Japan Taxes: Tax Planning for Foreigners Working in Japan

1. Location of Payroll for Foreign Expatriate Employees

The first consideration is location of payroll. Often, it may be most efficient if their salary is paid outside Japan. Important implications of off-shore payment include the following:

1. Ability to apportion taxable income based on Days In / Days Out

   A general benefit to a normal (i.e., non-permanent resident, non-director) expatriate employee receiving salary off-shore is that a proportion of salary received (calculated based on the number of days that the employee was absent from Japan on business during the year) may be excluded from Japan-source income (and therefore not subjected to Japanese individual income tax unless such funds are deemed to have been remitted to Japan). The Days In / Days Out benefit is not available to directors or individuals who have lived in Japan in excess of five of the past 10 years (i.e., permanent residents of Japan for tax purposes).

2. Withholding Income Tax

   Japanese withholding income tax is generally not possible if an expatriate’s salary is paid offshore. As a result, expats paid off-shore may be required to submit a Japanese individual income tax return, and pay Japanese individual income tax by the 15th of March each year with respect to the previous calendar year.

3. Japanese Social Insurance

   In principle, all persons working in Japan must join the Japanese social insurance system. This consists of a number of different programs the most important of which are health insurance and welfare pension insurance. Social insurance payments are shared equally by the employee and employer.

   Although in principle all employees in Japan are required to join the social insurance system, the Japanese authorities have historically been willing to accept that expatriate employees do not join the system.

   This has generally been on the condition that:

   1. The expat employee is paid outside Japan, and

   2. That equivalent private arrangements are made.

      Note that although this position has generally been accepted in the past, the authorities may change their position in the future. It is therefore important to properly assess the risk associated with any position taken regarding the enrollment of expatriates in the Japanese social insurance scheme.

4. Labor Insurance

   Workers in Japan are generally covered by Japanese labor insurance (consisting of worker’s accident insurance and unemployment insurance) through their employer. Premiums are shared (though not equally) between the employer and employee (via monthly withholding in the case of the employee).

   However, foreign expatriates may not be able to obtain coverage under the national labor insurance system if their salary is paid offshore, since it may not be possible to make appropriate withholding deductions. As a result, foreign expatriatess may wish to consider private insurance arrangements in respect of accident or unemployment.

Location of Payroll for Japanese Employees

It is generally agreed that payroll for Japanese employees should be located in Japan.

This allows for the deduction of social insurance, labor insurance, and income tax withholding.

The following article is a A Guide to Japan Payroll.

2. Structuring Specific Items of Compensation

Some of the most common items found in compensation packages (and the associated Japanese tax treatment) are as follows. Note that many of these items are equally applicable to Japanese nationals and foreign expatriate employees.

1. Housing

   If the employee’s housing qualifies as company housing (i.e., the lease is in the name of the company, and the non-director employee reimburses the company approximately 5-10% of the rent each month), then approximately 90-95% of the value of rent would NOT constitute a taxable benefit to the employee.

   In the case of a director, the company housing benefit is less tax-efficient since the director must reimburse the company for either 35% or 50% of the rent value. The following article discusses Issues in Structuring Compensation for Directors of Japanese Companies. The highly detrimental taxes associated with Japanese directors are a factor in the use of Nominee Directors in Japan.

   As a practical matter, the expatriate’s monthly reimbursement to the company (5-10% of the rent value) can be handled through the Japan payroll. This practically means that the expatriates being paid through an offshore payroll receive a small portion of their salary (slightly more than 5-10% of the rent) in Japan. See the following article for an Overview of Japan Payroll.

2. One-time settling-in payments

   Such payments generally constitute a taxable benefit from a Japan tax viewpoint.

3. Commodities and services differential payments

   Such payments generally constitute a taxable benefit from a Japan tax viewpoint.

4. Furniture rental payments

   Such payments generally constitute a taxable benefit from a Japan tax viewpoint.

5. Offshore retirement benefits

   Where the company makes such payments on the employee’s behalf, such contributions in principle constitute a taxable benefit for Japanese individual income tax purposes.

6. Health coverage

   If the company pays or reimburses the employee with respect to an offshore health insurance fund, such payments in principle are subject to Japanese individual taxation.

7. Club membership (e.g., Tokyo American Club)

   If the membership is for business purposes, the membership fee would generally not constitute a taxable benefit to expatriates.

8. Home leave

   In general, reimbursement of an expatriate's home leave expenses are not taxable in Japan, provided that certain conditions are met, including the most economical route to and from Japan is used. Only one (non-taxable) home leave per year is typically allowed.

9. Personal rental car use

   If such expenses were incurred in respect of an employee’s private use of a car, any reimbursement would constitute a taxable benefit.

10. Relocation expenses

    If the company pays or reimburses actual relocation expenses, such reimbursement generally does not constitute a taxable benefit for Japan tax purposes.

11. Commuting allowance

    Companies in Japan customarily reimburse employees for the cost of travel from their home to the office. This is usually done by reimbursing the cost of a monthly commuter pass for trains and buses. Such reimbursement is a non-taxable benefit to the employee up to JPY 100,000 per month.

12. Language lessons

    In general, if an employer pays for language lessons, this would be considered a non-taxable benefit to the employee.

Japan offers numerous opportunities for foreign expatriate workers to conservatively structure their compensation. To maximize this opportunity, compensation structuring should be considered well in advance of a Japan assignment and, if possible, in advance of the commencement of the visa application process. Further planning for both the individual and corporate tax sides needs to be undertaken if the foreign expatriate employee may become the director of a Japanese company.