A Guide to Japan’s Amazing Tax Exemption Scheme for Investment by Individuals

In many countries, capital gains made by individuals are taxable, and with a hefty rate at that. Interestingly, Japan has a special system in place which allows tax-free investments and in some cases even tax deductions. What is the reasoning behind such a system? How could you benefit from it after making an investment? Let’s find out together!

The Wonderful NISA Scheme: Turn a Profit From Investing Without Paying Tax

In 2014, the Japanese government introduced NISA (Nippon Individual Savings Account), a new tax exemption program for small investments by individuals that was based on the U.K.’s Individual Savings Accounts. To put it simply, money earned from stock and mutual fund investing in a NISA account can be excluded from one’s taxable income, with the maximum amount for each NISA account being 1.2 million JPY a year.

In other words, as long as you buy stocks through a NISA account, any dividends you receive are not subjected to taxation.

NISA is open to any adult who lives in Japan legally. Most investments are fair game for a NISA account, including individual stocks, ETFs, and other mutual funds. For those under the age of 20, there is also the Junior NISA, which is a way to save money for minors. Overall, NISA is a great tool for beginners who would like to try investing but are worried about taxation.

Two Types of NISA

Apart from the regular 5-year NISA, which is designed for shorter-term investment, there is also the “Tsumitate NISA,” which is designed for long-term investment.

As opposed to the higher limit of regular NISA investments, Tsumitate NISA investments are capped at 400,000 yen per year. Also, the investments are limited to selected investment trusts, meaning you can’t pick and choose your stocks and ETFs like you can with a standard NISA account. In exchange for these limitations, however, it offers a tax-exempt period of a whopping 20 years, making it a great choice for people planning to make long-term investments.

One thing to note is that the Japanese government is planning to launch a revamped NISA system by 2024, and the standard NISA will become a bit more complicated. The Tsumitate NISA, however, will be mostly unchanged, so if you’re trying to decide which type of account to start with, you might want to consider choosing Tsumitate NISA.

The Foreign Tax Credit: Don’t Get Taxed Twice!

There are ways to buy foreign stocks, invest in overseas markets, or manage investment products bought in your home country despite living in Japan. If you have made enough profit to be subjected to taxation in those countries, don’t forget to apply for a “foreign tax credit.”

In order to prevent Japanese residents from paying income tax twice, anyone who is taxed abroad is eligible for a tax deduction. Imagine you have a total income of 6 million yen this year, 2 million of which was made overseas. Without the foreign tax credit, you would be required to pay about 772,500 JPY of income tax.

By applying for the foreign tax credit, however, you will be able to reduce your tax burden by 257,500 yen! This is calculated by dividing your foreign earned income (2 million yen) by your total income (6 million yen), and then multiplying the result by the total tax amount (772,500). See the official NTA website for full details.

Of course, the foreign tax credit is only applicable to legally earned income. Moreover, one has to already have residency in Japan when the investment was made. Don’t miss out on the opportunity to save some bucks if you have your eyes on foreign investment markets.

The Angel Tax System: Save More by Investing in Startup Companies

To encourage people to invest in startups, the Japanese government implemented the “angel tax system,” granting benefits to shareholders of certain companies.

How angelic the system is depends on the age of the company. If it was established less than 3 years ago, investors would be eligible for Plan A, where the full investment is deductible from the gross taxable income of that year after paying a mere 2,000 JPY fee. In short, you receive a big discount on your income tax, albeit with an upper limit of 8 million JPY.

If the startup is older than 3 years, but less than 10 years old, investors can go for Plan B, where the invested amount is deductible from capital gains from other investments, with no ceiling. This tax deduction is especially useful for experienced investors, since in Japan, earnings from stock trading and other forms of investments are subjected to various taxes such as income tax (15%), resident tax (5%), and more (an extra 15-55% depending on the profit made).

But what if the startup you invested in suffers huge losses or closes down? Keep reading!

Convert Losses Into a Tax Deductions

It is impossible to always turn a profit; such is the way of investment. Hoping to help out those who are losing money, the government of Japan has two measures in place: aggregation of profit and loss, and deduction for carryover of loss.

Let’s say you bought stock A and stock B this year, and made 100,000 JPY from A but lost 40,000 JPY from B. Normally, all of the 100,000 yen JPY earned would be subjected to taxation. With “aggregation of profit and loss,” however, the 40,000 JPY you lost on stock B can be deducted from your capital gains, meaning your total taxable income would be reduced to just 60,000 JPY!

On the other hand, if stock B cost you 150,000 JPY, even after applying aggregation of profit and loss, you would still suffer a net loss of 50,000 yen. This is when “deduction for carryover of loss” comes into play. This rule allows a tax deduction from a loss to be carried over to the next 3 years. As long as you make money during this period, you are free to convert the 50,000 JPY loss into tax credit so as to pay less income tax. These two rules help to provide a bit of cushion from the high risks that come with investments.

Invest Wisely and Save On Taxes!

Hopefully, this article was able to give you a basic idea of how Japanese investors save on taxes. Investment (covered in this article) is just one of the myriad ways to make good use of your capital. While profit is not guaranteed, some of the systems and rules laid out in this article do help to reduce some of the risks and downsides that come with normal investing. If you have a few bucks to spare, why not take advantage of these tax exemption schemes and try investing to set yourself up for a better retirement?

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The information in this article is accurate at the time of publication.