In the excitement of incorporating a Japanese KK company, starting business in Japan, and recruiting Japanese employees, few if any foreign company executives consider what they would do with the KK company if sales don’t grow as expected, or a sudden unexpected event such as the coronavirus COVID-19 pandemic brings business to a standstill. That’s the time when many executives first realize that shutting down a Japanese KK company is not as straightforward as ending employment and walking away (which is what might be legally acceptable in the US or elsewhere).

A Japanese KK company and its directors (Board of Directors if it has one), continues to exist and is legally required to file annual financial statements and tax-returns, and pay statutory minimum annual corporate taxes, until it is either declared bankrupt or registered as liquidated on the Ministry of Justice’s registry of companies. Bankruptcy in Japan requires either the bankrupt company or a creditor to file a petition for its bankruptcy and to pay a substantial advance amount to cover court and trustee costs. The alternative, which most companies in such a predicament opt for, is statutory liquidation.

Liquating a KK company is governed by Japan’s Companies Act, comprises three legal filings and two tax filings, and takes 4 – 6 months (much longer if prior years’ financial statements need restatement, the National Tax Agency decides to audit, or unknown creditors object). The process is as follows:

1. The KK company convenes a shareholder extraordinary general meeting (“EGM”) at which the shareholders resolve to dissolve the directors (or Board of Directors if applicable) and appoint one or more representative liquidators. The minutes of the dissolution EGM must be filed at the Legal Affairs Bureau (part of the Ministry of Justice) within 15 days of the dissolution EGM.
2. Within 60 days of the dissolution EGM, the liquidator must prepare dissolution financial statements (general ledger, profit and loss statement, and balance-sheet) for the period from the KK company’s most recent financial yearend until the date of the dissolution EGM.
3. The liquidator then convenes an EGM for shareholders to approve the dissolution financials, prepares and files tax-returns, and ensures the KK company pays taxes due. As an aside, the dissolution EGM resets the KK company’s financial year, thus the KK company’s first liquidation financial year starts on the day after the date of the dissolution EGM.
4. Some time after the dissolution EGM, the liquidator must publish a formal notice in the Official Gazette announcing the KK company’s liquidation and advising creditors to file claims. Concurrent with publishing the formal notice, the liquidator must send creditor notices to all known creditors, including to parties to whom the KK company has outstanding warranty obligations.
5. Two months after the formal notice is published in the Official Gazette, the liquidator settles valid creditor claims.
6. After settling valid creditor claims, the liquidator closes the KK company’s bank accounts, agrees intercompany loan write-offs (if applicable), and decides a formal liquidation date.
7. The liquidator then prepares the KK company’s liquidation financial statements (general ledger, profit and loss statement, and balance-sheet) which will show zero balances, for the period from the KK company’s dissolution EGM until the liquidation date.
8. The liquidator then convenes an EGM for shareholders to approve the liquidation financials and liquidation expenses, prepares and files tax-returns, and ensures the KK company pays taxes due.
9. The liquidator then files the final notice of liquidation at the Legal Affairs Bureau.

In the best-case scenario, where shareholders approve EGMs by return and there are no unknown creditor claims or National Tax Agency requests, we can complete a KK company’s liquidation in 4 months. Generally though, a liquidation takes about 6 months to complete.

Most foreign companies need to include transactions with non-Yen invoice currencies in their Japanese subsidiary company or office’s financial statements and yearend tax-returns. Many don’t know, and their Japanese tax accountant might not have told them, that Japan’s Tax Code includes statutory rules governing the foreign currency exchange rates and currency conversion methodology a Japanese company must use when entering forex transactions in its financial statements.

A typical end to end transaction with an overseas supplier denominated in a foreign currency is:

1. An invoice is received denominated in a non-Yen currency, such as USD or EUR.
2. A credit entry is made in the “買掛金 Accounts payable (CoGS, etc.)” journal, converted to JPY and balanced with debit entries in the relevant expense journals.
3. Some time later, an outbound international wire transfer of Yen, converted to the foreign currency, is made to pay the foreign currency invoice.
4. The JPY amount paid, excluding bank fees, is entered as a credit entry in the relevant “当座預金 Current account”, “普通預金 Savings”, or other cash journal.
5. The bank’s international wire transfer fees are entered as a debit in the “支払手数料 Payment fees” expense journal.
6. The original credit entry in the “買掛金 Accounts payable (CoGS, etc.)” journal is reversed with a debit entry of the same amount.
7. If the amount of Yen converted to the foreign currency at payment (as entered as a credit entry in the relevant “当座預金 Current account”, “普通預金 Savings”, or other cash journal) was less or more than the amount calculated for the original credit in the “買掛金 Accounts payable (CoGS, etc.)” journal, a foreign exchange gain or loss entry is made in the “雑収入 Miscellaneous income” journal or the “雑損失 Miscellaneous losses” journal to balance the general ledger.

The above creates obvious potential for exchange rate manipulation to decrease a Japanese company’s taxable income, which is why Japan’s Tax Code states very clear rules to ensure Japanese companies don’t randomly pick currency conversion rates or currency exchange methodologies intended to increase expenses or reduce income.

Article 61-8, Paragraph 1, “Conversion of Foreign Currency Transactions” of Japan’s Tax Code describes specific rules for converting foreign currency transactions to Yen:

1. The TTM (telegraphic transfer midrate) rule, in which all foreign currency conversions, whether involving buying or selling Yen, are made using a TTM rate.
2. The TTB / TTS (telegraphic transfer buy / telegraphic transfer sell) rule, in which all expenses are converted using a TTS rate and income converted using a TTB rate.

If a Japanese company uses -1- above, it must use it for all foreign currency conversions in that and future financial years. Similarly, if a company uses -2- above, it must use it for all such conversions in that and future financial years. This prevents a Japanese company from “exchange rate shopping” to artificially increase foreign denominated expenses or decrease foreign denominated income.

Article 61-8, Paragraph 1, “Conversion of Foreign Currency Transactions” of Japan’s Tax Code also specifies strict rules for determining the TTM, TTB, and TTS rates:

1. The rates should be those published by the Japan company’s main bank.
2. The rates must be one of:
   1. The closing TTM, TTB, or TTS rates on the transaction date (for accruals the date the invoice was issued, for payment the date payment occurred). If there was no market on the transaction date (such as on weekends and Japanese national holidays) the previous business day’s TTM, TTB, and TTS closing rates are used).
   2. The TTM, TTB, and TTS closing rates on the last day of the month or week immediately preceding the month or week within which the transaction date falls.
   3. The TTM, TTB, and TTS closing rates on the first day of the month or week within which the transaction date falls.
   4. The average TTM, TTB, and TTS closing rates for the week or month immediately preceding that in which the transaction date falls.

   As with the decision to use TTM or TTB/TTS rates, the rule for determining the TTM, TTB, and TTS closing rates must be consistent for all currency conversions.

As with most matters related to yearend accounting for your company’s Japanese subsidiary company or office, while following the above rules can’t guarantee avoiding a National Tax Agency audit, it will at least minimize the risk.

Most foreign companies with balanced financial strategies charge intercompany management fees and recharge various expenses to their Japanese subsidiary company or office; some to such an extent the Japanese subsidiary company or office consistently makes a losses or minimal profits. Although it’s understandable that foreign company CFOs want to minimize taxable income in a relatively high tax jurisdiction such as Japan, and justified intercompany management fees and recharges to their Japanese subsidiary company or office are one way to achieve such an outcome, the National Tax Agency’s transfer pricing auditors are constantly looking for companies exploiting intercompany management fees and recharges to to their Japanese subsidiary company or office in this way. If your company’s Japanese subsidiary company or office made unexpectedly high profits, and your CFO instructed you to create some intercompany management fees or recharges to eliminate the profit, there are some basic rules you must follow if you want to avoid the National Tax Agency auditors, a potentially very expensive multi-month audit, and tax penalties.

Rule 1. Issue monthly intercompany invoices (not a single yearend aggregated one-liner). The National Tax Agency is very unlikely to accept without question a “last day of the financial year” intercompany invoice in a Japanese subsidiary company or office’s financial statements with a one-line “intercompany management fees and recharges” fee. This is especially a problem if the invoice almost cancels (minimal profit), exactly cancels (breakeven), or more than cancels (loss) the Japanese company’s taxable income. There are some Japanese accountants (会計士) and tax accountants (税理士) who seem to take an “I’m not the client’s representative director, so I’ll just let them dig themselves into an audit hole” view, and allow such an invoice in the final financial statements and tax-returns. Problems can then arise, because part of a standard Japanese corporate tax-return is a simple one-line summary of monthly expenses, in which a spike in expenses in month 12 can cause  the National Tax Agency’s automated system to flag the tax-return for a manual review. Three months later, when the National Tax Agency calls to start an audit, the same tax accountant will happily tell you his or her fee for attending tax audits is JPY120,000 a day (or much more) plus consumption tax. To avoid an unnecessary audit, intercompany management fees and recharges should be calculated and invoiced to to the Japanese subsidiary company or office on a monthly basis. This is not a tax avoidance tip, because if your company invoices excessive intercompany management fees and recharges to its Japanese subsidiary company or office, regardless of spreading the fees over the full financial year the National Tax Agency’s sophisticated algorithms will still detect a potential issue and trigger a manual review. Of course, if such a “last day of the financial year” intercompany fees invoice is supported with justifiable arm’s length fee calculations, the National Tax Agency will accept it, although an auditor might still call to validate the charges.

Rule 2. Issue detailed intercompany invoices with exhibits describing the fees (not one-liners with no explanation). When a Japanese tax accountant files a Japanese subsidiary company or office’s corporate tax-return and financial statements, he or she must attach to it (and certainly must have reviewed) invoices, and supporting detail of such invoices, for all intercompany management fees and recharges. This is because one of the first tests the National Tax Agency’s algorithms applies to a Japanese subsidiary company’s tax-returns in its search for possible tax evasion, is to subtract the value of intercompany management fees and intercompany recharges from the Japanese subsidiary company or office’s net income to determine if it would have been profitable (or more profitable) without them. This is especially true if the Japanese company has high sales income. A simple one-line invoice stating “Total intercompany management fees and recharges for October 2020, JPY1,920,000” is not sufficient supporting detail; in fact it might again trigger a National Tax Agency manual review. An invoice for intercompany management fees should state what the management services were, who provided them, and at what hourly rate. An invoice for intercompany recharges should state what expenses were recharged, with receipts for each expense (just as is expected for expenses the Japanese subsidiary company or office incurs directly), and what markup or administrative charge is associated with such recharged expense. Why must such detailed information be attached to filed financial statements and tax-returns? Because in the National Tax Agency’s opinion, intercompany management fees and recharges for management services which were never provided, or for expenses which were never incurred, is one of the most common ways foreign companies try to manipulate their Japanese subsidiary company or office’s tax liability.

Rule 3. Issue “arm’s length” intercompany invoices. When a National Tax Agency auditor manually examines intercompany invoices for management fees, he or she will compare the amounts the Japanese subsidiary company or office is paying with amounts it would pay for similar services if purchased from an independent service provider (arm’s length comparison). Similarly, when examining intercompany recharges, he or she will compare recharged expenses with the price of locally sourced equivalents. If (as noted above in Rule 2) invoices contain sufficient detail for the auditor to make arm’s length comparisons, and if the transactions pass such tests, all should be well. If there is not enough detail, the auditor will contact the Japanese company to ask for more detail and possibly start a full audit. It’s essential to ensure intercompany management fees and recharged expenses pass such arm’s length comparisons, because if not, and if a company is charging high intercompany management fees and recharges to its Japanese subsidiary company or office, the National Tax Agency will demand the company restate all affected financial statements and tax-returns. That can be very expensive both in CPA fees to prepare and file restated tax-returns and in additional taxes and late interest.

While following the above three rules can’t guarantee the National Tax Agency accepting intercompany management fees and recharges to your company’s Japanese subsidiary company or office, nor guarantee avoiding a tax audit, it will at least minimize the risk of both.

Coronavirus COVID-19 pandemic, three words that have destroyed many companies’ finances, reduced corporate treasuries and savings accounts, and forced many companies, especially in the aerospace and travel sectors, to look closely at the Japanese subsidiary’s costs and performance. What many are finding is employees in Japan on inflated salaries, overly expensive prestige Tokyo offices now empty (but still costing monthly rent) as employees work remotely, and worse, many companies that furloughed staff in Japan are finding overall performance has been unaffected. Against the backdrop of reduced market demand and reduced cash, it’s inevitable employers will need to reduce Japanese labor costs.

Given Japan’s reputation for lifetime employment, impossible labor laws (notably Japan’s Labor Contracts Act ‘労働契約法’ and Labour Standards Act ‘労働基準法’), and judges supposedly waiting for any opportunity to overturn unfair dismissals, how does a Japanese employer legitimately reduce its workforce?

First let’s look at the root of lifetime employee (in Japanese 正社員). You won’t find those three Japanese characters in any Japanese law; both the Labour Contracts Act and Japan’s Labor Standards Act refer to ‘労働者’ (rodosha, which means worker). If there’s no mention in either the Labour Standards Act or Labor Contracts Act, why is the term lifetime employee so freely used? We need to look at Article 16 of Japan’s Labor Contracts Act:”

• “Article 16. If a dismissal lacks objectively reasonable grounds and is not considered to be appropriate in general societal terms, it is treated as an abuse of rights and is invalid.”

It’s Japanese courts’ interpretation of Article 16 that gives rise to lifetime employment. Japanese judges tend to undo dismissals unless the dismissed employee did something that gave clear undeniable cause, such as drunkenness, lewdness, violent, or abusive acts in the workplace. As an aside, this is why it’s so important an employer doesn’t listen too carefully to a Tokyo recruiter’s oft exaggerated claims of a candidate’s performance, but instead relies upon exhaustive interviewing. Under normal circumstances, a problem employee can be very difficult to shed……but these times, with the COVID-19 pandemic in full force, are not normal circumstances. So what difference does the pandemic make to the challenge of cutting Japanese staff levels?

It’s a vagary of Japanese labour law that the potential reversal of dismissal is governed by the Labor Contracts Act, yet the process of dismissal is governed by the Labour Standards Act, specifically Article 20(1):

• “Article 20(1) If an employer wishes to dismiss a worker, the employer must provide at least 30 days’ advance notice. An employer not giving 30 days’ advance notice must pay the worker the average wage they would earn in working for a period of at least 30 days; provided, however, that this does not apply if business continuance has become impossible due to a natural disaster or any other compelling reason, nor does it apply if the worker is dismissed for reasons attributable to the worker.”

Note the “…this does not apply if business continuance has become impossible due to a natural disaster or any other compelling reason.”

Before using Article 20(1) as justification for ending your Japanese employees’ employment, you need to be aware of some important points not stated in the Labour Standards Act but which you must follow if you want to avoid successful (from the dismissed Japanese employee’s perspective) labour litigation:

1. A Japanese employer should actively involve its employees in the process of reducing the workforce. This means:
   • Notifying the employees in advance that the company is facing severe financial issues.
   • If practical, asking for pay reductions or voluntary resignations.
2. If ending selected employees’ employment becomes unavoidable, a Japanese employer should:
   • Be certain there is clear justification for ending the employment of the selected employees (especially showing that economic necessity is not being used as an excuse to remove underperforming employees).
   • Pay the affected employees thirty days’ wages as severance pay.

Of course the above points will be moot if the Japanese employer is on the verge of bankruptcy.

What happens if a disgruntled Japanese employee objects strongly to dismissal? His or her first stop will probably be the Labour Standards Inspection Office, in which case an inspector will asses the above and either advise the employee to accept the dismissal or, if there seems to be the suspicion of unfair dismissal, contact the Japanese employer to start mediation. Such mediation will be directed toward the Japanese employer reinstating the employee or at least offering an enhanced severance package, but only in cases where the above outlined process wasn’t followed or the inspector considers the dismissal is unjust.

If an employee is litigious, he or she will probably bypass the Labor Standards Inspection Office and go direct to an attorney specialized in labor litigation. Assuming the attorney decides to accept the case, the Japanese employer will then receive a letter from the attorney demanding reinstatement, damages and legal fees, or possibly demanding an extended severance package. Given the average Tokyo law firm charges JPY35,000 an hour for junior attorneys and JPY55,000 an hour and up for partners, even responding to a demand letter can cost JPY250,000 or more. If litigation ensues, average monthly legal fees can easily range JPY250,000 – JPY500,000 or more, and cases can take several years to move through court. Fortunately, if redundancy is properly managed with a reasonable employee, litigation is rare.

This post was revised on June 26 to reflect the Japanese government’s increased COVID-19 subsidy daily amount and extended extraordinary period for application and grants.

To combat the COVID-19 coronavirus pandemic, the Japanese government extended its existing business employment subsidy (the Employment Adjustment Subsidy) to include emergency cash relief for businesses affected by the COVID-19 coronavirus pandemic. If your company is one of the many asking what Japanese business subsidies are available during the coronavirus pandemic, and how their Japanese office can apply for this COVID-19 subsidy, please read on.

1. What is the “Employment Adjustment Subsidy”? The Employment Adjustment Subsidy (in Japanese 雇用調整助成金) has been available for some time. The subsidy is a form of Japanese furlough encouraging companies to retain employees even though the coronavirus pandemic has reduced income. The brief process is:.
   • The company ascertains if it is eligible for the subsidy.
   • The company agrees a furlough schedule with its employees (which can include shortened work hours as opposed to full absence).
   • The company files an application for the subsidy with the Japanese government.
   • The company pays to each employee at least 60% each month of his or her salary.
   • The Japanese government pays the company a subsidy of up to JPY15,000 a day for each furloughed employee.
   The Japanese government amended the subsidy’s terms to make it available to a wider range of businesses, make it easier to qualify, and increase the cash benefit. Specifically for Japanese companies affected by the coronavirus pandemic, the Japanese government defined an extraordinary period from April 1 – September 30, 2020 during which the easier qualification applies. What follows applies only to subsidy applications made during the extraordinary period; more restrictive terms will apply after the extraordinary period ends.
2. Qualifying Businesses. To qualify,
   • Your Japanese company must show at least a 5% decline in revenue in any month during the extraordinary period compared with the same month in 2019.
   • Your Japanese company must already be registered as a place of employment with the Employment Security Office (which would have been done when hiring its first employee).
   • The furloughed employees must already be enrolled in employment insurance.
3. Subsidy Application Procedure. The exact procedure to apply for the Employment Adjustment Subsidy is:
   • Agree a Labor Management Agreement with the employees to determine the furlough schedule, calculation of reduced pay, etc.
   • Agree an individual furlough (or reduced working hours) schedule with each employee.
   • Submit the plan to the Labor Bureau either before or after implementation.
   • Calculate and pay wages in accordance with the Labor Management Agreement to reflect each employee’s furlough allowance and deduction.
   • Complete the application forms for the specific subsidy amount each month and submit to the Labor Bureau with supporting documents showing the wages paid, employee attendance, etc..
4. Subsidy Percentage Rate. The exact percentage of subsidy a company can receive depends on its size and whether the employees are retained at the end of the furlough period:
   • Small and medium companies, defined as:
     • Retail and Restaurants with up to JPY50M capital or 50 employees.
     • Service companies with up to JPY50M capital or 100 employees.
     • Wholesale companies with up to JPY100M capital or 100 employees.
     • Other companies with up to JPY300M capital or 300 employees.
     These companies can claim subsidies of up to 100% of each employee’s paid furlough wages (up to a maximum of JPY15,000 each employee) for employees who are absent fulltime during the furlough period and to whom the company pays at least 60% of regular wages. If the employee is dismissed during the furlough period, the subsidy is reduced to 80% of the furlough amount.
   • Large companies can claim subsidies of up to 75% of each employee’s paid furlough wages (up to a maximum of JPY15,000 each employee) for employees who are absent fulltime during the furlough period and to whom the company pays at least 60% of regular wages. If the employee is dismissed during the furlough period, the subsidy is reduced to 67% of the furlough amount.

The Ministry of Health, Labour and Welfare has detailed information available here (in Japanese).

COVID-19 affects us all: for some the effects are horrific, losing a loved one or suffering debilitating illness for weeks. For some, the effects are not physical but financial, such as for smaller companies which might have an office in Japan which has seen its income decimated by the coronavirus pandemic’s economic effects. Many companies are asking how to reduce their Japanese office costs during the coronavirus pandemic, and the best advice we can give is as follows:

1. Reduce representative director costs. According to the Ministry of Justice’s interpretation of Japan’s Companies Act, a kabushiki kaiska KK company does not need a resident representative director, yet some foreign companies still pay a small fortune each month for a nominee resident representative director service. Similarly, a godo kaisha GK company does not need a resident representative (aka executive manager or functional manager). There are cases when a KK company or GK company does need a resident director, such as maintaining a financial services license, a telecoms license, for commercial office leases (although not always), or sometimes for maintaining a domestic bank account (although banks generally accept a switch from resident to non-resident representative after an account is opened for a reasonable time). If your Japanese office doesn’t need a resident representative director or manager, replace him or her with a head-office person, otherwise, this might be a good time to search for a lower cost service provider. While fees for nominee director services tend to be high in Japan (because nominee directors cannot use a “I was only a nominee and had no responsibility for day to business” defense in the event of legal action or debt collection), fees have reduced substantially in the past five years. Sadly a branch-office must have a resident representative in Japan, so fees for nominee representatives for branch-offices are generally unchanged. The costs of registering a change of representative are about JPY100,000 plus tax for the legal procedure, then there will need to be notifications made to the National Tax Agency, Japan Pension Service (if the office has employees), the Labour Bureau (again if the office has employees), and finally the bank (if the company has a bank account).
2. Reduce office costs. If your Japanese employees started to telework during the pandemic, and productivity seems much the same as before, you might want to consider vacating a large office and leasing a smaller month to month serviced office from Compass Office, Regus, Servcorp, or one of the numerous other serviced office providers in Japan. While I wouldn’t generally recommend a serviced office for a larger teams, if transitioning to a small core office team with the majority of employees teleworking, a serviced office could result in a reduced expense. If you do decide on such a move, remember that registering a change of address within the same ward or city is much less expensive than a change which results in the registered address being in a different ward or city.
3. Furloughing employees. Even in the midst of the coronavirus pandemic, Japanese companies that layoff employees without due consideration are frowned upon, even though Japan’s Labour Standards Act provides for dismissal in such situations: Article 20 (1) “In the event that an employer wishes to dismiss a worker, the employer shall provide at least 30 days advance notice. An employer who does not give 30 days advance notice shall pay the average wages for a period of not less than 30 days; provided, however, that this shall not apply in the event that the continuance of the enterprise has been made impossible by a natural disaster or other unavoidable reason nor when the worker is dismissed for reasons attributable to the worker.” While Article 20 (1) implies that a Japanese company faced with immediate and substantial loss of income does not need to provide advance notice or wages in lieu of such notice, if the loss of income is moderate, Japanese companies are expected to apply more moderate solutions. The recommended way to proceed with reducing a Japanese office’s workforce costs during the pandemic is as follows:
   • Decide what needs to be done to ensure the business’s survival.
   • Explain to the employees what needs to be done, ensuring they understand the company’s true financial situation.
   • Implement the solution taking into account as far as reasonably possible, the employees’ feedback.
   Using such a process, many companies have reduced employee salaries with employee agreement for the duration of the pandemic (in which case the employees continue to work albeit at possibly reduced hours), or to furlough employees (in which case the employees don’t work, but the employer must pay 60% of each employee’s salary and can claw back up to JPY8,330 a day subsidy for each employee from the Japanese government. There is talk of increasing the maximum daily subsidy to JPY10,000 or much higher, but for now the JPY8,330 daily COVID-19 subsidy limit remains.

The above are just three of the things smaller companies can do to reduce the cost of maintaining a Japanese office until such time as life reverts to the ‘old’ normal. The secret, as with most things in Japanese business, is to involve employees in the process as far as possible. Legally, you must anyway do so, morally you absolutely should do so.