Introduction
With the increase in international transactions, even non-resident companies without a base in Japan may incur multiple tax obligations such as corporate tax, consumption tax, and withholding tax, depending on the nature of their business activities or service provision in Japan. In recent years, there has been particular attention on the expansion of the concept of Permanent Establishment (PE), the tightening of consumption tax taxation for foreign companies, and compliance with transfer pricing regulations and tax compliance procedures. The tax risks for non-resident companies largely depend on the content of contracts, the dispatch of personnel, and the actual provision of services, making appropriate initial design and ongoing monitoring essential. This article comprehensively organizes the key tax issues that non-resident companies are likely to face when conducting business in Japan.
1. The Basic Framework of Taxation in Japan
The taxation of corporate income tax in Japan for non-resident companies is primarily categorized based on the presence or absence of a Permanent Establishment (PE). If there is no PE, taxation is limited to income sourced within Japan. On the other hand, if a PE exists, corporate tax and local corporate taxes are imposed on the income attributable to that PE. There are three types of PE under Japanese law: fixed place of business PE, construction PE, and agent PE. A fixed place of business PE refers to physical locations such as offices, factories, and warehouses. A construction PE is established when it pertains to construction, installation, or assembly projects lasting more than one year. An agent PE is recognized when there is a person in Japan who continuously exercises the authority to conclude contracts on behalf of the company. These definitions may be modified by applicable tax treaties, so it is essential to verify the treaty provisions of the relevant country.
2. Typical cases where PE risk increases
The PE risk for non-resident companies is determined based on substance rather than form. In particular, the dispatch of employees to Japan, long-term stays on a project basis, and on-site operations in the provision of technical services increase the risk. If dispatched employees are involved in decision-making in Japan or lead contract negotiations with clients, an agent PE may be established. Additionally, attempts to avoid construction PE through the division of project periods or the dispersion of contracts among multiple entities are typical examples that may be denied in tax audits. Regarding fixed place PE, there are often cases in practice that are difficult to judge, such as exclusive use of rented offices or using warehouses for the storage and preparation of company products for sale.
3. Non-resident corporations and withholding tax
With respect to payments to non-residents, withholding tax is required when the income qualifies as domestic source income. Typical examples include royalties, service provisions, interest, and dividends. For service provisions, services provided domestically are subject to withholding tax, while services completed abroad are exempt. However, for services that span both domestic and international locations, apportionment is necessary, and if the contract does not clearly specify the work location or scope, there is a risk that the entire amount may be subject to taxation. Since many cases apply tax rate reductions or exemptions under tax treaties, it is essential to prepare the treaty application notification at the time of payment.
4. Electronic Services, Digital Transactions, and Sales Tax
If a non-resident company provides electronic services to consumers or businesses in Japan, there is an obligation to file consumption tax. B2C electronic services require registration as a taxable business, while B2B electronic services are subject to the reverse charge mechanism. Typical examples include SaaS, cloud services, online advertising delivery, and electronic content provision. It is particularly important to determine whether the electronic service falls under the category of "provision of telecommunications services." Even for non-residents, if domestic taxable sales exceed 10 million yen annually, they will generally be considered a taxable business, so foreign companies with significant sales in Japan should be cautious.
5. Invoice System and Registration Obligations for Non-Residents
The invoice system that started in 2023 requires domestic businesses to register as qualified invoice issuers. Even non-resident companies must register if they have taxable sales in Japan. Some overseas companies mistakenly believe that "registration is unnecessary because they do not have a base in Japan," but if they provide electronic services or participate in events that generate taxable sales in Japan, failing to register will prevent their business partners from claiming input tax deductions, resulting in disadvantages in transactions. Additionally, if they register, they will also incur additional obligations such as filing consumption tax returns and complying with the Electronic Bookkeeping Act in Japan.
6. Non-residents and Transfer Pricing Regulations: Risks of Ongoing Transactions
If a non-resident company has a subsidiary in Japan, compliance with the arm's length principle for intra-group transactions under transfer pricing regulations is required. In particular, the appropriateness of pricing for services provided, royalties, cost sharing, and personnel dispatch is a key focus in investigations. Even if a non-resident does not have a corporation in Japan, issues related to virtual permanent establishment (PE) and profit allocation for transfer pricing may arise if the overseas headquarters sells directly to Japanese customers and the Japan office is effectively providing support services. In practice, designing business flows, documenting role allocations, and preparing contracts are extremely important.
7. Key Points on Establishing Domestic Branches and Branch Taxation
If a non-resident company establishes a branch in Japan, it will be treated as a permanent establishment (PE), which creates an obligation to report income attributable to the branch. Transactions between the branch and the head office are generally treated as internal transactions; however, when tax treaties are applicable, profit allocation based on the "PE attribution principle" and the arm's length principle is required. Since the branch does not have a legal personality, there are no shareholder-related transactions; however, there may be cases where there are differing views with tax authorities regarding internal loan interest and internal service provision. The management of accounts, the application of transfer pricing concepts, and the handling of withholding income tax and consumption tax become complicated at the branch, making it essential to conduct a prior examination of whether establishing a corporation (subsidiary) or a branch is more appropriate.
8. Response to Tax Audits for Non-Residents
Tax audits in Japan are also conducted for non-residents. In particular, issues such as Permanent Establishment (PE) recognition, withholding tax omissions, the scope of taxation for service provision, and the determination of electronic services for consumption tax are often subjects of investigation. During the audit, important factors for judgment include contracts, business content, daily business records, the authority of dispatched personnel, and the status of transaction documentation. When making claims based on tax treaties, it is necessary to document and present the interpretation of the treaty and its consistency with domestic law. Non-resident companies tend to misunderstand the obligations for retaining domestic documents and the scope of the Electronic Bookkeeping Act, and the level of routine documentation significantly influences audit risk.
9. Summary
The taxation of non-resident companies in Japan is a complex area where many factors intertwine, such as the presence of a permanent establishment (PE), the location and nature of service provision, the form of electronic service delivery, and the structure of intra-group transactions. During the initial construction phase, the assessment of tax risks, ensuring consistency between contracts and actual practices, and compliance with the invoice system and electronic bookkeeping laws can often result in a higher practical burden compared to domestic companies. For foreign companies to continue their business stably in the Japanese market, ongoing reviews by international tax experts and the establishment of a governance framework are essential.