After the establishment of a Japanese subsidiary, in some cases, a foreign parent company lends funds to its Japanese subsidiary due to the Japanese subsidiary’s cash flow. This section describes Withholding Tax imposed on the interest that will be subsequently paid to the foreign parent company.
Under Japanese domestic tax law, when a Japanese company pays interest to a foreign company, it is required to withhold an amount equal to 20.42% of the interest and pay the withheld Withholding Tax to Japan Tax Office by the 10th day of the month following the interest payment date. The term “payment” for the Withholding Tax purpose includes not only the actual remittance of money, but also the transfer into the loan principal or the offsetting with any receivables held by the Japanese subsidiary. Thus, if a foreign parent company offsets the loan interest against the service fee to be paid to its Japanses subsidiary, this offset constitutes a “payment” of interest and triggers the Withholding Tax obligation.
However, when interest is paid to a foreign parent company located in a country with which Japan has a tax treaty, the 20.42% Withholding Tax under Japanese domestic tax law may be reduced or exempted. For example, according to the U.S.-Japan Tax Treaty as amended in 2019, Withholding Tax imposed on the payment by a Japanese company to a U.S. company is exempt under certain requirements, including the LOB (Limitation on Benefits) clauses*.

(*) LOB clauses under the U.S.-Japan Tax Treaty are complicated, but in concept, these clauses check whether the U.S. parent company receiving payment of dividends, interest and royalties has certain roots in the United States. For example, under the treaty, a person/company who falls into one of the following categories is treated as having certain roots in the U.S. and satisfying the LOB clauses (i.e., is eligible for the treaty exemption).

• U.S. resident individuals
• Companies listed in the U.S. stock market
• Certain U.S. companies in which 50% or more of the stock is owned by U.S. resident individuals

In addition, please note that in order to apply the tax reduction/exemption under a tax treaty, you are required to submit certain notifications to Japan Tax Office by the day before the payment date of dividends, interest and royalties.
The following picture shows the cases where Japan and the country the parent company is located in do not have a tax treaty, and they have a tax treaty.

Finally, it is necessary to check the corporate income tax rule of the country in which the foreign parent company is located to determine whether the Japan Withholding Tax imposed on the interest is eligible for Foreign Tax Credit on the foreign parent company’s side. Please note that it is highly likely that the Japanese Withholding Tax on payments without application of the tax treaty despite the treaty can be applied will not be eligible for Foreign Tax Credit on the foreign parent company’s side.