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Compensation & Tax Planning For Foreigners Working in Japan

Background

The number of highly skilled foreigners undertaking Japan assignments is likely to increase in coming years in response to the country’s skilled labor shortage. Professional advisors to foreign multinationals therefore need at least a basic understanding of how their client’s employees’ compensation can be structured in a tax efficient manner.

The purpose of this article is to provide an outline of some of the most important issues in structuring expatriate compensation in Japan.

Note that this topic is closely related to the subject of Japan payroll – the following article provides an Introduction to Japan Payroll.

1. Location of Payroll for Foreign Expat Employees

A key consideration is location of payroll. Location refers to payment onshore (i.e., in Japan) vs. offshore payment (i.e. outside Japan). Often, it will be most efficient if an expats salary is paid outside Japan. Important implications of such offshore payment include:

a. Apportionment of Taxable Income Based on Days In / Days Out of Japan

A regular (i.e., non-permanent resident, non-director) expatriate employee may benefit if (at least part of) their salary is received outside Japan. This is because non-Japan source / non-remitted compensation is usually not subject to Japanese individual income tax. The amount actually excluded from Japan source income is based on the number of days that the employee is absent from Japan on business during the year.

This Days In / Days Out benefit is not available to directors or individuals who have lived in Japan in excess of five out of the past 10 years (i.e., permanent residents of Japan for tax purposes). Also, non-Japan source funds remitted to Japan will be subject to Japanese tax.

This article provides additional information about Compensation Issues For Directors of Japanese Companies.

b. Japanese Income Withholding Tax

Japanese withholding income tax is generally not applied if an expatriate’s salary is paid offshore. As a result, expats paid off-shore will need 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.

c. Japanese Social Insurance

Generally, anyone working in Japan must join the Japanese social insurance system. This consists of several programs including national health insurance and welfare pension insurance. Social insurance contributions are shared equally by the employee and employer.

The Japanese authorities may accept that expatriate employees do not join the system if:

  • The expat employee is paid outside Japan, and
  • Equivalent private arrangements have been made.

Note that it is important to consult with an appropriate professional advisor to assess the risk associated with any position taken regarding the enrollment of expatriates in the Japanese social insurance system.

d. Labor Insurance

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

Foreign expatriates may not be able to obtain coverage under the Japanese labor insurance system if their compensation is paid offshore. As a result, foreign expats may require private insurance arrangements in respect of accident or unemployment.

2. Structuring Specific Compensation Items

The following is an overview of the Japan side treatment of some common items found in expat compensation packages:

  • Housing

If the expat 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 rent value would NOT constitute a taxable benefit to the employee.

In the case of a director, the company housing benefit is less tax effective. The following article discusses Issues in Structuring Compensation for Directors of Japanese Companies.

As a practical matter, the expatriate’s monthly reimbursement to the company (5-10% of the rent value) will be handled through the Japan payroll. This means that even expats being paid via an offshore payroll will receive a small portion of their salary (slightly more than 5-10% of the rent value) in Japan.

  • One-time Settling-in Payments

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

  • Commodities and Services Differential Payments

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

  • Furniture Rental Payments

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

  • Offshore Retirement Benefits

Where the employer makes contributions to a non-Japan retirement plan on the employee’s behalf, this usually constitutes a taxable benefit for Japanese individual income tax purposes.

  • Health Coverage

If the company pays for the employee’s offshore health insurance coverage, such payments may constitute a taxable benefit for Japanese individual income tax purposes.

  • Club Membership (e.g., Tokyo American Club)

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

  • Home Leave

Typically, reimbursement of an expatriate’s home leave expenses will not constitute a taxable benefit in Japan. However, certain conditions need to be met. These conditions usually include, using the most economical route to and from Japan and a limit of one (non-taxable) reimbursement per year.

  • Personal Vehicle Use

Reimbursement of an employee’s private car, would usually constitute a taxable benefit.

  • Relocation Expenses

If the company reimburses actual relocation expenses (as opposed to providing a general moving allowance), such reimbursement is usually not a taxable benefit for Japan tax purposes.

  • Commuting Allowance

Companies in Japan customarily reimburse employees for the cost of the daily commute from their home to the office. This is done by reimbursing the cost of a monthly bus / train commuter pass. Such reimbursement is a non-taxable benefit for the employee up to JPY100,000 per month.

  • Language Lessons

In general, employer subsidized language lessons, would be considered a non-taxable benefit.

Conclusion

Japan provides opportunities for foreign expatriate workers to conservatively structure their compensation. To properly take advantage of this opportunity, compensation structuring should be considered well in advance of a Japan assignment.

Additional planning (for both the expat and the company) needs to be undertaken if the foreign expatriate will become the director of a Japanese company.

Contact AA International Law (AAI Law) to learn more about how we can assist your company to determine an appropriate tax structure in Japan.

The above is provided for general information purposes only and does not constitute advice to undertake or refrain from undertaking any action. Only qualified Japanese professionals are able to advise on Japan immigration, legal, and tax matters.