Withholding income taxes may be the most vulnerable area when it comes to tax audit in Japan. In principle, withholding income tax is assessed by types of income and recipient classification of income.
Type of income is the biggest headache for most companies. The head scratching part of the tax adjustment is a tax concept called “economic benefit” which tax authorities can deem certain expensed transactions as salary subject to withholding income tax. When tax authorities challenge certain transaction acknowledged by the company as salary, you will be assessed the transaction made as after withholding. The result being liable for withholding payment for the assessed transaction, plus penalty fees for late settlement of withholding income tax.
The most notable case for recipient classification of income are subsidiary in Japan making payments to parent company overseas whether it it interest, royalty, management fee or dividends. These payments to non-residents and foreign companies not only involve withholding income tax but also tax treaty as well. Typical examples are shown below by chart of accounts.
Bank AccountBanks in Japan provide passbooks which you can insert into the ATM machines to print your transactions. In most cases this is fine for tax audit. But for other compliance related audits, banks can issue certificate of balance outstanding in English with extra charge. Interest arising from bank accounts is withheld income tax and inhabitant tax so amounts printed in passbooks are net figures after withholding amount. Banks also issue interest statement of gross amount on paper so it is important to preserve this document. Depending on how you process payments, passbook printouts may only show a lump sum of payment not being able to identify transaction one by one.
Commisions (Outsourcing Fee)
Commisions (Outsourcing Fee)When engaging with an individual in a subcontractor agreement, careful attention needs to be provided considering withholding income tax obligations. The tax authority in Japan loves to challenge subcontractor engagement to full time employment. In case the subcontractor engagement does not qualify as such under the tax code in Japan, it will be deemed as salary to full time employee status staff subject to withholding income tax obligations. Questions which needs to be asked are
- Is the subcontractor responsible for his performance?
- Is the subcontractor under supervision of the company?
- Does the subcontractor have constraints regarding working hours and place of work?