Witholding Income Tax - Nagamine & Mishima Consulting

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 Account

Banks 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)

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?

Depending on the answer to these questions,some subcontractor engagement will require withholding obligations regardless of the contractual content. If deemed employee salary for the subcontractor agreement, not only on withholding income but also consumption tax position will change. Therefore, close communication will be necessary with the tax accountant in regards to subcontractor agreement.

Commisions (Transactions outside Japan)

When making commission payments to non-Japanese entity or individuals overseas, you will need to ask the following questions regarding such commission. 1. Is the commission subject to withholding income tax? 2. Will it be subject to withholding for special reconstruction income tax? 3. Is the tax treaty applicable? In case of intercompany commission, executed signed agreement must be in place. And to make sure of the following, 1. Actual transaction is made in accordance with the intercompany agreement 2. Proof of transaction 3. Logical explanation for the transaction amount There are incidents when commission transaction expands to transfer pricing issues. Relevant transfer pricing documentation will be necessary in these circumstances.

Dividends

Dividend

When arranging payments for dividends from unlisted companies in Japan, make sure you withhold 20% withholding income taxes. Always be sure to check with your tax accountant to see if tax treaty applies. Many treaties allow deduction or exemption for withholding income tax. Apart from tax treaty documents, there are cases when you need to prepare documents from your tax jurisdiction so advance preparation is critical to enjoy tax treaty benefits. Please be aware that holding period of 6 month with shareholding requirements of 25% will require in many cases for tax treaties. Recognition timing of dividends differs depending on the company structure of KK(Kabushikigaisha) & GK(Godogaisha). For KK, stockholders meeting must be held and depending on how you state in your article of incorporation, board meeting must also be held. For GK, equivalent of board meeting must be held.

Fringe Benefit

Posting items under fridge benefits are target of withholding income tax adjustment. The tax auditors will be looking into transactions which can be defined as salary under the withholding income tax guidelines in Japan. This is one of the areas cultural aspects comes into play. Whether or not a transaction can be defined as employee salary is completely dependent on the context of Japanese business culture. Therefore, some of the fridge benefits which may not have an issue as deductible expense under your country’s tax code may end up in different treatment in Japan. Ask for tax accountant or ask your Japanese employees if some of the fridge benefits you plan to provide are common practice in Japan. There are basically 2 rules if you wish to stay safe in order not to get challenged for salary adjustment for withholding income tax. One rule is that fridge benefit must be provided equally to every employee. Second rule is value amount of the benefit is not considered luxurious or upscale for the type of expenditure.

Meeting Expense

Meeting expense is one of the expenses challenged as entertainment expense subject to limitation as income tax deductibles. For meeting expense at coffee shops and restaurants, always have your sales personnel write down the following items on the back of the receipt to substantiate the business purpose. 1. A list of the attendees 2. Group or association of each individual If the above information is not kept properly, tax auditors in Japan will not hesitate to deem this transaction as salaries subject to withholding obligations.　Please note that even if the above information is provided, the following elements provide room for the tax auditors to challenge as entertainment expense as well. A) Time B) Place C) Amount Spent