision or local authority thereof, in the discharge of functions of a governmental nature, shall be taxable only in that Contracting State.

    • (b) However, such salaries, wages and other similar remuneration shall be taxable only in the other Contracting State if the services are rendered in that other Contracting State and the individual is a resident of that other Contracting State who: (i) is a national of that other Contracting State; or 28 (ii) did not become a resident of that other Contracting State solely for the purpose of rendering the services.

    • 2. (a) Any pension and other similar remuneration paid by, or out of funds to which contributions are made by, a Contracting State or a political subdivision or local authority thereof to an individual in respect of services rendered to that Contracting State or a political subdivision or local authority thereof, other than payments made by the United States under provisions of the social security or similar legislation, shall be taxable only in that Contracting State.

    • (b) However, such pension and other similar remuneration shall be taxable only in the other Contracting State if the individual is a resident of, and a national of, that other Contacting State. 3. The provisions of Articles 14, 15, 16 and 17 shall apply to salaries, wages and other similar remuneration, and to pensions and other similar remuneration, in respect of services rendered in connection with a business carried on by a Contracting State or a political subdivision or local authority thereof.

What does this Mean?

Paragraph two (2) of Article 18, is exempt from the saving clause by way of paragraph 5 under article 1 of the treaty (with an exception identified below).

Let’s translate that into English:

Paragraph two (2) of Article 18 provides that if the pension being paid is a public or government pension, then it is only taxable in the country that issues the pension. Therefore, if a US person earns public pension from work performed in Japan, then they can claim that it is only taxable in Japan. It does not apply to a US Citizen or Permanent Resident of the United States involving benefits from the United States.

      • “5. The provisions of paragraph 4 shall not affect the benefits conferred by a Contracting State under paragraphs 2 and 3 of Article 9, paragraph 3 of Article 17, and Articles 18, 19, 23, 24, 25 and 28, but in the case of benefits conferred by the United States under Articles 18 and 19 only if the individuals claiming the benefits are neither citizens of, nor have been lawfully admitted for permanent residence in, the United States.

What does this Mean?

Luckily in the example of a US person residing in Japan and receiving benefits from a public pension in Japan — the saving clause exception may not limit the tax benefits. But, if that same US person was receiving benefits from the United States under paragraphs 18 or 19 (Social Security), then it is only excepted when the person is neither a US Citizen nor Permanent Resident.

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