In the previous section introducing Japanese corporate tax structuring, we noted that many foreign companies doing business in Japan are not properly structured to reduce their Japanese corporate taxes. This might be because there is not a lot of clear and unambiguous tax advice available about business in Japan and Japanese business income tax; my personal experience supports such an explanation. While managing a US software vendor’s Japanese subsidiary, I asked several partners of the Tokyo office of our Big-5 corporate auditor the following question: “We are losing a fortune in Japanese taxes; can someone here please tell me how we can better structure our US – Japan operations to get more cash back to the head-office?” In 6 years managing that company, and despite a constant stream of cash lost to Japanese income taxes, I did not receive a clear answer to that question and eventually figured it out for myself.
In the next sections, I will try to give you the benefit of that experience to answer the above question. I am neither a CPA nor a tax attorney, Venture Japan is neither a law firm nor a tax accounting firm, so your company must take legal and tax accounting advice about this, but these thoughts apparently have some merit, because an auditor from the National Tax Agency (Japan’s IRS) once asked me “So, tell me, has any company taken your advice from the website?”
First though, a note of caution. You must carefully consider that all high-tax countries, Japan included, make clear distinctions between what is illegal tax evasion and what is legitimate tax deferral and tax reduction. Directors of Japanese companies are joint and severally liable (meaning all directors are liable for any one director’s failure) and legally responsible for corporate misdemeanors and are much less protected by the corporate veil than their counterparts in the US and Europe. Japanese laws governing companies, commerce, and taxation, contain penal provisions and if the Public Prosecutors Office suspects a director is complicit in tax avoidance, it can hold him or her in detention (just as happened recently with Carlos Ghosn) for extended periods before filing charges. In Japan, most trials are magistrate trials, where the judge (or a panel of 3 judges) hears evidence and passes judgement. Japanese courts have a very high conviction rate and of all the cases judges hear each year, they only acquit a few defendants. Case-law (when judges use decisions made by judges in similar previous cases as precedent) applies in Japan, but while in the US case-law often creates conflicting precedents that blur the original intent of a statute, the decisions of Japanese judges tend to reinforce and harden statutes. So be warned: When doing business in Japan, your company must thoroughly research the Japanese laws relating both to its industry and to the establishment, management, and taxation of your Japanese business. If not properly implemented, tax reduction and tax deferral can verge on tax evasion and put directors in prison. Before embarking on any tax structuring strategy, your company must take legal advice from a Japanese attorney to make sure that its tax reduction strategy is not considered tax evasion.
So how can your company legitimately reduce its Japanese business tax?”
First, we need to consider the factors that decide how a company can tax-efficiently structure its business in Japan. The 3 key factors will be:
- The type of physical presence it has in Japan:
- No physical presence (i.e. operating purely through independent ‘arms-length’ 3rd-parties).
- A branch-office in Japan.
- A dependent 3rd-party agent.
- A subsidiary company:
- A godo kaisha GK (Japanese LLC or limited liability company).
- A kabushiki kaisha KK (Japanese corporation).
- The local margins it earns on its Japanese sales revenue:
- High Japanese cost of sales (such as companies that have design, development, manufacturing and assembly costs in Japan).
- Low Japanese cost of sales (such as companies that import and sell products with no Japanese domestic manufacturing and assembly costs).
- The nature of the products and services it sells in Japan:
- Licensed products (such as media, intellectual property, software and other ‘soft’ products) produced by a foreign parent and sub-licensed in Japan.
- Physical products and components produced by a foreign parent and resold in Japan.
- Physical products manufactured, assembled and sold in Japan using components produced by a foreign parent.
- Human resource services (IT outsourcing, consulting etc.) sourced at a foreign parent and resold in Japan.
- Services and business processes licensed or franchised from a foreign parent and resold in Japan.
We can simplify the process because most foreign companies doing business in Japan will fit in one of the following seven categories:
- Soft product licensor with no Japanese presence, licensing to a totally independent Japanese sub-licensor distributor or OEM reseller.
- Physical product supplier with no Japanese presence supplying a totally independent Japanese distributor or OEM.
- Soft product supplier licensing through a dependent Japanese sub-licensor whose costs are relatively low.
- Physical product company selling through a dependent Japanese reseller whose costs are relatively low.
- Physical product company selling to a dependent Japanese ‘manufacture, assemble and resell’ company whose costs are relatively high.
- Service company licensing or franchising to a dependent Japanese sub-licensor or franchisee whose local costs are relatively high.
- Human resources (such as IT outsourcing or consulting) company) selling through a dependent Japanese reseller whose local costs are relatively low.
So, next we need to understand the various Japanese corporate business income taxes your Japanese company must pay.