Doing business in Japan information
by Venture Japan
In the previous section on Japanese tax structures and audits for foreign companies doing business in Japan, I noted that even if your tax structure is based on one of the four traditional structures and passes a tax audit, it still may not be the most efficient structure to use.
The first structure for doing business in Japan (dealing solely through 3rd party distributors with no resident Japanese subsidiary) may be income tax efficient but if the metric of 'potential value realized' is applied then I believe that this structure performs far worse than the alternatives. I noted in the section on direct sales in Japan that as a foreign executive (I am English) who has successfully sold and negotiated directly with Japanese customers, I am convinced that in 99% of cases your Japanese business revenues will be far higher if you have a direct selling Japanese subsidiary than will ever be achieved selling through a Japanese distributor. In a simplistic sense, you may eliminate a 42% corporate income tax charge by 'staying out' of Japan but in doing so you lose 30% - 60% to a distributor that may anyway only ever realize 20% of your potential Japanese market value!
Many foreign companies doing business with Japan do so through the customer liaison subsidiary or 'service and support' branch-office which reduces the effective direct Japanese corporate income tax charge to less than 2.5% of the Japanese subsidiary's operating expense. The problem is that to legitimately maintain its status as a customer liaison office, the Japanese subsidiary must have absolutely no contact or communications with a Japanese customer or distributor which directly results in earning revenue, i.e. your Japanese office must exist solely to provide arm's-length technical and product support to your Japanese distributors but must not negotiate contracts with them or actively sell to them. In addition to the same criteria as will be applied to the customer liaison subsidiary, the service and support branch-office must maintain an arms-length 'no see no hear no speak' relationship with the ultimate foreign parent.
Having personally managed a 'customer liaison office' I do not recommend it as a long-term tax reducing structure because I believe the downside risks are increasingly unacceptable unless it simply supports one or more totally independent 3rd-party Japanese distributors and never interacts directly with customers. The problem is that over time the role of the office begins to blur - especially because (despite the myths of doing business in Japan) most Japanese businesspeople do not speak fluent English and will soon gravitate to dealing with the Japanese subsidiary rather than with the foreign head-office. The inevitable tendency is for a customer liaison office to evolve into a direct sales office in all but title. I even know of one or two that have employees on sales compensation plans with revenue quotas! Think they won't be found out? I once had a Japanese customer whose brother worked in the tax office responsible for the area where our office was located - Japan is a very small country!
If you are 100% confident that your Japanese distributor is maximizing both the base (pre-tax) revenues you earn doing business in Japan and the intangible Japanese brand value of your products, then either of the above structures, properly 'isolated', can be optimal. Ultimately the customer liaison subsidiary is tax efficient, but very likely only on a fraction of your potential Japanese market value. Why? Because I will guarantee that most foreign companies could be doing substantially more business in Japan by direct sales from a Japanese subsidiary office or company than they ever will through a disinterested 3rd-party distributor.
So, for those enlightened companies who do not want to bet their future success on a distributor but want to enter the Japanese market and quickly start doing profitable and tax efficient business in Japan, what is the most tax efficient way to setup a direct sales presence here?
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