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Japan PEO / Japan Employer of Record Services

Introduction – A Trend To Simplification

As professional advisors, we are often called on to advise foreign clients considering the commencement of operations in Japan. Overall, the trend is to operate internationally with maximum simplicity and minimum commitment of scarce management and financial resources.

In some cases, the establishment of a new Japan entity will be the only way forward. This may be due to the nature of the client’s Japanese customers (for example large, conservative Japanese companies) or the type of operations to be undertaken in Japan (for example, manufacturing or R&D).

In cases where the functions that need to be undertaken in Japan are marketing / liaison type functions, clients are increasingly expressing interest in Japan PEO / Japan Employer of Record style solutions as an alternative to a full corporate set-up.

This article discusses PEO / Employer of Record style options available in Japan and the issues associated with such an approach, including the international tax issues that need to be considered.

What Is an Employer of Record / PEO Style Solution?

A PEO (or employer of record) service allows a client to utilize employees without the need to directly hire such employees. Typically, employees are hired by a third-party service company and the employees then provide services to the client. The PEO provider takes responsibility for the legal and HR aspects of the employment relationship.

In the realm of international operations, a PEO / Employer of Record service can allow a client to hire employees in other countries without the need to establish an entity in each jurisdiction.

PEO Style Solutions in Japan

It is commonly understood that Japan does not have PEO / Employer of Record services in the sense the term is used in countries such as Australia and the United States. Japan does have a system called haken but this is generally utilized domestically and aimed at lower level / administrative workers. Thus, haken will often be a poor fit when attempts are made to use it for non-Japanese / higher level workers.

However, ignoring such technical definitional differences, there are PEO / Employer of Record style solutions available in Japan that may be appropriate for foreign companies.

Reasons to Not Establish an Entity in Japan

It is worth considering the reasons that clients may not wish to establish a stand-alone entity in Japan. Common reasons include the following:

  • Financial cost of establishing an entity in Japan
  • Financial cost of ongoing compliance associated with establishing a Japan entity
  • The amount of foreign management time expended in the day to day management of a Japan operation
  • Uncertainty about the long-term viability of the Japan operation

Advantages of a PEO Style Arrangement

Factors that can make a PEO style arrangement attractive to foreign companies in Japan include the following:

  • A Japan PEO / Japan Employer of Record provider will have familiarity with local employment laws.
  • Ability to provide full Japanese payroll. Japanese employees place high value on the benefits associated with a local Japan payroll. This includes national medical cover and national retirement scheme.
  • Reduced risk of legal action being taken against the foreign parent company
  • Ability to manage HR matters in Japan
  • Ability to have someone on the ground in Japan with the sole goal of promoting the company’s product

Alternatives to a Japan PEO / Japan Employer of Record Style Arrangement

Two alternatives to a PEO / Employer of Record style arrangement are as follows:

  • Engage a Local Distributor – This involves a relationship with a distributor in Japan who will take responsibility for the marketing and sale of the product in Japan. Common problems with this approach include:
    • The distributor will typically manage many products and it is often difficult to obtain focus on the overseas company’s products.
    • The distributor may position the foreign company’s products inappropriately in the market, thus damaging long-term sales prospects.
  • Employ People as Independent Contractors – Under an independent contractor arrangement, the foreign company simply engages Japan based individuals as independent contractors. Common problems associated with this approach include:
    • Independent contractors are unable to receive a regular Japan payroll. As noted above, Japanese employees place high value on a regular payroll that will include participation in the national medical scheme and national pension scheme.
    • Tax returns. In Japan, it is unusual for an employee to prepare an individual tax return since this function is carried out via a year-end adjustment in the December payroll each year. Independent contractors by contrast are required to submit an individual tax return and this may be something potential employees are unfamiliar with and reluctant to do.

Typical Procedure

A typical Japan PEO / Employer of Record arrangement would be as follows:

  1. Business Support Agreement: The client enters a business support with the Japan PEO / Employer of Record provider. This agreement should be carefully drafted to ensure that the client receives the dedicated support that it requires in Japan while minimizing tax risk – especially Japan transfer pricing and permanent establishment (“PE”) risk.
  2. Employee Onboarding: Employees who will be providing services pursuant to the business services agreement will be onboarded. This can involve applying for work visas and dependents visas in cases where the employees are non-Japanese. Employees are then brought on to the PEO / Employer of Record’s Japan payroll. Particular attention needs to given to Japanese social security (especially statutory health insurance) since uninterrupted coverage is the number one concern for Japanese employees.
  3. Sales to Japanese Customers: Sales to Japanese customers will typically occur directly between the foreign client and the Japanese customer. This allows sales to be recognized in your foreign company rather than in Japan.

Management of International Tax Risk for Japan PEO / Japan Employer of Record

An important issue associated with many PEO / Employer of Record providers is their failure to consider international tax risk.

International tax is becoming a significant focus of many tax authorities and the Japanese tax authorities are no exception. If these issues are not explicitly considered at the early stages, there is potential for the client to suffer both reputational damage and financial damage.

In particular, the issue of Permanent Establishment (“PE”) needs to be considered. In simple terms, if the activities undertaken via a PEO / Employer of Record service are not carefully managed AND properly documented, the activities in Japan may be deemed a PE of the client’s company outside Japan.

This could lead to the foreign client being subject to Japanese tax based on (at least) sales to its Japanese customer even if it has no subsidiary in Japan. In addition, the foreign client may need to re-state its accounts and prior year tax returns. Even if no problem is eventually found, PE investigations by tax authorities are time consuming and expensive. If a problem is identified it can lead to a significant Japan tax liability (plus interest and penalties.)

Professional advice is critical at the outset in order to ensure that the business service agreement with the PEO / Employer of Record provider is appropriately drafted.

Conclusion

A PEO / Employer of Record can be a good solution for foreign clients whose requirements in Japan are focused on market development and liaison with Japanese customers. Professional advice should always be sought before entering into agreements in order to ensure that the international tax risk (in particular permanent establishment (PE) risk is properly managed.