Japanese tax structuring

 

Good Japanese corporate tax structures

6.  good Japanese corporate tax structures.

As asked in the previous section on tax structures to avoid when doing business in Japan, "For those enlightened companies who do not want to bet their future success on an uncontrollable 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?"

Of Japan's many business entities, there are 3 that are of practical value to foreign companies starting business in Japan:

  1. the branch office,
  2. the kabushiki kaisha "KK" which is equivalent to a US C-corporation,
  3. the yugen kaisha "YK" which is in some ways equivalent to the US LLC (PLEASE NOTE - effective May 1, 2006, Japan's Limited Liability Company Law is abolished and for legal purposes yugen kaishas will be treated as sole director kabushiki kaishas. Existing yugen kaishas will continue to operate as "tokurei yugen kaisha" or "TYK". The last day upon which a yugen kaisha can be registered is April 30, 2006).

Despite the potential of the tokumei kumiai "TK" (silent partnership) to provide an efficient tax structure, I am not including it here because its use is complex, outside the scope of many smaller foreign companies (unless they have a very sophisticated CFO) and also because recent tax assessments by the Japanese tax authorities are potentially affecting its usefulness. Similarly, for foreign companies who are considering investments in Japanese special situations, real-estate development etc., the tokutei mokuteki kaisha 'TMK' special purpose company is also likely to be a good option, although it is also not included in this discussion for the same reasons the TK is excluded.

Of the 3 considered structures, the branch office is the least tax efficient in a simple 'single foreign parent'<>'single Japanese child' structure because it creates a massive tax liability on both its and its foreign parent's Japanese revenues. In the section on setting up a Japanese branch office I mention that I represent a US high-tech which achieved some impressive initial results operating as a Japanese branch-office - that particular US company had some very serious and very sudden cash problems that forced the use of a branch office as a purely interim solution. For both tax and liability reasons the Japanese branch-office in a simple structure should generally be avoided. Where the branch office can win, is in a doubled-up 'foreign parent'<>'Japanese child' structure. In such a situation 'foreign company A' does business in Japan through arms-length distributors while its subsidiary 'foreign parent Z' supports its Japanese activities through 'child branch-office Z'. Many asset management and investment companies operate in Japan using such a structure with 'foreign parent Z' often being a Cayman SPC.

The kabushiki kaisha "kk" may be a necessary solution in certain situations (for example, to satisfy corporate governance requirements) but it is not especially tax efficient. "But those Japanese business myths tell me that 99% of Japanese companies are set up as kabushiki kaishas" you say - agreed, but 99% of those kabushiki kaishas are 'mom and pop' shops with no profits left after mom, pop and suppliers have been paid and 99.99% of them are not functioning at the subsidiary layer of a global corporate structure, i.e. tax efficiency was not a consideration in their choice.

A kabushiki kaisha may be a good choice for a Japanese customer liaison subsidiary but is not the best choice for a Japanese subsidiary distributor unless your costs of doing business in Japan are high and your Japanese margins are low. Unless you try to use an inflated transfer price (which a tax audit will look for) you will have Japanese profits that can only flow back to the foreign parent as post-tax (i.e. less 42% income tax) dividends which will then presently lose a further 20% withholding tax less tax treaty relief (although the new US-Japan tax treaty will eliminate the withholding tax for dividends paid to a US parent holding 50% or more of the kabushiki kaisha's stock).

A less well-known tax inefficiency of a kabushiki kaisha is that if directors are paid bonuses then those bonuses are deemed to be paid from profits, even if no trading profits were made (i.e. the KK is a customer liaison office). That means that if you pay your directors a $200,000 bonus you will incur an $84,000 corporate income tax charge even if the kabushiki kaisha operated at break-even. If you do incorporate a kabushiki kaisha as your Japanese subsidiary and want to pay your directors performance related bonuses, then structure their compensation based on an annually fixed 'divide-by-12' salary package which assumes a certain performance level. In the following year you can then retroactively increase or decrease compensation depending on the actual performance achieved.

There are other complex structures involving multiple foreign parents and Japanese child entities dealing amongst each other (which is how Japanese companies minimize their income taxes) and creative agent/distributor structures, but to answer the original question, I consider the yugen kaisha "yk" to be the most tax efficient, cash efficient, cost effective and sensible way for foreign companies, especially US companies, to start doing business in Japan. From May 1, 2006 that will mean acquiring an existing tokurei yugen kaisha because the last day to register a new YK is April 30, 2006.

7.  Tokurei yugen kaisha 'TYK' tax benefits >>


Japanese tax structuring

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