Tax structuring refers to the manner in which a Japan entity will recognize income and be subject to Japanese corporate tax. Our Japan tax structuring advisory work assists clients in identifying and implementing an appropriate tax structure for their operations.
In terms of timing, a tax structure should be decided before the Japan entity is established or shortly thereafter.
A tax structure should be selected with great care since it will significantly impact the scope of income that will be subject to tax in Japan.
There are trade-offs between the activities permitted under each tax structure and the scope of income that will be subject to Japanese corporate tax. For example, a Japan Representative Office / Liaison Office will not be subject to Japanese corporate income tax. However, it can undertake limited activities in Japan, and may not engage in sales activities.
Some common Japan tax structures used by foreign companies operating in Japan include the following:
1. Japan Representative Office / Liaison Office
Utilizing a Japan Representative Office / Liaison Office structure offers simplicity. The structure is not subject to Japanese corporate income taxes and generally does not require registration with the Japanese Legal Affairs Bureau.
The primary disadvantage of a Japan Representative Office / Liaison Office structure is that the permitted activities are limited to auxiliary services as specified under Japanese domestic law. A Double Tax Treaty (“DTA”) in place with the country where the head office is located may expand the scope of activities.
In particular, the office may not engage in sales activities in Japan.
2. Cost-Plus Tax Structure
Cost-plus is a very common tax structure utilized by foreign companies doing business in Japan.
A cost-plus arrangement involves a written service contract between the Japan business entity and the foreign company (often the foreign parent). The Japan entity will typically be either a subsidiary of a foreign company (i.e., a Kabushiki Kaisha [“KK”] or a Godo Kaisha [“GK”]) or the branch of a foreign company.
Pursuant to the service contract, the Japan entity provides services to the foreign company. The Japan entity is compensated by way of a reimbursement of its expenses plus an additional mark-up.
Mark-ups of between 7% and 10% are quite common.
Permitted Activities Under a Cost-Plus Tax Structure
Unfortunately, Japan has few formal guidelines with respect to activities permitted under a cost-plus arrangement.
The Japan entity is not permitted to undertake sales activities in Japan when a cost-plus tax structure is being utilized. Permitted activities may include information gathering, customer relations and providing technical assistance to customers.
Key Tax Risks
The key tax risks that need to be monitored when a cost-plus tax structure is used in Japan include:
- Permanent establishment risk.
- Transfer pricing risk.
3. Buy-Sell Tax Structure
A buy-sell structure allows a Japan business to perform the broadest scope of activities in Japan. If the Japan entity intends to perform sales activities in Japan, a buy-sell structure should be considered.
Under this approach, the Japan entity purchases products and re-sells them to Japanese customers.
The main tax risk associated with buy-sell tax structures in Japan is transfer pricing. Essentially, the purchase price paid by the Japan entity to a related party should be determined on an arm’s length basis. If the inter-company price is seen as aggressively shifting profits out of Japan, the Japan tax authorities may assess additional corporate income tax along with penalties and interest.
4. Non-Entity Options
Certain clients may be able to utilize available specialized structures.
One such structure is the tokumei kumiai, which may allow a foreign investor to receive profits from Japan after paying a final flat withholding of 20% to the Japan tax authorities.
This article provides An Introduction to Japanese Tokumei Kumiai.