Withholding Tax

A business that pays a nonresident or a foreign corporation an amount related to a derivative is responsible for withholding and remitting the tax when the payment falls into a category subject to withholding. In the tax work of a Japanese company that receives payments, income tax imposed on certain income is deducted from corporation tax.

The payer deducts the tax and remits it

In withholding tax, the person who pays, not the person who receives, remits the tax to the government. A person who pays interest, etc. or dividends, etc. in Japan to a resident withholds tax at the time of payment. The person remits it by the 10th of the month following the month in which it was withheld¹. A person who pays a nonresident or a foreign corporation Japan-source income in a category listed for withholding does the same². Even if the payment is made outside Japan, it is treated as made in Japan when the payer has an address, residence, office, or the like in Japan. The remittance deadline is then the last day of the following month³.

Japan's categories of Japan-source income include no category named derivative transactions⁴⁵.

What is subject to withholding

When paying a nonresident or a foreign corporation, withholding is required on Japan-source income in the categories the Income Tax Act lists for withholding. The categories for a foreign corporation do not include salaries and similar income. A Cabinet Order can exclude some income. For a foreign corporation, income covered by the special rules for a foreign corporation with a permanent establishment and for interest, etc. on trust property is also excluded²⁶. The listed categories do not include income attributable to a permanent establishment, income from the management or holding of assets in Japan, income from the transfer of assets in Japan, or the category left to a Cabinet Order².

The Income Tax Act sets the rate for each category⁷. The table below picks out some of the categories to show the structure of the provisions.

"Not listed" means that the income is not subject to withholding under this article. It does not mean that the income is not taxed, because it may be taxed by another method.

The rates are income tax rates, and the reconstruction special income tax is added on top. From 2027, the defense special income tax is added as well⁴⁷⁸. Which row of the table a derivative payment falls into, or whether it falls into a category not in the table, must be decided case by case from what the payment is.

When a nonresident with a permanent establishment receives certain Japan-source income attributable to that establishment, the payer need not withhold if the nonresident shows the payer a certificate from the head of the tax office⁹. A similar system exists for foreign corporations¹⁰.

The application form that lowers the rate under a tax treaty

To claim a reduction of or exemption from the withheld income tax under a tax treaty, the nonresident or foreign corporation that receives the income files an application form (titled "application form for income tax convention"). The form differs by type of payment, and the main ones are for dividends (Form 1), interest (Form 2), and royalties (Form 3). The form is prepared for each payer. It is submitted, through the payer, to the head of the tax office with jurisdiction over the payer's place of tax payment, no later than the day before the recipient first receives the income⁸.

For a treaty with a limitation on benefits article, a recipient claiming a reduction or exemption on income covered by that article attaches an attachment form for limitation on benefits (Form 17) and a certificate of residence to the application form⁸.

If the form has not been filed by the day before payment, the payer withholds at the domestic-law rate, not at the maximum rate provided in the tax treaty. The recipient can later file the application form and a refund claim form for withholding tax under the treaty (Form 11) to claim the difference¹¹.

Consider a hypothetical example in which V Corp, a Japanese company, pays a nonresident counterparty (the payee) 10 million yen of Japan-source income. The domestic-law rate is 20% and the maximum rate provided in the tax treaty is 10%. The reconstruction special income tax and similar taxes are not included. The net amount received is found with the following formula.

$$\text{net amount} = \text{payment} - \text{payment} \times \text{rate}$$

If the form is not filed in time, the recipient's net amount is 1 million yen lower than if tax had been withheld at the maximum rate. If a later refund claim is allowed, the recipient can claim the 1 million yen difference, and the net amount becomes 9 million yen.

Figure description

Dotted lines show the flow of the application form, and solid lines show the flow of money. The form is submitted to the head of the tax office with jurisdiction over the payer's place of tax payment.

Figure description

The figure shows a payment made in Japan. The intervals are not proportional to elapsed time.

How a group allocates the profit from cross-border trades among its members is covered in Transfer Pricing for Cross-Border Trades.

US withholding on dividend equivalents

The United States treats certain payments that reference dividends on US stocks as US-source dividends and subjects them to withholding¹². These payments are called dividend equivalents. A 30% tax applies to US-source dividends and similar income that a nonresident individual receives and that is not effectively connected with a US business¹³. A foreign corporation is taxed at 30% on the same terms¹⁴. Residents of countries that have a tax treaty may receive a reduction or exemption¹⁵. The amount of tax on a dividend equivalent also reflects whether a treaty benefit was available at that time¹⁶.

Payments that are dividend equivalents

A dividend equivalent is a payment that is contingent on, or determined by reference to, a US-source dividend. It is one of the following: a substitute dividend under a securities lending or sale-repurchase transaction, a payment under a specified notional principal contract, or a payment under a specified equity-linked instrument. Payments that substantially resemble these are also included, and distributions that are not taxed even if the recipient holds the shares are excluded¹²¹⁷. A notional principal contract is a contract defined in Treasury Regulation § 1.446-3(c)¹⁸. An equity-linked instrument is a transaction that references the value of shares, such as a future, forward, or option¹⁹.

Under the rules for 2017 and later, a simple contract, which calculates payments by reference to a single fixed number of shares determined when the calculation is made and has a single maturity or exercise date, is covered when its delta is 0.8 or greater²⁰²¹. Delta is the ratio of the change in the contract's value to a small change in the value of the number of shares it references²².

Deep diveWhen delta is measured, and how a contract that is not simple is tested

Delta is measured at the earlier of the time the contract's price is determined and the time the contract is issued. If the price is determined more than 14 calendar days before issuance, delta is measured at the time of issuance²². A contract that is not simple is tested by a substantial equivalence test, which compares it with a simple contract with a delta of 0.8²³.

Calculating the dividend equivalent

For a simple contract, the dividend equivalent is found for each dividend with the following formula²⁴.

$$\text{dividend equivalent} = D \times N \times \delta$$

$D$ is the dividend per share, $N$ is the number of shares the contract references, and $\delta$ is the delta. The dividend equivalent is determined on the earlier of the dividend's record date and the day before the ex-dividend date²⁴.

The party that receives the dividend equivalent is the long party, and the party that pays it is the short party²⁵.

Deep diveHow payments are counted, and implicit dividends

Payments are counted on a gross basis. If a gross amount that references a dividend is used in a calculation that nets the payments between the parties, a payment has been made even when the netted result is zero or when the long party pays the net amount²⁶.

Even if a dividend is not written into the terms, a payment is treated as referencing a dividend when terms such as the interest rate or the price are set with the dividend priced in. If the short party does not provide a reasonable estimated dividend in writing at the time delta is calculated, the actual dividend amount is used²⁶.

Consider a hypothetical example in which a non-US long party enters into a simple equity swap referencing 1,000 US shares. The contract is a notional principal contract issued on or after January 1, 2018, with a dividend of USD 2 per share and a withholding rate of the statutory 30% or an assumed treaty rate of 15%. The contract is also assumed to meet no other condition for being a specified notional principal contract, and the combined-transaction and anti-abuse rules are assumed not to apply.

In Case A, the dividend equivalent is $2 \times 1{,}000 \times 0.9 = 1{,}800$ USD. At 30%, USD 540 is withheld and USD 1,260 remains in hand. At 15%, USD 270 is withheld and USD 1,530 remains. In Case B, delta is below 0.8, so under this rule there is no dividend equivalent and no withholding. With the same number of shares and the same dividend, a different delta changes whether tax is withheld.

This rule applies to payments made on or after January 19, 2017. However, the tests for specified notional principal contracts and specified equity-linked instruments depend on when the transaction was issued. For a transaction with a delta of 1 (one that moves by the same amount as the referenced shares), the rule applies to transactions issued on or after January 1, 2017. For other transactions, it applies to those issued on or after January 1, 2018²⁷.

Practice for the payer and the recipient

When paying a nonresident or foreign corporation in Japan

The steps the law requires of the payer are listed below in time order.

1. Confirm whether the recipient is a nonresident or a foreign corporation, and whether the payment falls into a category of Japan-source income².
2. Confirm whether the tax treaty application form and its attachments were filed by the day before payment. If they were, use the maximum rate. If not, use the domestic-law rate⁸.
3. Deduct the tax at the time of payment².
4. Remit it to the government by the 10th of the month following the month in which it was withheld. If the payment is made outside Japan, the deadline is the last day of the following month²³.
5. File a payment record with the head of the tax office in accordance with the applicable Ordinance of the Ministry of Finance. The deadline is, in principle, January 31 of the year after the year in which the payment became fixed. For records on dividends, etc. and on a share of partnership business profits, limited to profits earned through a permanent establishment and specified by Cabinet Order, it is within 1 month from the day the payment became fixed²⁸.

When paying a US dividend equivalent

Under the US withholding provisions, each party to a contract that provides for the payment of a dividend equivalent is treated as having control of that payment¹². A payment subject to withholding is reported on Form 1042-S, and a Form 1042 return is filed²⁹. Because a dividend equivalent is determined on the gross amount before payments are netted, there can be a payment for reporting purposes even when no funds move³⁰.

Dealers in equity derivatives have the qualified derivatives dealer (QDD) regime. A QDD that meets certain conditions is not subject to the section 881 tax on dividend equivalents it receives in that capacity. However, the QDD's own section 871(m) amount is subject to the section 881(a)(1) tax. This is the QDD's own share of the burden, which the QDD calculates for each dividend on an underlying share from its own positions³¹. The 2026 edition of IRS Publication 515 says that QDDs begin calculating this amount in 2027³².

When a Japanese company is the recipient

When a Japanese company receives a payment listed in the Income Tax Act, such as interest or dividends, and income tax is imposed on it, that income tax is deducted from the corporation tax for the business year, in accordance with a Cabinet Order. This applies only when a document stating the amount of the deduction and the details of its calculation is attached to the final return or similar filing³³.

When a company pays foreign corporate tax abroad, the amount is deducted from the amount of corporation tax, up to the deduction limit. For a year in which the limit is exceeded or not reached, the deduction limits and the foreign corporate taxes eligible for deduction of business years within the previous 3 years can be carried forward and used, in accordance with a Cabinet Order. Which foreign taxes are eligible and how the limit is calculated are set by Cabinet Order³⁴.

What this article does not cover

Which category of Japan-source income an individual derivative payment falls into, and rate exceptions under the Act on Special Measures Concerning Taxation, are not covered on this page. Whether a foreign tax on a derivative payment qualifies for the foreign tax credit, and internal procedures and the responsible department that the law does not set, are not covered either.

Notes

1. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 181, paragraph 1. A person who pays interest, etc. or dividends, etc. in Japan to a resident withholds income tax at the time of payment and remits it to the government by the 10th of the month following the month of the withholding date. The text of the provisions as checked on e-Gov Law Search on October 5, 2026. ↩

2. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 212, paragraph 1. It covers payments of Japan-source income under Article 161, paragraph 1, items 4 to 16 to a nonresident, and under items 4 to 11 and 13 to 16 to a foreign corporation, excluding what a Cabinet Order specifies. ↩ ↩² ↩³ ↩⁴ ↩⁵ ↩⁶

3. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 212, paragraph 2. A payment made outside Japan is treated as made in Japan when the payer has an address, office, or the like in Japan, and the deadline is the last day of the following month. ↩ ↩²

4. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 161, paragraph 1, items 1 to 17. Item 2 is income from the management or holding of assets in Japan, other than income falling under items 8 to 16. Item 17 is income, other than that under the preceding items, whose source is in Japan as specified by Cabinet Order. Items 8 to 10 are as shown in the table. ↩ ↩²

5. "法人税法" (Corporation Tax Act, unofficial translation, in Japanese), Article 138. The article sets out the Japan-source income of foreign corporations and lists no category named derivative transactions. ↩

6. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 212, paragraph 1, parenthetical. For a foreign corporation, it also excludes what Article 180, paragraph 1 and Article 180-2, paragraphs 1 and 2 cover. ↩

7. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 213, paragraph 1. The amount of income tax withheld under Article 212, paragraph 1 is, in principle, 20% of the amount (item 1). The rate is 10% for Article 161, paragraph 1, item 5 (item 2), and 15% for items 8 and 15 (item 3). ↩ ↩²

8. National Tax Agency, "No.2888 租税条約に関する届出書の提出（源泉徴収関係）" (Submission of application forms for income tax conventions (withholding)) (laws and regulations as of April 1, 2026), "概要" (Overview), "共通事項" (Common matters) and "特典条項を有する租税条約の場合" (Treaties with a limitation on benefits article) (in Japanese). The reconstruction special income tax and the defense special income tax for 2027 and later are from the opening statement of the Overview. ↩ ↩² ↩³ ↩⁴ ↩⁵

9. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 214, paragraph 1. When a nonresident that has a permanent establishment and meets the Cabinet Order requirements shows the payer a certificate from the head of the tax office with jurisdiction over its place of tax payment, for income under Article 161, paragraph 1, items 4, 6, 7, 10, 11, 12 (a) (excluding the part relating to salaries), and 14 that is attributable to the permanent establishment, the payer need not withhold under Article 212, paragraph 1 while the certificate is valid. ↩

10. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 180, paragraph 1. It sets out, for a foreign corporation that has a permanent establishment and meets the Cabinet Order requirements, a system with the same purpose as Article 214. ↩

11. National Tax Agency, "No.2889 租税条約に関する源泉徴収税額の還付請求" (Refund claims for withholding tax under income tax conventions) (laws and regulations as of April 1, 2026), "概要" (Overview) (in Japanese). ↩

12. 26 U.S.C. § 871(m)(1), (2), (3), (7). Paragraph (2) defines a dividend equivalent as a substitute dividend under a securities lending or sale-repurchase transaction, a payment under a specified notional principal contract, or a substantially similar payment. Paragraph (1) treats it as a US-source dividend, and paragraph (7) treats each party to the contract as having control of the payment for purposes of chapters 3 and 4. The definition of a specified notional principal contract is in paragraph (3). ↩ ↩² ↩³

13. 26 U.S.C. § 871(a)(1)(A). A tax of 30% is imposed on a nonresident individual on US-source fixed or determinable annual or periodical income, such as interest, dividends, rents, salaries, and annuities, that is not effectively connected with a US trade or business. Checked at the Legal Information Institute, Cornell Law School, on October 5, 2026. ↩

14. 26 U.S.C. § 881(a). A tax of 30% is imposed on a foreign corporation on the same kind of US-source income that is not effectively connected with the conduct of a trade or business in the United States. ↩

15. IRS, "Publication 515 (2026)," the opening explanation under "Withholding of Tax." US-source income is in many cases subject to a 30% US tax, and a tax treaty with the country of residence may provide a reduction, including an exemption. ↩

16. 26 CFR § 1.871-15(j)(4). The amount of tax on a dividend equivalent is determined by the facts at the time the dividend equivalent is determined, including whether a treaty benefit was available at that time. ↩

17. 26 CFR § 1.871-15(c)(1). It defines a dividend equivalent as a payment that references a dividend under a securities lending or sale-repurchase transaction, a specified notional principal contract, or a specified equity-linked instrument, among others. Paragraph (c)(2) excludes distributions that are not taxed even if the recipient holds the shares, among others. ↩

18. 26 CFR § 1.871-15(a)(7). A notional principal contract is a notional principal contract under § 1.446-3(c). ↩

19. 26 CFR § 1.871-15(a)(4). An equity-linked instrument is a transaction that references the value of an underlying security, other than a securities lending or sale-repurchase transaction or a notional principal contract. ↩

20. 26 CFR § 1.871-15(d)(2)(i). A simple notional principal contract with a delta of 0.8 or greater at the time of calculation is a specified notional principal contract (paragraph (r)(2) sets, by issuance date, when the application of paragraphs (d)(2) and (e) begins). Paragraph (d)(2)(ii) tests a notional principal contract that is not simple by the substantial equivalence test in paragraph (h). The conditions for contracts entered into before 2017 are in paragraph (d)(1). ↩

21. 26 CFR § 1.871-15(a)(14)(i). A simple contract is one in which all payments are calculated by reference to a single fixed number of shares determined when the contract is calculated and the referenced payment has a single maturity or exercise date. A contract with a condition that makes the amount rise or fall discontinuously, such as a digital option, is not a simple contract. ↩

22. 26 CFR § 1.871-15(g)(1), (2). Paragraph (g)(1) defines delta. Paragraphs (g)(2)(ii) and (iii) set the time of calculation at the earlier of the time the contract's price is determined and the time it is issued, and at the time of issuance if the price is determined more than 14 calendar days before issuance. The treatment of listed options and similar instruments is in paragraph (g)(4). ↩ ↩²

23. 26 CFR § 1.871-15(h)(1), (2), (3). The benchmark for a simple contract is an actual or hypothetical simple contract with a delta of 0.8 and the same underlying and maturity, among other terms. ↩

24. 26 CFR § 1.871-15(j)(1)(ii), (j)(2). For a simple contract, the dividend equivalent is the product of the dividend per share, the number of shares, and delta. It is determined on the earlier of the dividend's record date and the day before the ex-dividend date. For a contract that is not simple, paragraph (j)(1)(iii) applies, and the dividend equivalent is the product of the dividend per share and the number of shares in the initial hedge. ↩ ↩²

25. 26 CFR § 1.871-15(a)(9)(i), (ii). The long party is the party that receives the dividend equivalent. The short party is the party that is obligated to pay it. ↩

26. 26 CFR § 1.871-15(i)(1), (2). Paragraph (i)(1) counts a gross amount that references a dividend as a payment when it is used in a netting calculation, even if the net is zero. Paragraph (i)(2)(ii) also counts a dividend implicitly reflected in terms such as the interest rate or the price. Paragraph (i)(2)(iii) deems the actual dividend to be used if the short party does not provide a reasonable estimate in writing. ↩ ↩²

27. 26 CFR § 1.871-15(r)(1), (2). Paragraph (r)(1) applies the rule to payments made on or after January 19, 2017. Paragraph (r)(2) begins the application of paragraphs (d)(2) and (e) for transactions with a delta of 1 from those issued on or after January 1, 2017, and for other transactions from those issued on or after January 1, 2018. Listed structured notes designated in a notice begin with payments on or after January 1, 2020. ↩

28. "所得税法" (Income Tax Act, unofficial translation, in Japanese), Article 225, paragraph 1, item 8. A person who pays Japan-source income under Article 161, paragraph 1, item 4, or items 6 to 16, in Japan to a nonresident or a foreign corporation files a payment record. The filing deadline is in the main text of that paragraph and its parenthetical. The parenthetical sets a deadline of within 1 month from the day the payment became fixed for item 8 records relating to the dividends, etc. defined in item 2 and to income under Article 161, paragraph 1, item 4. ↩

29. IRS, "Publication 515 (2026)," "Forms 1042 and 1042-S Reporting Obligations." A payment subject to withholding under chapter 3 of the Internal Revenue Code is reported on Form 1042-S, and Form 1042 is filed. ↩

30. IRS, "Publication 515 (2026)," "Dividend Equivalents." Because a dividend equivalent is determined on the gross amount, there can be a payment for reporting purposes even when no funds move (see Regulations section 1.871-15(i)). ↩

31. 26 CFR § 1.871-15(q)(1). A qualified derivatives dealer is not liable for the section 881 tax on a dividend equivalent it receives as an equity derivatives dealer, if it complies with its qualified intermediary withholding agreement, but is liable for the section 881(a)(1) tax on its own section 871(m) amount. Paragraph (q)(3) defines that amount, per dividend, as the product of its net delta exposure and the dividend per share. ↩

32. IRS, "Publication 515 (2026)," "Definitions," "Dividend equivalents." It refers to Notice 2024-44, under which QDDs begin calculating their own section 871(m) amount in 2027. ↩

33. "法人税法" (Corporation Tax Act, unofficial translation, in Japanese), Article 68, paragraphs 1 and 4. Paragraph 1 deducts, in accordance with a Cabinet Order, income tax imposed on a domestic corporation's receipt of interest, dividends, and similar payments in the items of Article 174 of the Income Tax Act from its corporation tax. Paragraph 4 applies it only when a document with the details of the deduction is attached to the final return or similar filing. Checked on e-Gov Law Search on October 5, 2026. ↩

34. "法人税法" (Corporation Tax Act, unofficial translation, in Japanese), Article 69, paragraphs 1, 2, and 3. Paragraph 1 deducts foreign corporate tax from the amount of corporation tax, up to the deduction limit. Foreign corporate tax is a tax imposed under foreign law that corresponds to corporation tax and is specified by Cabinet Order. Paragraphs 2 and 3 provide for carrying forward the deduction limits and the foreign corporate taxes eligible for deduction of business years within the previous 3 years. ↩