Under Japanese Tax Law, Japanese companies are taxed on their worldwide income, while foreign companies are taxed only on the income earned from their activities in Japan. A Japanese company is defined as a company whose head office or main office is located in Japan (usually when the company is firstly created and registered in Japan), the nationality of its shareholders or place of central management is not relevant. Companies other than this are regarded as foreign companies.
There are several factors determining the taxes payable in Japan by a foreign company, depending on the following circumstances:
- The foreign company has a taxable presence (a “permanent establishment” or “PE”) in Japan,
- If the foreign company does have a taxable presence in Japan, the nature of this presence (a branch, an agent PE or a construction site PE),
- The nature of the Japanese source of income.
After the latest revision of the Corporate Tax Law and CTL Enforcement Ordinance in 2019, the types of taxable presence a foreign corporation may have in Japan include the following:
Branch, factory, other fixed places in which business is conducted in Japan, mine, quarry, building for rent, etc., but exclude a specified place used only for the purpose of storage, display, or delivery of goods or merchandise belonging to the enterprise and any other activity of a preparatory or auxiliary character.
Construction, installation, assembly project, or supervisory services related thereto for a period of greater than one year, but exclude a specified place used only for the purpose of storage, display, or delivery of goods or merchandise belonging to the enterprise and any other activity of a preparatory or auxiliary character
A person other than an agent of an independent status (i.e. Agent PE) acting in a contracting state on behalf of an enterprise and has, and habitually exercises, in a contracting state, an authority to conclude contracts, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are:
- in the name of the enterprise
- for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or
- for the provision of services by that enterprise.
Types of agent PE
Under Japanese Tax Law, there are three sorts of agents who might be considered as a permanent establishment. An agent PE is a person who has an authority to conclude contracts in Japan for or on behalf of the foreign company.
Contract concluding agent
Authorised representative, a person having and habitually exercising an authority to conclude contracts in Japan for or on behalf of the foreign company, unless the activities of such person are limited exclusively to the purchase of goods or merchandise,
A person who is habitually maintaining in Japan a stock of goods or merchandise from which it regularly fills orders and delivers goods or merchandise on behalf of the foreign company, in other words who retains assets on behalf of a foreign company in order to respond to ordinary requests from customers,
A person habitually securing orders, negotiating or performing other important activities in Japan for concluding contracts, exclusively or almost exclusively, for or on behalf of the foreign company.
Other points to note
Agent PE can become Japanese tax liability for a non-Japanese company that, for example, did not establish a physical presence such as a branch in Japan, but instead only sent employees to Japan to negotiate sales contracts or undertake similar activities. Understanding these regulations is often critical to understanding the tax exposure a foreign company may have to Japanese tax.
The effect of these rules is to make a foreign company that has an agent in Japan liable to Japanese tax on the profits earned through the agent. Also, an agent in this context does not just include third parties but could include companies related to the foreign company or, as is quite commonly the case, the employees of the foreign company itself who come to Japan in order to do business.
Determination of whether a person is an agent PE is unrelated to his/her Japanese tax residence status. It would be possible for an employee of a foreign company to be treated as a taxable presence in Japan by making frequent business trips to Japan to negotiate contracts on behalf of his/her employer without the employee himself becoming a tax resident in Japan.
Whether the taxable presence is created by an authorised representative, or an agent who is providing storage and delivery for a foreign company, or an order-securing agent, under Japanese Tax Law, these three situations create a permanent establishment and therefore the company is subjected to taxes on the income made in Japan.
Even when a foreign company has not established a registered branch in Japan it can be treated as having a de facto branch, or PE, in Japan under certain circumstances.
There is however an exception from being treated as an agent PE of the foreign company for the persons who are carrying out the activities of the foreign company business independently. An agent of independent status is excluded from the definition of an agent that constitutes a PE. A person may be treated as an independent, and hence excluded from creating a PE for a foreign company, if he/she meets all of the following conditions:
- When carrying out his/her activities the agent is not receiving detailed or comprehensive instruction from the foreign company, and can himself exercise sufficient discretion over his/her activities and is legally independent from the foreign company,
- Through the use of his/her own knowledge and ability relating to the business he/she undertakes, the person is bearing risk and is economically independent from the foreign company,
- The person is himself carrying on his/her normal business activities or processes.
An independent agent will be generally, for example, a broker.
Figure 1: Taxation situation of a SME according to its physical presence in Japan
Effect of tax treaties on treatment of permanent establishment
Important to note is that, in case the country of residence of a foreign company has concluded a tax treaty with Japan, the definition of a PE in the treaty overrides the one under Japanese domestic tax laws. Tax treaties between Japan and the jurisdiction of residence of the foreign company have a strong effect on the treatment of permanent establishment. It is important to refer to these treaties to understand the exposure of the SME to Japanese tax law.