Establishing Business Operations in Japan
By: RICHARD E. WEINER
November 2004
Imagine that your company had decided to establish business operations in Japan to better serve your customers in that market. Your first decision would be whether to appoint an independent consultant or to hire an employee in Japan. Which should you choose?
1. Independent Consultant or Employee?
If your company has decided to appoint an independent consultant to help you expand your business in Japan, you need to be careful to structure the relationship so the independent consultant does not constitute your "permanent establishment" in Japan. Under Japanese tax law, "permanent establishment" of a foreign company subjects it to corporate income tax based on revenues generated by and attributable to that entity.
To ensure that your independent consultant is not considered a "permanent establishment," you must abide by the following guidelines:
- Your independent consultant should be a corporation, not an individual. Your company makes an agreement to expand your business in Japan with the corporation, which hires an individual to accomplish this task.
- Your independent consultant would not have the authority to bind you to any obligation. It could not sign contracts on your behalf. It could, however, assist you in negotiating business deals and discussing contract terms.
- You would pay your independent consultant commissions, not a standard monthly (or annual) consulting fee. If your independent consultant received a standard fee, he or she might be considered to be a "standing agent" of your company's "permanent establishment."
- If you hire an employee, you will, under almost all circumstances, have created a "permanent establishment" and be subject to corporate income tax in Japan based on the revenues generated by and attributable to that employee. You will also have to pay United States corporate income tax on those revenues, because the United States taxes its corporations on worldwide income, regardless of where it is earned.
However, under the Convention between the United States of America and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, which took effect on July 9, 1972 (the "United States-Japan Income Tax Treaty"), you would be entitled to receive a partial tax credit in the United States for the corporate income tax that you paid in Japan.
Your employee in Japan would be entitled to all of the rights and safeguards accorded to employees in that country. These include the following:
- Your employee would be entitled to participate in the Japanese National Health Insurance Plan and the National Welfare Pension Plan, and your company would be required to enroll in such plans. Premiums would be shared equally by your company and your employee in Japan.
- Your employee would be entitled to participate in the Japanese Worker's Compensation Insurance Plan, for which you would be required to pay the entire cost of premiums.
- Your employee would be entitled to participate in the Japanese Unemployment Insurance Plan. You would be responsible for 75% of the premiums for the plan, with your employee contributing the remaining 25%.
- Your employee would be entitled to receive between 10 and 20 days of paid vacation per year (depending on years of service) and approximately 25 days of paid holiday time per year (including 14 paid national holidays, 5 paid holidays in August and 6 paid holidays at the end of the calendar year).
Japanese companies usually give their employees both winter and summer bonuses, which are usually equal to 3 months' salary each. Although not legally required, you would be expected to offer your employee an annual salary equal to 18 times his or her monthly wages.
You could not unilaterally change the terms of your employee's employment contract, especially if such changes are detrimental to the employee.
You could not unilaterally terminate the employee's employment without "just cause." "Just cause" is narrowly defined under Japanese labor law and involves more than simple misconduct or negligence. You would have to show that the employee engaged in "serious misconduct" or repeatedly and systematically performed poorly. The standards of performance would have to be articulated in the employment contract, with written warnings issued for failure to meet those standards. The employee would also have to be given a period of time to improve and receive a warning before you could terminate for "just cause."
2. Branch Office or Subsidiary?
Before hiring an employee to help expand your business in Japan, your company would be required to establish (i) a Japanese registered branch office or (ii) a Japanese subsidiary in which the employee could work.
To establish a registered branch office in Japan, you would have to:
- Appoint a registered representative who would have the power and authority to represent the branch office. Your representative would have to be a resident of Japan but would not need to be a citizen of Japan.
- Register the branch office's place of business and its representative with the appropriate government authorities. An "initial inward direct investment" report on your company and business objectives would also have to be submitted.
- Consider any claim or cause of action against the registered branch office or any risk or liability of the registered branch office as a claim or cause of action against or risk or liability of your company in the United States, since the registered branch office would be considered to be an "extension" of your company into Japan.
- Pay taxes in Japan on the income generated from sources there. As indicated above, you would also be taxed in the United States on the income generated by the registered branch office, with a reduction under the United States-Japan Income Tax Treaty.
If your company decided to establish a subsidiary in Japan, you would probably form a Japanese limited liability company (which is known in Japanese as a "Yugen Kaisha") by taking the following steps:
- File an Application for Commercial Registration for the new subsidiary and submit an "initial inward direct investment" report. You must also file a report after you acquire shares in the subsidiary, detailing the type, purchase price and amount of the shares purchased by your company, and various tax reports regarding the subsidiary with the Japanese national and municipal tax authorities. Finally, you would be required to make an initial capital investment in the subsidiary of at least ¥3,000,000.
Elect directors to serve on the subsidiary's board of directors. These directors then appoint the officers of the subsidiary and have general supervision over its business operations. The officers of the subsidiary would be responsible for its day-to-day operations.
Any claim or cause of action against the subsidiary or any risk or liability of the subsidiary would be limited to the subsidiary and its assets, and would not be considered to be a claim or cause of action against or risk or liability of your company in the United States, provided that the subsidiary was properly incorporated and operated in compliance with Japanese commercial laws.
As a domestic Japanese company, the subsidiary would be taxed in Japan on its worldwide income. In addition to Japanese corporate income tax, local enterprise tax and corporate residence tax would also be imposed, for an overall tax rate of approximately 41%. As indicated above, you would be taxed in the United States on the income generated by the subsidiary, with a reduction under the United States-Japan Income Tax Treaty.
A 10% withholding tax would be imposed on the issuance of dividends to your company from the subsidiary.
Establishing business operations in Japan requires careful strategic planning and an in-depth understanding of corporate, tax and labor laws. Depending on your business objectives, you may wish to appoint an independent consultant or to hire an employee in Japan. Your decision will have significant business, legal and tax consequences as you attempt to expand your business activities there.