Takashi Yamaguchi, English Speaking Japanese Tax Accountant

Non-deductible compensations for company officers

As I mentioned in the former blog (“Income” and “profit”, what is the difference? ), there are some expenses for financial reporting purpose but not deductible for the Japanese corporation tax purpose.
This time, I would like to talk about “non-deductible compensations for company officers” as an example of such non tax deductible items.
As long as there is no “specific provision” in the tax law, accounting expenses shall be tax deductible. However, the Corporation Tax Law (“Law”) provides that compensations paid to company officers are generally not tax deductible (Article 34 of the law).

The public stance and the realty

The reason why the Corporation Tax Law is reluctant to allow tax deduction of compensation for company officers is to prevent reduction of taxable income by their “special pleading” to increase their own compensation.
“Special pleading” is originally a matter of corporate governance, so it should be regulated by the Companies Act.
In fact, the Companies Act stipulates that certain matters must be determined by the Articles of Incorporation or the general meeting of shareholders regarding the compensation etc. that the director receives from the company, and is trying to prevent “special pleading” (Article 361 of the Companies Act).

However, at the family company etc. where the shareholders and their relatives are appointed as officers of the company, it is not necessarily the case that “separation of ownership and management” of business is secured as the Companies Act assumes, accordingly it is likely that “special pleading” is always acceptable.
In order to secure fair taxation, while keeping the public stance to respect control by the shareholders, a rule is required so that the tax law can invoke its own treatment on “special pleading”.
Therefore, even if it is legitimate from the viewpoint of corporate governance as “the shareholders had agreed with it”, the tax law restricts its deduction with “specific provision”.

What is an “officer”?

The company officer for the Corporation Tax purpose is broader concept including officers (directors, executive officers, accounting advisors, corporate auditors) under the Companies Act as well as any other person who is substantially engaged in corporate management (Article 2  Item 15 of the Law).
In the case of a “family company” that is dominated by a small number of shareholders, if there are stakeholders of major shareholders (special relationship employees) among the employees, even if they are employees for the Companies Act purpose, they may be regarded as  the “officers” for tax purpose (Article 7 item 2 of the Enforcement Order of the Corporation Tax Law (hereinafter referred to as the “Order”)).
If your company employs someone who has special relationship with major shareholders, you should be careful about their tax status.
Also, even if they are not an employee of your company, they can be the “officer” for tax purpose when they are substantially engaged in management of the company’s business.
Special attention is necessary when your company has so-called “consultants”, “advisors” etc.


The compensations Include economic benefits (such as payment in kind, fringe benefits) as well as salaries paid in cash.
If your company offers compensation plans to grant share of the company or its warrant, reimbursement of entertainment expense etc. without receipt, usage of corporate-owned assets (automobiles, real estate, etc.) for free or nominal charge, life insurance policy to not only its employee but also for the sake of his/her family.
In addition, assumption of liability for personal expenditure not related to the business of the company is regarded as the “compensation”.
Giving economic benefits according to officers’ arbitrary without approval or just self-will causes a problem under the companies Act before tax.
Please be careful of it.

Deductible compensations

In principle, salaries for officers can not be tax deductible expense, however, consideration for execution of duties as an executive officer is exceptionally deductible when it is paid regular basis according to a certain reasonable manner.
The Corporation Tax Law allows the following three payment patterns as an exception.

Fixed and periodical compensation

It is a compensation paid at regular intervals of one month or less and the amount paid for each period is the same amount (Article 34 para 1 item 1 of the Law).
A typical example is monthly salary (base salary).
No advance notification to the tax office is required but there are certain restrictions on change of the amount in the middle of the fiscal year.
Each periodical compensation after the change must be the same fixed amount to remain tax deductible.

Type of change Acceptable Reason Example
Periodic revision Changes within 3 months from beginning of fiscal year Revision based on resolution of ordinary general shareholders meeting.
Irregular revision Significant change in the duties of the officer Reduction of compensation is inevitable since the officer has been hospitalized for long period of time due to accident or illness and not able to fulfill his/her duty as the officer.
Reduction of compensation is inevitable due to his/her wrongdoing.
Change in the title of the officer Increase of compensation for additional duties and responsibilities due to promotion to a representative director from a director.
Revision due to remarkable deterioration of business performance The business condition of the company had remarkably worsened Reduction of compensation is inevitable from viewpoint of the relationship with the shareholders considering the management responsibility as an officer for the deterioration of business and financial performance. 
Due to default of repayment of borrowings, etc., reduction of compensation is inevitable in rescheduling with the bank.
As performance, financial situation or cash flow deteriorated, it is necessary to maintain and secure credit with stakeholders such as business partners, reduction of compensation is inevitable in order to improve the business situation.

If you change for reasons other than the above, the difference will be non-deductible.
Please note that part of the salary paid before the reduction will be non-deductible unless there is the reason to compromise with the third parties even in the case of deteriorated business performance or cash flow.
I would say, it is best to pay fixed and periodical compensation at a prefixed amount with a margin then make a regular review at a general meeting of shareholders every year.

Compensation with the advance notification

Compensations falling under neither the fixed and periodical compensation nor the performance linked compensation, can be tax-deductible only when the company files a “notification concerning prefixed compensation” to the tax office in advance and makes payments of the compensation of the stated amount on the payment dates notified therein (Article 34 para 1 item 2 of the Law).
The deadline for the advance notification to the tax office is as follows.

In principle Within 1 month from the date of the resolution of general meeting of shareholders, whichever earlier
Within 4 months from the start of the accounting period (date of commencement of fiscal year)
For newly established corporation Within 2 months after the establishment date of the new corporation


Performance-linked compensation

It is compensation paid to executive officers based on key performance indicators for profit of a company.
Performance-linked compensation paid to executive officers by a non-family company or a family company (only if it is an wholly owned subsidiary of non-family company) can be tax-deductible when it satisfies the certain requirements concerning the calculation method, payment timing, etc. (Article 34 para 1 item 3) of the Law).

Since the “key performance indicators for profit” is limited to those stated in the securities report (alike Form-10K for US SEC purpose), this exception is actually applicable to only large companies such as listed companies.

Non-deductible as an unreasonably expensive compensation

Even if the compensation falls under any of the above three exceptions, when the compensation amount is regarded as unreasonably expensive, the amount exceeding the reasonable amount will not be tax deductible (Article 34 para 2 of the Law).
Whether or not “unreasonably expensive” should be judged considering duties of the officer, the revenue of the company, compensation scale for its employees, and the situation of officers compensation paid by other corporations doing similar business in similar scale (Article 70 item 1 of the Order).

In addition, the amount of compensation paid to the officer by hiding the facts or manipulating books and records cannot be tax-deductible (Article 34 para 3 of the Law).

Tax treatment of the officer-employee

The officer-employee means an officer of the company (excluding certain officers with tile such as the president as provided in the Order) who is habitually engaged in duties as an employee of the company such as manager, chief etc. (Article 34 para 6 of the Law).
Typical examples are “Managing Director, Sales Department” or “Director, General Administration Division” and so on.
As for the officers who are also major shareholders of the family company (specific officers) can not be treated as the officer-employee  (Article 71 of the Order) .

For the officer-employees, the company is allowed to pay compensations for officer’s duties (the officer compensation) and employees duties (employee compensation) respectively.
With regard to compensation for the office-employees, tax treatment will be determined as follows.

  Salary bonus
Officer compensation Only the fixed and periodical compensation is deductible. Either the prefixed compensation with advance notification or the performance linked compensation is tax deductible.
Employee compensation Deductible except “unreasonably expensive” amount. Deductible except “unreasonably expensive” amount.
However, not deductible if it is paid at a different timing from the bonus payment to other employees.

Therefore, in order to clearly distinguish the officer compensation from the employee compensation, it is desirable to establish an officer compensation policy in addition to general compensation policy.
Also, bonus paid as the employee compensation but paid on different payment date from other employees is not tax-deductible (Article 70 item 3 of the order). So you need to be careful of timing of payment.

Retirement compensation for officers

“Unreasonably expensive” amount of retirement compensation paid to officers such as “retirement allowances” or “retirement bonus” is  not tax-deductible (in the parentheses of Article 34 para 1 of the Law).

Whether or not “unreasonably expensive” should be judged considering length of period the officer engaged in business of the company, the reason of his/her retirement, and the situation of officers retirement compensation paid by other corporations doing similar business in similar scale (Article 70 item 2 of the Order).
However, practically speaking, it is difficult for taxpayers to draw the line for “unreasonably expensive” therefore it often triggers tax controversy in the tax audit.
First of all, it is desirable to clarify the basis for calculation of retirement compensation for officers in retirement policy for officers, then gather information on retirement compensation paid by the other companies in the same industry and the similar size.


Officers compensations will be subject to income tax at each officer level.
The owner-CEO of the company should weigh tax burdens of corporation tax and personal income tax so that he/she can optimize the entire tax burden.
Also, as compensation increases, the burden of social insurance premium increases accordingly.
If the economic benefit to the officer is treated as compensation, it should be regarded as salary income for income tax purpose therefore it is subject to withholding tax upon its payment.
A treatment of officer compensation will affect various tax implications.

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