Introduction
Under Japanese tax law, a stock option (SO) grants an employee or director the right to acquire shares of a company or its subsidiary at a predetermined exercise price within a specified period. For listed companies, the distinction between tax-qualified and non-qualified stock options provides a clear framework to determine when income tax arises (at grant, at exercise, or upon sale). However, when a Japan-resident foreign national exercises stock options granted by a foreign unlisted company, the tax implications become substantially more complex.
This complexity stems from the interaction of Japanese Income Tax Law, the Act on Special Measures for Taxation, cross-border sourcing rules, and the exit tax regime. Further, the absence of market valuation for foreign unlisted shares and limited access to corporate information add significant practical difficulties. Building upon the previous article that explored the relatively simple “grant-stage” tax implications, this article analyzes what happens when the option is actually exercised, outlining the major tax issues and compliance considerations that arise in practice.
1. Basic Taxation Framework When a Japan Resident Exercises Foreign Stock Options
Under Japanese tax rules, any economic benefit realized upon exercising a stock option—commonly referred to as “exercise gain”—is generally treated as employment income. This applies whether the issuing entity is a Japanese corporation or a foreign company. The exercise gain equals the fair market value of the shares at the time of exercise minus the exercise price (and any acquisition cost of the option), multiplied by the number of shares acquired.
However, when the issuer is a foreign unlisted company, determining fair market value becomes inherently challenging because no market price exists. In practice, companies and taxpayers rely on third-party valuation reports or internally prepared financial data to estimate value. Japan’s tax authorities have not issued a unified standard for evaluating foreign unlisted shares, making it essential to adopt a reasonable methodology and maintain documentation to support the valuation.
Additionally, for Japan-resident foreign nationals classified as “non-permanent residents,” it becomes necessary to determine whether the exercise gain constitutes Japan-source income. When the individual is an employee, Japan-source income is determined based on the location of the services rendered. Thus, if the option entitlement was earned across multiple jurisdictions, an allocation may be required to reflect the portion attributable to Japan-source duties. If the individual also serves as a director of a Japanese entity, an additional allocation reflecting their contribution as a director may be required. For U.S. and EU multinational groups using global equity compensation frameworks, this allocation step is often critical.
2. Practical Taxation Issues When Exercising Options — Withholding, Valuation, and Filing Obligations
A major issue in practice is determining who bears the withholding tax obligation. As a rule, if the foreign company lacks a permanent establishment (PE) in Japan, it is not treated as a Japan withholding agent, and a Japanese subsidiary also does not automatically assume withholding obligations. However, the Japanese subsidiary may still be required to file informational returns regarding the economic benefit provided at exercise.
On the individual side, the taxpayer must determine the appropriate valuation and report the exercise gain as employment income. For foreign unlisted companies, valuation is notoriously difficult, and because exercise produces no cash inflow, individuals may face the burden of paying significant tax without corresponding liquidity. Consequently, in practice, many taxpayers resort to selling a portion of the shares at exercise to secure funds and determine a realizable value.
For foreign nationals classified as “permanent residents,” the entire exercise gain is taxable in Japan, with the potential application of the foreign tax credit if overseas taxes arise.
3. The Impact of Japan’s Exit Tax on Stock Options — A Critical Mobility Issue
Japan’s 2019 exit tax reform explicitly added stock options (rights to acquire shares) to the list of assets subject to tax upon departure. Consequently, when a Japan-resident individual holding stock options granted by a foreign employer relocates overseas, unrealized exercise gain may become taxable even before the options are exercised.
This presents significant challenges for expatriates, as many foreign assignees return to their home country while still holding unexercised stock options. Under the exit tax, the hypothetical exercise gain (fair value at departure minus exercise price) is taxed at approximately 20%. Although a tax deferral regime exists, it requires collateral and involves complex administrative procedures.
The timing of exercise therefore plays a central role in international tax planning:
Should the taxpayer exercise in Japan?
Before departure?
After becoming nonresident?
Misjudging this timing can lead to substantial unexpected tax liabilities. Furthermore, even if exit tax was imposed at departure (based on deemed exercise), if the actual value increases after leaving Japan, the subsequent exercise may still trigger informational reporting obligations as nonresident income arising from economic benefit. This point is frequently overlooked and warrants special attention.
4. Conclusion — Exercise-Stage Taxation Is the Most Complex; Early Planning Is Essential
Compared with the relatively simple tax considerations at grant, the tax implications at exercise are vastly more complex. A wide range of issues—valuation of foreign unlisted shares, involvement of the Japanese subsidiary, withholding obligations, sourcing and allocation of remuneration, exit tax exposure, foreign tax credits, and mobility-related reporting—interact in intricate ways.
In particular, the following issues represent the core of practical risk management:
Difficulty of valuing foreign unlisted shares
Necessity of international allocation based on working periods
Significant tax impact depending on timing of exercise
Exit tax exposure when relocating abroad
Possible reporting obligations for Japanese subsidiaries
Given these complexities, any multinational enterprise granting stock options to employees or directors in Japan—and any Japan-resident foreign national holding such options—must adopt a holistic, proactive approach to tax planning. Early consultation with international tax specialists in Japan is essential to avoid unintended tax liabilities and ensure full compliance.
We are providing Support for stock options from foreign parent companies in English.