Japanese tax structuring


Tokurei yugen kaisha 'TYK' limited liability company tax benefits

7.  Tokurei yugen kaisha 'TYK' tax benefits.

PLEASE NOTE - Effective May 1, 2006, Japan's Limited Liability Company Law is abolished and for legal purposes yugen kaishas will be treated as sole director kabushiki kaishas. Existing yugen kaishas will continue to operate as "tokurei yugen kaisha" or "TYK". The last day upon which a yugen kaisha can be registered is April 30, 2006. This section will be revised within the next few days.

As mentioned in the previous section on tax structures to consider for doing business in Japan, the tokurei yugen kaisha "YK" has numerous administration advantages compared to the kabushiki kaisha "KK" and especially for a US parent can offer a substantial tax advantage compared to either a branch office or kabushiki kaisha.

A US parent can elect to treat a tokurei yugen kaisha Japanese subsidiary as a 'disregarded entity' or partnership for income tax purposes. That means that if you are a US company starting business in Japan, a yugen gaisha is a per se eligible entity under the 'check the box' entity classification regulations for US tax purposes and will allow you to obtain flow-through US income tax treatment for your Japanese business income.

Unless you have the resources to engineer and maintain a 'Dutch TK' (a tokumei kumiai "tk" 'silent partnership' that is funded by a Dutch parent further to the Japan-Netherlands tax treaty) the yugen gaisha is the way to go. If you are a US SME starting business in Japan then it is probably the optimal solution. The yugen gaisha has low administration costs, is not subject to annual statutory audits, has minimal corporate governance overhead and gives litigation protection for the foreign parent. The only real obstacle to any foreign company starting business in Japan with a yugen kaisha will most likely be its local Japanese executives who will complain (as noted in those myths of the Japanese market) that the perceived prestige of the kabushiki kaisha is essential to success. To counter that largely out-dated myth, I would point your subsidiary President to one of the most notable foreign company subsidiaries to be incorporated in Japan as a yugen kaisha - Exxon Mobil y.g.!

While every Japanese subsidiary will have unique aspects to its costs of doing business in Japan and its relationship with its foreign parent, the most generally tax efficient and legal structure for starting business in Japan that I know is as follows:

  1. setup a yugen kaisha as your Japanese company (from May 1, 2006 this will mean acquiring an existing tokurei yugen kaisha) and, if you are a US parent, consider electing to have treated as a check-the-box entity,
  2. carefully structure a distribution agreement between the yugen gaisha and the foreign parent with transfer fees calculated at the justifiable limit of the spectrum and tested using similar arms-length metrics to those used by the Japanese tax office (all transfer fees will be liable to withholding taxes of 20% less relief if the revenue stream is classed as royalties - although that withholding tax will be eliminated for US companies doing business in Japan with the ratification of the new 2004 US-Japan tax treaty),
  3. carefully structure a management services and consulting services agreement between the foreign parent and the yugen gaisha ensuring that the services can be realistically provided by the parent and that the cost paid for those services by the yugen gaisha is justifiable,
  4. create a justifiable funding plan for the yugen kaisha using a mix of equity and debt financing while ensuring that the yugen gaisha is not likely to be penalized under 'thin capitalization' rules and that interest payments are justifiable (difficult given Japan's sub-1% interest rates but achievable in the early days as the chances of raising local Japanese loans will be slim!),
  5. if you are a software company - carefully consider the ratio between your initial license fees, update/upgrade license fees and maintenance/support fees because transfers of maintenance/support fees are not liable to withholding taxes (again this is about to change for US companies doing business in Japan because of the ratification of the new 2004 US-Japan tax treaty),
  6. again if you are a software company - consider shrink-wrapping your software (as opposed to selling software + annual update contracts) because a gray area exists in the definition of shrink-wrapped software that can presently allow you to avoid deduction of withholding taxes (again this is about to change for US companies doing business in Japan because of the ratification of the new 2004 US-Japan tax treaty),
  7. if your Japanese revenues will be high-margin and your head-office is in a lower tax rate country (the UK for instance), then consider adding corporate product development and marketing functions to the yugen gaisha (as opposed to head-office) to reduce Japanese income tax exposure while increasing your profits in the lower tax head-office country (intra-corporate outsourcing),
  8. consider structuring the yugen kaisha as a manufacturer and final assembler whereby it imports components from the head-office (paying a transfer price for those components), licenses manufacturing technology from the head-office and also manufactures custom/localized components and does final assembly in Japan,
  9. consider shifting R&D functions to the yugen gaisha.

The objective is to legitimately shift margins from Japan (a high tax jurisdiction) to lower tax jurisdictions by shifting costs to the yugen kaisha. The business benefit is realized because its more efficient to use cash for manufacturing and R&D than to lose it in income taxes. The above structure could result in your effective Japanese income tax rate being less than 10% - substantially less than the 42% paid by many foreign companies on the profits they earn doing business in Japan, while substantially reducing your costs in lower tax regions and increasing your output.

PLEASE NOTE that this section is here for guidance only. Japan has 45 or more tax treaties in place, each of which is different and all of which are constantly being challenged and reinterpreted. Before using any form of non-standard structure YOU MUST GET INDEPENDENT TAX ACCOUNTING AND LEGAL ADVICE!

8.  tokumei kumiai 'TK' tax benefits >>

Japanese tax structuring

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