Introduction
Cases of foreign companies dispatching employees to Japan are increasing year by year. Along with this, various tax issues arise, including the dispatched employee's income tax, social insurance, withholding tax, cost settlement between the dispatching and receiving companies, and permanent establishment (PE) risks. Since these processes require an understanding of international taxation, they become a challenging area for personnel in charge of foreign-affiliated companies in Japan. This article systematically organizes the tax implications by type of dispatch contract, the Japanese corporation's expense deduction and withholding tax obligations, the PE risks for foreign corporations, and the treatment of personal income tax for the dispatched employees, clarifying typical practical issues.
1. Secondment Types and Their Tax Positioning
When employees are dispatched from foreign companies to Japan, they are generally classified into two forms: "in-house transfer" and "transfer of employment" in Japan. In-house transfer maintains the employment contract with the dispatching company, and the Japanese subsidiary has limited authority to give instructions. On the other hand, transfer of employment switches to an employment contract with the Japanese subsidiary, which has full authority to give instructions.
In terms of taxation, it is important to determine which company the dispatched employee is actually providing labor under the direction of, and "substance" is prioritized over "form." Even in the case of a secondment while remaining on the books, if the Japanese corporation is effectively managing the labor, it may be considered the payroll provider on the Japanese side.
The cost burden on the foreign corporation also affects the structure. When a Japanese corporation bears costs to the sending organization as compensation for labor provided, the nature of that burden (whether it is equivalent to salary or compensation for services rendered) will affect the withholding tax obligations and corporate tax treatment on the Japanese side. Therefore, it is extremely important that the descriptions in the contract align with the actual circumstances.
2. Secondment Costs (Expense Settlement to the Sending Company) and Corporate Tax Treatment
The costs that a Japanese corporation pays to the sending company (secondment burden fees) often become a point of discussion in tax matters. The main criterion is whether the amount paid by the Japanese corporation is appropriate as "consideration for the provision of labor (personnel cost burden)."
The expenses for the dispatched employee's salary, social insurance premiums, overseas assignment allowances, housing costs, and travel expenses are generally recognized as deductible expenses based on actual costs. However, if indirect costs or profit margins from the sending company are included, these may be considered "compensation for services provided" for the Japanese corporation, making them subject to transfer pricing regulations. Additionally, if classified as services provided, there may be cases where withholding income tax applies to payments made to foreign corporations, so caution is required.
In practice, companies are required to itemize expense categories, track costs on an employee-by-employee basis, and clearly define the scope of cost allocation in secondment agreements. During tax audits, the reasonableness of the expenses and the substantive nature of the cost burden are key points of review; therefore, maintaining well-organized documentation is advisable.
3. Foreign Corporation PE (Permanent Establishment) Risk
If a dispatched employee stays in Japan for an extended period, there is a risk that the foreign corporation may be considered to have established a "Permanent Establishment (PE)" in Japan. Once PE status is recognized, the foreign corporation will have an obligation to file corporate taxes in Japan.
In the determination of PE (Permanent Establishment), the activities of the dispatched employee are important. For example, if they are engaged in sales activities, exercising contract conclusion authority, providing technology, or performing management tasks for a foreign corporation, it may be assessed that the foreign corporation has a business presence in Japan.
In practice, it is common to clearly state that the secondee is engaged in the operations of the Japanese corporation and to limit the scope of their duties to prevent activities for the foreign corporation. It is also recommended to specify the scope of work, command hierarchy, and compensation burden division in the secondment agreement to mitigate PE risks.
4. Income Tax Taxation of the Assignee in Japan
The individual on assignment is subject to income tax based on the determination of resident or non-resident status in Japan. If they stay in Japan for more than one year, they are often classified as a "resident." Residents are subject to worldwide income taxation, and they will need to file a tax return in Japan, which includes salary paid by the home company.
The issue of whether the Japanese corporation has withholding tax obligations regarding salaries from the sending company is a practical point of discussion. Even if the Japanese corporation does not perform payroll calculations, there are cases where it may be recognized as a withholding tax obligor, so caution is necessary. To ensure that the total income of the dispatched employee, including salaries paid abroad, can be properly reported in Japan, obtaining pay slips and appointing a tax representative are essential.
Additionally, adjustments specific to expatriates may arise, such as foreign tax credits, housing-specific expense deductions, and tax treatment of accompanying family members. Tax authorities have been focusing on investigating the taxation of global talent's salaries in recent years, so it is necessary to ensure documentation and explainability.
5. Application of Social Insurance (Welfare Pension and Health Insurance) and Social Security Agreements
When being dispatched to Japan, whether or not enrollment in social insurance is required is determined by Japanese law and social security agreements. Generally, if employed by a Japanese corporation, there is an obligation to enroll in employee pension and health insurance. However, if the dispatch is a short-term assignment to a Japanese corporation while remaining employed by the home company, and a "Certificate of Coverage (CoC)" has been obtained from a country with a social security agreement, enrollment in Japanese social insurance can be exempted.
In the case of assignments from countries without a social security agreement, Japanese social insurance is generally applicable. Since the burden of social insurance premiums is significant for companies, it is important to conduct advance planning for the assignment and cost estimation, and to reach an agreement within the finance and human resources departments.
6. Points That Are Likely to Be Highlighted in a Tax Audit
In tax audits related to secondments from foreign companies, the following points are primarily confirmed.
Consistency between the content of the secondment contract and the actual situation
Validity of the secondment costs borne by the Japanese corporation
Whether or not there is withholding tax on foreign-sourced income
Is the work of the dispatched employee not for a foreign corporation (PE risk)?
The tax office tends to closely examine the cost settlement process, salary structure, and business content with the sending organization. In particular, the failure to withhold taxes on foreign-sourced salaries is a common issue that leads to additional tax assessments.
7. Establishment of Practical Documentation and Governance Structure
To minimize risks, it is necessary to establish documentation and internal systems before the start of the secondment. The minimum documents that should be prepared are as follows.
Secondment Agreement (Specifying Business Content, Command and Orders, and Compensation Burden)
Basis for Calculation of Secondment Cost Burden
Payroll Statement and Payment Method Record
PE Risk Assessment Memo
Materials for Determining Social Insurance Applicability
These documents are essential to prepare, as they will be used not only for tax audits but also for compliance audits with the global headquarters.
8. Summary
The secondment of foreign companies to Japan involves complex issues that span multiple tax areas, including corporate tax, income tax, withholding tax, social insurance, transfer pricing, and PE risk. Since each process, such as secondment contracts, expense reimbursements, salary payments, tax filing obligations, and social insurance determinations, has tax implications, a governance structure that provides an overall perspective is required.
As the number of dispatched employees increases, tax authorities are strengthening their investigations in this area. By ensuring proper documentation and having reviews conducted by experts such as tax accountants who are well-versed in international taxation, companies can minimize risks while ensuring compliance. It is hoped that this article will serve as a reference for foreign-affiliated companies operating dispatch schemes in their Japan offices.