2019-05-04
Takashi Yamaguchi, English Speaking Japanese Tax Accountant
Setting up a “Personal Company” in Japan
You may think you need to establish a company for setting up your business. However, I would say, it is not necessary. You would better to consider whether sole proprietorship or a company better suited to your business.
Table of Contents
Is that company really essential?
It has been said that 99% of Japanese companies consist of Small-Medium sized Enterprises (SMEs).
This general perception is consistent with the 2016 statistics by NTA (National Taxation Agency of Japan). According to NTA, there are 2,6702,033 corporations, excluding companies dormant or under liquidation process, associations/foundations, and governmental legal entities, and share the capital amount of 99.2% of those is JPY 100 million or less.
Besides, the statistics indicate that there are 2,294,035 corporations with capital of JPY 10 million or less, which occupies 85.9% of the entire number of the companies.
This “99%” tends to be used in context to emphasize how large enterprises are rare in Japan, but the absolute number of the companies tells us how the presence of SMEs is overwhelming.
Since minimum requirements of capital amount, a number of directors, etc. are abolished by reform of the Company Act of Japan in 2006, the establishment of a company owned by a sole shareholder, so-called “Personal Company”, becomes easier.
Considering such a situation, I speculate that the vast majority of the 2.3 million “small companies” may consist of Personal Companies, of their business conduct is a substantially sole proprietor.
However, as long as it has been established as a company, a Personal Company also has to be organized and managed in accordance with the Company Act.
In a Personal Company, as the owner has to do everything by oneself, such administrative burden may become a hindrance to the company’s business.
Contrary, the owner may not be able to fulfill the administrative duty as he/she is too busy for the business.
I believe that the business owner should opt for a better business environment in which the owner can concentrate on the business.
Even if you are going to hire external advisers to have them proceed with the internal matters, you have to sort out the necessary information and provide it to them. Otherwise, the external parties cannot work on your company’s internal matters.
Accordingly, a sole proprietor may be preferable business structure to a Company structure if you do not want to spend money and time to keep formality as a company.
When you are going to have joint contributors with relatively large capital, a company structure with a limited liability system can be a better option for good credit rating and protection of general shareholders from business risks.
But, if just yourself is going to do business, your company may not be able to maintain its credit without your personal “keep-well” agreement.
And if the company gets into a problem, you may not be exempted from the company’s liability from a business moral perspective despite you are protected by a limited liability system.
You would better think again if a Personal Company is really essential for your business.
Is a sole proprietor disadvantaged?
Many say they set up Personal Companies for “tax saving”.
Indeed, personal income tax is imposed at a “progressive tax rate” of which the top rate is 45% as below chart.
| 総合課税所得の合計 The total amount of ordinary income |
税率 Tax rate |
控除額 Credit amount |
|
| 195万円以下 | JPY1,950,000 or less | 5% | 0 |
| 195万円超 330万円以下 |
more than JPY1,950K and JPY3,300K or less |
10％ | JPY97,500 |
| 330万円超 695万円以下 |
more than JPY3,300K and JPY6,950K or less |
20％ | JPY427,500 |
| 695万円超 900万円以下 |
more than JPY6,950K and JPY9M or less |
23％ | JPY636,000 |
| 900万円超 1,800万円以下 |
more than JPY9M and JPY18M or less |
33％ | JPY1,536,000 |
| 1,800万円超 4,000万円以下 |
more than JPY18M and JPY40M or less |
40％ | JPY2,796,000 |
| 4,000万円超 | more than JPY40M | 45％ | JPY4,796,000 |
In addition, inhabitant tax and enterprise tax (Local Tax) is imposed at 10%, 5% respectively, accordingly aggregated maximum tax rate on personal business income can reach 60%.
Contrary, the income tax rate applicable to a corporation is basically fixed and there are some reliefs granted for SMEs based on amounts of capital and income.
For a company with a capital of JPY 100 million or less, the combined income tax rate of Corporation Tax and Local Tax is 38.07% at maximum.
Seeing these tax rates, you may take it that doing business as a sole proprietor is disadvantageous.
However, the personal income tax rate does not exceed 38.07% unless you become to have a relatively large amount of income.
For instance, a rough estimation of the tax burden on business income (not gross sales amount. It is profit level amount net of necessary expenses) of an unmarried sole proprietor is as below.
個人事業者税負担割合
When your income reaches around 22 to 23 million yen, the tax burden likely exceeds 38%.
Achieving more than 20 million net income not turnover is a quite hard target.
If you foresee such good net profit right after the inception of the business, you would better have a personal company before the commencement of the business. Otherwise, I think it is better to carefully consider how you can get profit distribution from the personal company before its incorporation.
Profit distribution method could affect net return
“Dividend” and “director’s compensation” are a major ways of profit distribution from a personal company to its shareholder/director.
Dividend
Since the dividend is the return of profit after tax (remaining profit on which corporate tax etc. is taxed), the burden of corporate tax will be heavy and the net return to shareholders will be less.
Dividends received by shareholders are subject to personal income tax. Dividends from unlisted companies are taxed at a progressive rate as a comprehensive income.
There is a system called “dividend credit” to ease double taxation of corporation tax and personal income tax, but the effect is limited because the tax credit is limited to only 10% (plus 2.8% for inhabitant tax) of dividend amount.
So, dividends are less advantageous may of profit distribution from both of corporate and personal income tax perspective.
Director’s compensation
In principle, the salary paid to a director of the company (director’s compensation) is not tax-deductible for corporation tax purposes.
However, there is a special exception that monthly fixed salary and salary paid as in advance notification to the tax office can be deductible.
So it is common practice to claim deduction applying the exception for the director’s compensation.
The director’s compensation also provides tax benefits for personal income tax.
Because the deduction of the necessary expenses called “salary income deduction” (minimum 550,000 yen, maximum 1,950,000 yen) is granted to the salary income, the paid amount is not fully taxed.
In such a way, it is possible to reduce the burden of both corporate and personal income taxes by applying the salary income deduction for the calculation of personal income tax while claiming deduction of the director’s compensation for the calculation of corporation tax. it is the chief tax advantage benefited by a shift from a sole proprietorship to a legal entity.
However, if you have any income subject to the progressive tax rate other than business income (such as salary, real estate leasing), you should take them into consideration to estimate your income tax burden. You may be able to save the entire tax by allocating taxable income between you individual and a company but you should consider “Capital Gain Tax” on the transfer of personal property to the company. Otherwise, your tax-saving plan may end up with an unexpected tax burden.
More burden of social insurance premiums
In addition, salaries paid by a company are subject to social insurance (health insurance, welfare pension) charges. It costs approximately 200,000 yen to 3 million yen per year/person based on the gross paid amount.
Compared to the social insurance premium of a self-employed, which is flatted out at around 700,000 to 900,000 yen a year (in the case of a single person), the burden is considerably increased.
The social insurance costs are shared half between the company and the employee. Since the company share will be tax-deductible, it provides a tax benefit, but it surely decreases the company’s profit and the employee’s take-home pay.
If almost all of the company’s profits are paid out as the director’s compensation, it can bring the corporate tax burden close to zero, but at the same time, it incurs the social insurance premium costs at about 28%. Considering such premium costs and income tax burden at progressive tax rate, your take-home pay may be lesser than what you earned as a self-employed.
Consumption tax-saving opportunity is limited
Incidentally, the implication of consumption tax, which is imposed on gross sales, is not much different between a corporation and a sole proprietor.
However, a newly established corporation with a capital of less than JPY 10 million is exempt from the tax filing and payment of the consumption tax for the year of establishment.
Such newly established company, depending on the conditions, can be exempted for the next business year following establishment as well.
But no further exemption is granted if the company’s taxable sales for the base period (usually two years before the current tax year) exceeded JPY 10 million.
Does it have to be a Joint-Stock Company?
Under the old Company Act (the Chapter II “Company” of the Commercial Code of Japan), Kabusiki Kaisha (KK, joint-stock company) and Yugen Kaisha (YK, akin to a limited liability company) were required to maintain the minimum capital of JPY 10 million and JPY 3 million respectively, but even JPY 1 capital is OK under the current law.
YK system was abolished upon enforcement of the 2016 Company Act. Any YK established before that time is still lawfully existing and able to use the corporate title of “Yugen Kaisha” but it is regarded as a KK for the Company Act purpose and subject to rules for KK under the Act.
However, as for certain matters where YK cannot be treated exactly the same as KK, the rules are superseded by the special law so that the old law is still applicable to YKs.
Goumei Kaisha (a company akin to a general partnership) and Goushi Kaisha (a company akin to a limited partnership) are still able to be established under the current law. Besides, a new company system of Goudou Kaisha (Limited Liability Company) has been introduced.
Accordingly, now a “Company” under the current law means KK, LLC, Goumei Kaisha, and Goushi Kaisha (the Company Act Article 2 para 1).
And LLC, Goumei Kaisha, and Goushi Kaisha are collectively defined as “Membership Company” under the Act (Article 575 para 1).
Did you know you have a choice other than KK?
KK and Membership Company
A capital contributor to a Membership Company is called a “Member” while it is called a “shareholder” in the case of a KK, joint-stock company. The Japanese terminology “Shain” of the Member is generally used as the meaning of an employee of a company but, such employee is defined as “Shiyou-nin” or “Jyugou-sha” in Japanese for the Company Act purpose.
In the case of KK, the status of a “shareholder” who made a capital contribution to the company (i.e., an owner of the company) and a “director” who manages the company’s business are independent.
It means a director does not have to be a shareholder of the company (though it is possible to provide so in the articles of incorporation. The Company Act, Article 331 para 2).
A Personal Company existing as a KK means just a consequence of the only one shareholder became a director of the company (or the director become the only shareholder of the company).
In contrast, as for the Membership Company, since the Act views that ownership and membership are integrated, it provides that the business of the company has to be managed by a Member (Article 590).
Besides, as seen in the provision that transfer of membership interest (equivalent to the share of KK) is subject to unanimous consent by the other Members (Article 585), the Act expects close unity among the Members.
Also, as the Membership Company does not have to be governed by “Organization of the Company” such as general shareholders meeting, director, its internal process will be simple.
Don’t you think the Membership Company is suitable for a Personal Company or joint venture with a close group?
Features of each Member Company are as below.
Goumei Kaisha (General Partnership Company)
All Members owe unlimited liability.
It means that all Members have to secure the creditors’ repayment of the Company’s liability beyond their capital contribution (they may have to sell their own personal property for the sake of the Company).
When you are the only member of the Company, you are not secured as it is almost the same to a sole proprietor.
Having Members with sound financial resources may be good for the enhancement of the Company’s solvency. However, as Members of Goumei Kaisha owe joint and several liability, once a Member repay for the sake of the Company, other Members need to repay to the Member in accordance with respective liability amounts. Goumei Kaisha cannot be formed without mutual trust among the Members.
Goushi Kaisha (Limited Partnership Company)
It has to be formed with Unlimited Member and Limited Member, i.e., at least two Members. It means it is not available for a Personal Company.
Coupling of a Talented but no money entrepreneur (Limited Member) and rich sponsor ( but Unlimited and no interest in management of the Company) may be able to create a Personal Company in substance. But there is no such thing as a free lunch.
Goudou Kaisha (Limited Liability Company)
It is a new company structure legislated in the current Company Act and all of its members are Limited Members. In that sense, it can be said that there is no much difference from KK but you can make its internal organization much simpler than KK.
This seems to be a great virtue for large companies who have to bear the administrative, legal costs for the internal organization process. As a matter of fact, some major companies have been transformed into LLC from KK.
As the LLC can be established with a single Member, it would be a handy corporate structure regardless of business scale, from a Personal Company to a large enterprise.
When it was introduced, it had been occasionally called a “Japanese LLC” in comparison with the US LLC. However, different from the US, the pass-through rule (each of the Members is taxed for the LLC’s income in accordance with interest to the LLC) will not be applied to the Japanese LLC.
Is a foreign company a reasonable choice?
So, would it possible to do business in Japan through the Japan branch of a foreign corporation established in a country of less regulation or more flexibility under the governing law?
It is actually possible, but a foreign company is also governed by Japanese laws as long as it conducts business in Japan. For instance, commercial registration (as the branch of a foreign company) is required in advance to commencement of its business in Japan, a representative in Japan of the foreign company (generally employee of the company assigned to the Japan branch) should be appointed and registered.
As business income attributable to the Japan branch is subject to the Corporation Tax and Local Tax as same to a Japanese company, tax return filing is also required.
However, you would not better use a foreign company if it is established solely for the purpose of Japan business.
Because Article 821 para 1 of the Company Act articulates that such company shall not be engaged in transactions in Japan ongoing basis.
As any person who made a transaction representing the foreign company, breaching para 1 of Article 821, shall be responsible for the transaction jointly and severally with the foreign company (Article 821 para 2). It means representative at the Japan branch has to make a personal commitment to the counterparty of the transactions.
Considering such a situation, it would be much easier to establish a Japanese company rather than asking for personal commitment by the representative.
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Doing business as a sole proprietor or a company cannot be determined based on only pros and cons from a tax perspective. Whether your company has any possibility of conversion to “public” from “personal”, with more stakeholders such as employees, external capital providers or directors, and creditors such as financial institutions, can be the judgmental factor, I suppose.
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