Japan Estate Tax Consideration Part 3 - Life Insurance to Japanese Residents

I received many inquiries about offering US Life Insurance policy or ILIT (“Irrevocable Life Insurance Trust”) plan for Japanese Residents. Japanese residents may be interested in purchasing the US life insurance policy since Japan life insurance market is small which makes their options less attractive. Here are two big concerns you have to think before you proceed with this planning. I. Licensing Issue. First thing that comes to my mind is licensing issue. According to Japan Insurance Business Act, foreign insures (Art 185) as well as brokers (Art 286), must have a business license to provide (or intermediate for brokers) life insurance policy to Japanese residents. This concern will likely be still the same even if the policy will be directly acquired by the US ILIT, not by Japanese individual residents as long as the insureds are Japanese residents. Therefore, you would be better to confirm with the US Life Insurance Company to provide the policy for the Japanese residents. Make also sure that the potential insureds understand their risk they may have to face. II. Japanese Gift & Estate Tax (“Transfer Tax”) Concern. First of all, Japan Transfer Tax applies to beneficiaries (person who receive the asset), unlike the US Tax Law which applies to decedents (estate). Second, beneficiaries will be subject to the worldwide taxation under Japan Transfer Tax Law depending on the residency and citizenship of decedents and beneficiaries. For example, if the decedent (the insured) and the beneficiary of the insurance proceeds are both Japanese citizens, the proceeds will be subject to the worldwide tax under Japan Transfer Tax Law. Under Japan Estate Tax Code, there is only limited general exemption amount unlike the U.S.. Usually allowed only 30,000,000JPY + (6,000,000JPY x number of legal heirs). (i) Simple Life Insurance Policy Case

1. Insured (G) acquires the life insurance policy insuring G's life from the US Life Insurance Company (I) for the beneficiary (B);

2. G pays the annual premium to the I;

3. I pays the life insurance proceeds to the B at the time of G’s death.

Assume G and B are both Japanese citizen. Japan Estate Tax applies to the B on the amount of the proceeds at the time of G’s death. Under Japan Estate Tax Code, there is no all exemption rule for the life insurance such as "incident of ownership" rule under 26 USC2042(2). However, there is a certain deduction rule under Japan Estate Tax Law: if the ultimate beneficiary of the life insurance proceeds (in this case, B) is a statutory heir of the person, who paid the premium (in this case, G), such as wife or children, the amount, which is equal to 5 million JPY x number of legal heirs, can be deductible from the total amount of insurance proceeds for the estate tax purpose. (ii) ILIT Case. To make sure, here is the hypothetical time line: I made it simple.

1. Grantor (G) set up the US Irrevocable Life Insurance Trust (ILIT);

2. ILIT directly acquires the life insurance policy insuring G's life from the US Life Insurance Company (I);

3. ILIT directly pays the annual premium to the I;

4. I pays the life insurance proceeds to the ILIT at the time of G’s death;

5. ILIT distributes the proceeds in someway to the beneficiary (B) who is possibly the heir of G.

In my opinion, I believe here are the possible outcome for Japan tax: Possible Japan tax scenario (1): gift tax for the funded amount to B at the time of 1 + income tax for the appreciated amount to B at the time of 4(or 5); or Possible Japan tax scenario (2): estate tax for the proceeds amount to B at the time of 4(or 5). First, this transfer is taxable as a “deemed gift (or bequest)” to the B under Japan Transfer Tax. See Japan Estate Tax Code Article 9-2(1). But more importantly, Japan Gift Tax, not Estate Tax, will likely be applicable to the B who was deemed receiving the benefits at the time of trust funding, unless the ILIT is found as the “Life Insurance Trust” under the National Tax Agency Basic Instructions on Estate Tax Law (“Instructions”) No.9. 2-7. In 2013, Nagoya High Ct. approved Japan Tax Authority’s decision treating funding US based ILIT (but please note the decision is not widely referred for this topic) as a gift from the grantor to the beneficiary, at the time of trust funding, under Japan Gift Tax Law since the US based ILIT is not qualified for the “Life Insurance Trust” under the Instructions No.9. 2-7. Therefore, the Japan tax outcome will possibly be the above scenario (1). If the trust is found as the “Life Insurance Trust”, the proceeds will be deemed as a proceed from life insurance contract ( like I mentioned in (i) above) and will be treated as a bequest at the time of death of the insureds (the above scenario (2)). Also if the beneficiary is not a statutory heir of the decedent, this person will not be eligible for claiming the deduction that I mentioned above, such as life insurance proceeds deduction, for his/her estate tax. See Japan Estate Tax Code Article 12(1)(5). Please note that the above discussion will depend on the specific case so please do not think this is the answer for your case.