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Revised Japan-Germany Tax Treaty’s Impacts on Corporations

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According to the Ministry of Finance Japan, on 17 December 2015, Japan and Germany signed the ‘Agreement between Japan and the Federal Republic of Germany for the Elimination of Double Taxation with respect to Taxes on Income and to Certain Other Taxes and the Prevention of Tax Evasion and Avoidance’ (the New Treaty).

The New Treaty has wholly revised the existing treaty and is expected to revitalize further mutual investments and business exchanges between Japan and Germany.

The main contents of the New Treaty are as follows.

2.Major Revisions
Business profits (Article 7)
Along with the revision of the OECD Model Tax Convention in 2010, regarding taxation on a permanent establishment such as a branch, etc. of a foreign corporation and a non-resident, the New Treaty applies the arm’s length principle more strictly and calculates the business profits attributable to the permanent establishment by comprehensively recognizing internal transactions between its head office and branches.

Dividends (Article 10), Interest (Article 11), Royalties (Article 12)
The withholding tax rates on investment income (dividends, interest, royalties) are further reduced or exempted in the source country as follows:

From the point of preventing abuse of the benefits under the treaty, it is stipulated that only qualified residents meeting certain conditions and others are entitled to the benefits under the new treaty.

For the purpose of enhancing the prompt settlement of disputes related to the application of the treaty, arbitration proceedings in mutual agreement procedures (procedures settling disputes based on the resolution by third-party in case of not being resolved by the tax authorities of the two contracting countries) are introduced.
In order to deal with international tax evasion and tax avoidance more efficiently, the structure of mutual assistance in collecting taxes (mutual administrative assistance in tax matters) between the two countries is introduced, along with expanding the scope of taxes and cases subject to the provisions for exchanges of information regarding tax matters.

3. Revision’s Impacts on Corporations
Consideration of Capital Allocation
In the current treaty, dividend paid from Germany to Japan, income tax is withheld at source at a rate of 15% in Germany. When applying foreign subsidiaries’ dividend exclusion rules, the income tax withheld at source in Germany is not deductible as expenses in calculating corporation tax in Japan, which is cost burden for Japanese companies. Thus, by expecting to receive the benefits of tax reduction or exemption under the New Treaty, both Japanese companies investing in Germany and German companies investing in Japan should consider the timing of paying dividends and the allocation in group entities (capital allocation).

Reconsideration of contracting parties
Due to the reform of royalties’ taxation and others, a company having royalty contract with its holding entity located outside of Japan and Germany, could receive the benefits under the New Treaty by reconsidering its contracting parties.

Consideration of investment
The New Treaty aims to enhance further investments and economic exchanges between Japan and Germany by eliminating tax barriers, so companies could reconsider the new investment schemes.

Arbitration proceedings for mutual agreement procedures
The provision of arbitration proceedings for mutual agreement procedures under the New Treaty enhances the solution of disputes such as transfer-pricing rules and other international double taxation problems in case of not resolving the issues between the tax authorities of both countries.

Please note that you might be required to resubmit the ‘Application Form for Income Tax Convention’ if you calculate the income tax withheld at source under the New Treaty.

4. Effective Date
The New Treaty will enter into force after taking some internal procedures including approval by the Diet in the case of Japan. It is not decisive yet, but judging from the schedules of the previous tax treaties, the New Treaty will become effective from January 2017.

5. Conclusion
In this News, we have introduced ‘Revised Japan-Germany Tax Treaty’s Impacts on Corporations’.

Please note that this News only introduces general outlines of the content and does not include professional advice. So please make sure not to make any decisions without taking professional advice individually. If you have any questions, please feel free to contact us.

The Ministry of Foreign Affairs of Japan website
The Ministry of Finance Japan website