Japan withholding tax and final tax return for foreign directors of foreign-affiliated companies

We have checked the three cases so far,

In the first case, Mr. A, employed by the foreign company A, comes to Japan on a short business trip.

In the second case, Mr. A, employed by the foreign company A, works on a short-term business trip to a branch in Japan,

In the third case, Mr. A, employed by the foreign company A, is dispatched to the subsidiary in Japan as its employee.

This fourth time, Mr. A, employed by the foreign company A, is dispatched to the subsidiary as an officer  in Japan.

Let’s see if withholding tax is required or a final tax return is required.

It should be noted that officers and employees are taxed differently when it comes to non-residents.

Resident characteristics of foreign officer A

Suppose two cases. One is that Mr. A remains a non-resident for Japan tax purposes. For example, though the overseas parent company dispatches Mr. A to the Japanese subsidiary to become its officer, he routinely works at the offshore parent company. He attends the board meetings of the Japanese subsidiary through TV to engage in its management. Mr. A does not have an address in Japan. In such a case he would remain a non-resident.

The other case is that Mr. A lives in Japan for more than a year. He would be treated as a resident (non-permanent resident).

Click here for details on the classification of residents or non-residents.

Case; Non-residents

Non-residents > Japanese subsidiary pays the salary

Non-resident Subsidiary pay

Scope of Domestic source income

Non-residents are taxed in Japan when they have a certain domestic source income. Regarding salary income, the range of domestic source income differs depending on whether non-residents are officers or employees of Japanese companies.

As a general rule, the salary that corresponds to the period of work in Japan is considered a domestic source of income, which would be taxed in Japan. The portion corresponding to the period of service overseas is considered foreign source income and is not subject to Japanese income tax.

However, there is an exception to this rule.  When the non-resident is paid a salary based on his position as a director of a Japanese corporation, the salary earned outside Japan is considered domestic source income. It is subject to taxation in Japan (Article 161, Paragraph 1, Item 12 of the Income Tax Act).

 EmployeesOfficers of the Japanese company
Salaries corresponding to the period of work in JapanDomestic source incomeDomestic source income
Salaries corresponding to the period of work overseasForeign source income

 Non-residents > Japanese subsidiary pays the salary > withholding tax

Not only a salary that corresponds to a period of service in Japan but also a salary that corresponds to a period of service outside Japan are considered as a domestic salary. So Japanese corporation’s non-resident director will be taxed in Japan on both as domestic source income. 

When Japanese subsidiary pays salaries in Japan to non-residents, it has a withholding obligation (Article 212, Paragraph 1).

Non-residents > Japanese subsidiary pays the salary>Tax return

When non-residents are paid in Japan with its tax withheld, tax return is not required (Article 172, Income Tax) except in certain cases. (If salary is over 20 million yen, tax return is required).

Non-residents > Japanese subsidiary pays the salary>Tax exemption for short-term residents

The tax exemption for short-term residents is only for salaries received from the employer outside of Japan. Therefore, there is no short-term tax exemption for Mr. A as a Japanese company is a payer.

 

Non-residents > Overseas parent company pays the salary

As is described above, the salary is considered a domestic source of income when it corresponds to the period of service in Japan. The portion corresponding to the overseas service period is considered foreign source income.

There is an exception to this rule: if a non-resident is paid as a director of a Japanese corporation, the income from overseas work is also considered domestic source income.

What about the salary paid to Mr. A by the overseas parent company?

Since he would be paid based on the contract with the parent company, he would not be paid as a director of a Japanese company, domestic source income is limited to the portion corresponding to his service in Japan. 

Non-residents > Overseas parent company pays>Withholding tax

Regarding the salary that corresponds to his service period in Japan, which is subject to taxation in Japan, the payer is not required to withhold tax as it is paid overseas. It would be difficult from a practical standpoint to impose a withholding obligation on salary paid overseas.

As for the portion corresponding to the period of service outside Japan, since it is not based on the status as an officer of a Japanese corporation, it falls under foreign source income and is not subject to taxation in Japan.

Non-residents > Overseas parent company pays>Tax return

Non-residents are required to file a tax return in Japan if they are not withheld (Article 172, Paragraph 1 of the Income Tax Act).

Non-residents > Overseas parent company pays>Tax treaty (tax exemption for short-term residents)

The tax exemption for short-term residents is limited to the salary received from the employer outside of Japan. Therefore, the salary received from overseas parent companies may be subject to short-term stay tax exemption if other requirements are satisfied. 

Case; Non-permanent resident

Non-permanent resident > Japanese subsidiary pays

The scope of domestic source income, when Japanese subsidiary pays

Residents are further divided into non-permanent residents and permanent residents. Most foreign people relocating to Japan will likely fall under a non-permanent resident.
Residents (Non-permanent residents) are taxed in Japan when they have non-foreign source income (nearly equal to domestic source income) (Article 7, Paragraph 1, Item 2 of the Income Tax Law). Salary income is taxed in Japan if it falls under non-foreign source income.  

 Non-foreign source income(≒Domestic source income)Foreign source income
Paid in JapanPaid overseas

Permanent

resident

Taxed

Non-permanent

resident

TaxedTaxed if remitted to Japan
Non-taxed
Non-residentTaxedNon-taxed

Concerning taxation for non-permanent residents, please refer to this article.

As a general rule, the salary income corresponding to the service period in Japan is considered a non-foreign source income.

However, there is an exception when the resident (non-permanent resident) is the Japanese corporation’s director. In such a case, the portion of income earned outside of Japan is considered non-foreign source income (Article 95, Paragraph 4, Item 10, Parenthesis A of the Income Tax Act) and is subject to taxation in Japan.

The salary income of Mr. A paid by Japan subsidiary would be subject to taxation in Japan because both the portion based on domestic service and the portion based on overseas service are considered non-foreign source income.

Non-permanent resident > Japanese subsidiary pays>Withholding tax

As a resident (non-permanent resident), the salary corresponding to his service period in Japan is domestic source income and is subject to withholding at source. As for the salary corresponding to the period of service outside Japan, withholding tax is considered necessary because it is paid domestically (Article 183(1) of the Income Tax Act). 

Non-permanent resident > Japanese subsidiary pays>Tax return

In certain cases, such as residents with salary income withheld tax and adjusted at the year-end by the payer, and salary is less than 20 million yen, etc., then he does not need to file a final tax return (Article 120 of the Income Tax Law, Article 121 Paragraph 1). Details are here. https://www.nta.go.jp/taxes/shiraberu/taxanswer/shotoku/1900.htm

Since Mr. A is an officer, there is a possibility that it has exceeded 20 million yen, in which a final tax return would be required. 

Non-permanent resident > Japanese subsidiary pays>tax exemption for short-term residents

The tax exemption for short-term residents is a rule that exempts non-residents coming to Japan from taxation in Japan. It is assumed here that Mr. A is a resident, Short-term stay tax exemption does not apply.

Non-permanent resident > overseas parent company pays the salary

A resident (non-permanent resident) is taxed in Japan, basically, on domestic source income (Article 7, Paragraph 1, Item 2 of the Income Tax Act). 

As a general rule, the salary income that corresponds to the work period in Japan would be a domestic source income.

However, as mentioned above, there is an exception when the resident (non-permanent resident) is the Japanese corporation’s director. In such a case, the portion of income earned outside of Japan is also considered domestic source income and is subject to taxation in Japan.

However, the situation is different when the director gets paid by the overseas parent company.  The salary paid to Mr. A is based on the contract with the parent company; it is not based on a director of a Japanese corporation. So getting back to the basics, only the portion corresponding to the period of service in Japan is considered domestic source income, subject to taxation in Japan.

Non-permanent resident > Overseas parent company pays>Withholding tax

No withholding is required when the salary is paid outside Japan. 

Non-permanent resident > Overseas parent company pays>Tax return

If the portion of the salary that corresponds to the domestic service period was not withheld, it is necessary to file a tax return.

The portion corresponding to the period of service outside Japan is not subject to taxation and does not need to be filed.

Non-permanent resident > Overseas parent company pays>Application of tax exemption for short-term residents

The short-term tax exemption is for non-residents in Japan, so it does not apply to Mr. A, who is a resident.

This post is based on the laws as of December 8, 2019. The opinion is the writer’s personal opinion. Please consult with your tax accountant for the actual tax process.