A new protocol to the income tax treaty between the United States and Japan has been signed by representatives of both countries, but its provisions will not enter into force until both countries have completed ratification of the protocol. It amends the tax treaty, which has been in effect since 2003, to update several provisions and bring them into closer conformity with current tax policies of the U.S. and Japan. The protocol provides for exclusive residence-country taxation of interest; this will mean a zero rate of withholding on interest payments, except in certain circumstances of business activity in which case a 10 percent rate will apply; or if the interest is effectively connected with a permanent business establishment in which case no treaty-based reduction will apply. The protocol also includes an expanded category of direct dividends which could be eligible for a zero rate of withholding. The protocol amends the provisions of the existing tax treaty governing the taxation of capital gains in a manner that permits the United States to fully apply the Foreign Investment in Real Property Tax Act (FIRPTA). Consistent with a number of recent U.S. tax treaties, the protocol provides for resolution through mandatory binding arbitration of certain cases that the revenue authorities of the United States and Japan have been unable to resolve after a reasonable period of time. In addition, the protocol adopts provisions that enable the competent authorities to assist each other in the collection of taxes, and provides for the full exchange of information between the competent authorities to facilitate the administration of each country’s tax laws.
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