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Setting Up a Business in Japan – Choosing The Right Japan Business Entity

Background - Why Choosing the Correct Entity Is Important

Selecting an appropriate entity will often be the first step when establishing a business in Japan. This initial decision is important since it will impact all of the following:

  • the foreign company’s tax situation in it’s home jurisdiction,
  • the foreign company’s tax situation in Japan,
  • the amount of compliance required in Japan,
  • the amount of management time that will need to be devoted the Japan entity in order to ensure that it remains compliant.
  • the foreign company’s ability to undertake certain kinds of business in Japan,
  • the ability to obtain work visas in Japan,
  • the ability to open a Japan bank account,

Three Basic Choices

There are three broad categories  of entity that a foreign company can establish in Japan. These are:

  • Incorporated entities: This is mainly Kabushiki Kaisha (“KK”) and Godo Kaisha (“GK”),
  • Japan Branches of Foreign Companies (“JBO”), and
  • Japan Representative Offices

A fourth option (which is not strictly an entity option) is the use of a Japan PEO / Japan Employer of Record style solution. This article discusses Japan PEO / Japan Employer of Record solutions.

What Type of Entity Should We Establish in Japan

The following is a more detailed discussion of the above mentioned options for setting up an entity in Japan:

1. Japanese Incorporated Entities / Subsidiaries – KK’s and GK’s

There are two types of incorporated entity commonly used by foreign companies in Japan:

a. Kabushiki Kaisha or “KK”

This is usually translated to English as “Joint Stock Company”. 

A Kabushiki Kaisha (“KK”) is a traditional per se corporation and is a common form of business in Japan. It may have a large number of shareholders whose liabilities are limited to the extent of the capital invested.

b. Godo Kaisha or “GK”

This is usually translated to English as “Limited Liability Company” or “LLC”.

From a legal viewpoint, a Godo Kaisha (“GK”) is similar to a U.S. LLC in that it combines the characteristics of partnerships (flexibility) and corporations (limited liability). However, it should be noted that (in contrast to a U.S. LLC), a Godo Kaisha (“GK”) does not have the ability to be pass-through for Japanese corporate tax purposes.

Godo Kaisha (“GK”) are particularly popular with U.S. investors due to the possibility of utilizing the Internal Revenue Service’s (IRS) “checking the box” regulation (and thereby creating a pass through) for U.S. tax purposes.

Deciding Between a Kabushiki Kaisha (“KK”) and a Godo Kaisha (“GK”)

The following factors may be relevant when choosing between a Kabushiki Kaisha (“KK”) or a Godo Kaisha (“GK”).

  • Flexibility in Management: A major difference between a Kabushiki Kaisha (“KK”) and a Godo Kaisha (“GK”) is that a Godo Kaisha (“GK”) has greater flexibility in its management and operation.

For example, a Kabushiki Kaisha (“KK”) is usually required to distribute dividends to shareholders on a pro-rata basis. By contrast, a Godo Kaisha (“GK”) may be permitted to make distributions on any basis agreed under it’s articles of incorporation.

  • Image: In some industries, there is a perception that a Kabushiki Kaisha (“KK”) presents a more prestigious corporate image. This issue should be confirmed with existing Japanese clients to determine if there is a strong view in this regard.
  • Ease of Incorporation: The incorporation procedures and ongoing legal compliance requirements for a Godo Kaisha (“GK”) are simpler when compared to a Kabushiki Kaisha (“KK”). However, few investors would make a decision based on this factor alone.
  • Japan Tax: Both Kabushiki Kaisha (“KK”) and Godo Kaisha (“GK”) are taxable entities for Japanese corporate tax purposes and are subject to corporate income taxes on their worldwide income.

For U.S. tax purposes, the U.S. “check-the-box” regulations may allow a Godo Kaisha (“GK”) to be effectively treated as a branch of the U.S. parent. By contrast, for U.S. tax purposes, a Kabushiki Kaisha (“KK”) is treated as a “per se” corporation.

2. Japan Branch of a Foreign Company (“JBO”)

A Japan Branch is not a separate legal entity. Rather it is an extension of the foreign company that establishes the branch (referred to as the branch’s “Head Office”).

A Japan Branch may have some Japan side tax advantages when compared to a Kabushiki Kaisha (“KK”) or a Godo Kaisha (“GK”). These advantages may include:

  • Withholding Tax: If profits are sent back to the foreign Head Office, the remittance will generally not be subject to Japanese withholding tax. Dividends (e.g., sent by a Japan subsidiary to it’s foreign shareholders) by contrast will generally be subject to Japan side withholding.
  • Utilization of Losses: Where a Japan branch is established, the foreign Head Office may be able to utilize losses incurred by the branch in Japan. By contrast, where a Japan incorporated subsidiary is used, losses may be locked in the Japan entity and not be available for use by the foreign Head Office.

In spite of the possible tax advantages, branches are no longer widely used by foreign investors in Japan. This is mainly due to issues of image – in particular, a perception that branches demonstrate a lack of commitment to the Japanese market. A branch may also have difficulty dealing with large Japanese companies in some industries.

3. Japan Representative Office

Representative Offices are referred to as Rep Offices or Liaison Offices in English and as “renraku jimusho” in Japanese.

A Japan Representative Office is generally not required to be registered and is usually not subject to Japanese corporate income tax.

A Japan Representative Office is only permitted to undertake very limited activities in Japan.

The permitted activities for a Representative Office are set out in Japanese domestic law as modified by any applicable double tax treaty (“DTA”). The activities are typically limited to liaison or auxiliary type services. In particular, individuals working for the Japan Representative Office, cannot be undertake sales activities in Japan. Note that the definition of “sales” is interpreted very broadly by the Japanese tax authorities.

There may be practical problems operating in Japan through a Representative Office. For example, it may be difficult to enter leases and open bank accounts.

Using a Japan Representative Office may also cause complications when it comes to obtaining social insurance and labor insurance for the individual acting as the representative in Japan.

How To Decide Which Entity to Establish?

What constitutes a suitable entity for doing business in Japan is highly client specific. However, a good starting point is for the client and her professional advisors is to consider the following five factors:

a. What Are the Overall Objectives in Japan?
An important first step is to determine overall objectives. For example, is the purpose of the new Japan business entity to carry on actual sales in Japan or will the new entity merely undertake marketing services with sales continuing to be made out of the home jurisdiction?

On the financial / tax side, is the object to bring income back to the home jurisdiction or to keep it offshore?

b. Are There Any Home Jurisdiction Issues to Consider?
It is vital that clients consult with their home jurisdiction professional advisors prior to commencing the Japan set-up process.

The goal is to put in place a Japan entity that optimizes the position of the group as a whole so the focus should not be only on Japan side issues. The client’s home country professional advisors are usually best placed to make this assessment.

c. What Activities Will Be Undertaken in Japan?
The activities to be undertaken in Japan will impact the type of entity that can be used. There may be cases where (for example due to licensing considerations) where only a Kabushiki Kaisha (“KK”) can be utilized. A Representative office cannot be utilized where sales activities will be undertaken.

d. Are There Commercial Considerations (The Perception Intangible)?
In Japan, certain types of entity may be perceived as having higher status. If the Japan operation will be interacting with large, traditional Japanese companies, a Kabushiki Kaisha (“KK”) may be necessary, or at least highly desirable.

It is recommended that these types of “soft” issues be discussed in advance with Japanese customers, professional advisors, and employees.

e. Japan Side and Home Jurisdiction Tax Considerations?
Different entity types have different tax consequences. Tax issues need to be considered in both the home jurisdiction and in Japan.

For example, a Japan Representative Office / Liaison Office will generally not be subject to Japanese corporate taxes. Japan branches of foreign companies may allow for the easy allocation of head office expenses whereas pushing down expenses into a Japan subsidiary (a Kabushiki Kaisha (“KK”) or a Godo Kaisha (“GK”)) may require a detailed intercompany agreement.

In the case of a U.S. parent, use of a Godo Kaisha (“GK”) may allow the U.S. company to take advantage of U.S. side “check-the-box” rules.

Contact AA International Law™ to learn more about how our professionals can assist you to select an appropriate business entity 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.