We noted in the previous section on tax structures to consider for doing business in Japan, that the Japanese godo kaisha “GK” company, also known as the Japanese LLC, offers a real cross-border tax advantage for a US sole member when compared to either a Japanese branch-office or a KK kabushiki kaisha. For all companies outside the US though, both the Japanese kabushiki kaisha “KK” company and the Japanese LLC GK godo kaisha offer identical tax efficiencies. A Japanese branch-office is rarely tax-efficient, primarily because it exposes its foreign head-office to Japanese taxation.
A Japanese LLC GK godo kaisha and a Japanese KK kabushiki kaisha with identical paid-in capital, income, and expenses, will each pay identical Japanese business income tax, local inhabitant’s tax and Japanese consumption tax. Unlike a US LLC, a Japanese LLC GK godo kaisha cannot choose to be taxed as a partnership and cannot avoid paying any taxes in Japan. The advantage of a GK godo kaisha, and the reason global companies including Apple, Exxon Mobil and Amazon incorporated GKs in Japan, is that the IRS allows a GK as a disregarded “check the box” entity under US Treasury regulations §301.7701-2(b)(8). Thus, if you are a US company starting business in Japan, a GK godo kaisha allows you to get flow-through US income tax treatment for your Japanese business income.
Unless you have the resources to engineer and keep up a sophisticated cross-border structure such as a ‘GK TK’ (a tokumei kumiai “TK” silent partnership funding an independent GK godo kaisha operator which itself is usually held by an offshore entity), either a GK godo kaisha or a KK kabushiki kaisha is the best choice. As noted above, if you are a US company starting business in Japan, then the GK godo kaisha is probably the ideal solution. The GK godo kaisha is cheaper to incorporate, has slightly lower administration costs, and slightly less corporate governance overhead than a KK kabushiki kaisha, but gives similar litigation protection for its foreign parent. The only real obstacle to any US or other foreign company starting business in Japan with a GK godo kaisha, will most likely be its local Japanese executives who might complain (as noted in those myths of the Japanese market) that the prestige of the KK kabushiki kaisha is essential to success. To counter that very out-dated 1980’s myth, I would point your subsidiary President to some of those very successful foreign company subsidiaries incorporated in Japan as GK godo kaishas and mentioned above: Exxon Mobil GK, Apple GK, and Amazon Japan GK.
Every Japanese subsidiary has unique aspects to its costs of doing business in Japan and its relationship with its foreign parent, but in general, the most tax-efficient and tax legal structures for starting a wholly-owned business in Japan that I commonly see are (assuming your company will be the sole owner):
- If your company is a US resident, then consider incorporating a GK godo kaisha and electing to have it treated as a check-the-box entity.
- If your company is not a US resident, then incorporate either a KK kabushiki kaisha or a GK godo kaisha.
- Create a distribution agreement between the KK kabushiki kaisha or GK godo kaisha and your company, with transfer fees calculated at the justifiable limit of the spectrum and tested using similar arm’s-length metrics to those used by the Japanese tax office.
- To avoid surprises in future tax audits, use the National Tax Agency’s advance approval service to confirm that your transfer fees are acceptable.
- Note that royalty transfer fees will be liable to withholding taxes of 20.42%, which might be reduced if a tax treaty exists between Japan and your company’s country of residence. For example, the US – Japan tax treaty relieves royalty transfer fees 100%, meaning no withholding tax is payable.
- Create a management services agreement between the KK kabushiki kaisha or GK godo kaisha and your company.
- Ensure that your company documents the services it provides to the KK kabushiki kaisha or GK godo kaisha.
- Ensure that the cost the KK kabushiki kaisha or GK godo kaisha pays to your company for the services satisfies arm’s-length metrics.
- Create a justifiable funding plan for the KK kabushiki kaisha or GK godo kaisha, using a mix of equity and debt financing.
- Ensure that the KK kabushiki kaisha or GK godo kaisha’s ratio of equity to debt won’t cause the Japanese tax office to penalize any interest payments to your company under ‘thin capitalization’ rules. Japan’s Corporation Tax Law considers any company whose debt exceeds three times its equity as thinly capitalized.
- Ensure that any interest the KK kabushiki kaisha or GK godo kaisha pays on loans received from your company, satisfies arm’s-length metrics, especially if the KK kabushiki kaisha or GK godo kaisha is thinly capitalized.
- Note that interest payments to foreign residents are liable to withholding taxes of 20.42%, which might be reduced if a tax treaty exists between Japan and your company’s country of residence.
- If your company is a software company that is not a US resident, consider segregating agreements and invoices for upfront license fees, update and upgrade license fees, and maintenance and support fees.
- Initial license fees, update license fees and upgrade license fees are royalties, so depending on any tax treaty between Japan and your company’s country of residence, transfers of such fees are subject to a 20.42% withholding tax.
- Maintenance and support fees that do not include updates and upgrades, are services and are not subject to withholding tax.
- If your Japanese revenues are high-margin with relatively low Japanese COGS, but your company is in a lower tax-rate country such as Hong Kong or Singapore, then consider moving some R&D and other functions from your company’s head office to the KK kabushiki kaisha or GK godo kaisha. This is beneficial if you can cut your taxes in Japan by less than the increase in your head office’s taxes.
- Consider setting-up the KK kabushiki kaisha or GK godo kaisha as a manufacturer and final assembler, meaning it imports components from your company’s head-office (thus paying an arm’s-length transfer price for those components), licenses manufacturing technology from the head-office, sources localized components and does final assembly in Japan.