Director Compensation in Japan: Setting Pay and Deductibility Rules

For director compensation to be deductible for corporation tax purposes, it must qualify as fixed periodic compensation (定期同額給与), pre-notified fixed-amount compensation (事前確定届出給与) or performance-linked compensation (業績連動給与). For small and mid-sized Japanese companies, the standard approach is fixed periodic compensation: a monthly amount is in principle set within three months of the start of the fiscal year, and the same amount is paid every month for that year. If bonuses are to be paid, the tax office must be notified in advance.

Director compensation is set through Companies Act procedures

Unless the articles of incorporation provide otherwise, the compensation of directors of a kabushiki kaisha is decided by resolution of the general meeting of shareholders (Article 361 of the Companies Act). In practice, it is common for the general meeting to set a ceiling on total compensation for all directors, with the allocation to each director decided by the board or a similar body.

• Record the content and date of the resolution in the minutes
• Where the shareholder is an overseas parent company, document its shareholder resolution in writing as well
• Repeat the same procedure whenever the amount of compensation changes

In a godo kaisha, the compensation of executive members is set according to the articles of incorporation or decisions among the members. The differences between company forms are explained in Kabushiki kaisha vs godo kaisha.

Three types of deductible director compensation

Director compensation that does not fall into any of these categories is not deductible. Even when it does, any portion that is unreasonably high relative to the director’s duties, and any compensation paid by concealing or disguising facts, is not deductible.

Whether compensation is unreasonably high

Whether compensation is unreasonably high is judged mainly from two angles.

• Substantive test: judged in light of the director’s duties, the company’s earnings, the pay of its employees and the director compensation paid by companies of a similar size in the same type of business.
• Formal test: judged by whether compensation exceeds the limit set in the articles of incorporation or by resolution of the general meeting of shareholders.

If payments exceed the ceiling set by the general meeting, the excess is not deductible. Before raising compensation, confirm that it is within the ceiling.

Rules for fixed periodic compensation

When the amount can be revised

The amount of fixed periodic compensation can in principle be changed only up to the date on which three months have passed since the start of the fiscal year. For a company with a March year-end, it is common to make the revision at the annual general meeting in June. Where the company has an extension of the filing deadline and, due to special circumstances, cannot hold its annual general meeting within three months, the revision period may be extended.

In the first fiscal year after incorporation, too, the basic rule is to set the monthly amount within three months of the start of the year (the date of incorporation). The amount set is then paid unchanged until the end of that fiscal year.

When a mid-year revision is allowed

• Extraordinary revision events: revisions due to unavoidable circumstances, such as a change in the director’s position or a significant change in their duties
• Revisions due to deteriorating results: reductions because the company’s financial condition has worsened significantly, for example

For mid-year increases that do not fall under these events, the increased portion is not deductible. For example, if monthly compensation of ¥500,000 is raised to ¥600,000 partway through the year, the difference of ¥100,000 for each month after the increase is not deductible.

Economic benefits also count as director compensation

Director compensation includes not only cash but also economic benefits the company provides to directors, for example where the company bears a director’s personal expenses or rents company housing to a director at a substantially low rent. If the amount is broadly constant each month, it is treated as fixed periodic compensation. Even if recorded as a company expense, once it is deemed director compensation, it also means withholding tax was not collected.

Withholding on director compensation

For compensation paid to resident directors, income tax is withheld using the withholding tax tables, as with employees’ salaries, and paid by the 10th of the following month. Directors are also covered by the year-end adjustment. Even a company with no staff other than directors must file a notification of the opening of a salary payment office if it pays compensation.

Deadlines for pre-notified fixed-amount compensation (director bonuses)

To pay a bonus to a director, the timing and amount must be decided in advance and a “Notification of Pre-notified Fixed-amount Compensation” (事前確定届出給与に関する届出書) filed with the tax office.

If the notified amount is not paid on the notified date, the entire amount paid is in principle not deductible. The same in principle applies if less than the notified amount is paid. If you plan bonuses at a time when results are hard to predict, set the amount with care.

Retirement benefits and directors who are also employees

Retirement benefits for directors are treated separately from the three types such as fixed periodic compensation and are in principle deductible. However, those that qualify as performance-linked compensation must meet the requirements for that category, and any portion that is unreasonably high is not deductible.

The employee portion of pay for directors who also serve in an employee capacity, such as a department head (使用人兼務役員), is also treated separately. Presidents, representative directors and the like cannot be directors who also serve as employees.

How to approach the amount of director compensation

Consider the amount of director compensation by balancing taxes and social insurance premiums for the company and the director personally. Raising compensation reduces the company’s taxable income but increases the director’s income tax, resident tax and social insurance premiums.

1. Estimate the company’s profit from projected sales and expenses for the year
2. Confirm the director’s living costs and any amount needed for remittances to the home country
3. Estimate the company’s corporation tax and other taxes, and the director’s income tax, resident tax and social insurance premiums
4. Pass the resolution within three months of the start of the fiscal year and keep the minutes

Because director compensation cannot be changed freely during the year, there is no room to adjust if profit forecasts prove far off the mark. In the first fiscal year in particular, companies often start with a modest amount.

Points for directors living overseas and foreign directors

Withholding on compensation for directors living overseas

Director compensation from a Japanese company is in principle Japan-source income even if the director works overseas. When paying a non-resident director, tax is withheld at 20.42% at the time of payment. The exception is where the director works permanently overseas in an employee capacity, such as the head of an overseas branch.

For compensation paid to non-resident directors, if annual payments to the same person exceed a certain amount, a “Statement of Payment of Salaries, Remuneration, Pensions and Prizes to Non-residents” (非居住者等に支払われる給与、報酬、年金及び賞金の支払調書) must be submitted to the tax office.

A typical case is a director living in mainland China or Hong Kong who also serves as a director of the Japanese company. Many tax treaties provide that directors’ fees may also be taxed in the country where the company is located. Check this together with the tax position in the parent company’s jurisdiction.

If a director travels back and forth between Japan and abroad, first determine whether they are a resident or a non-resident. Residents are subject to withholding under the withholding tax tables and non-residents at 20.42%, so getting this wrong can change the tax amount substantially.

Implications for social insurance and visas

Representatives and directors who receive director compensation in Japan are in principle insured under health insurance and employees’ pension insurance. Enrollment procedures are explained in Mandatory social and labor insurance enrollment.

For managers residing on a Business Manager visa, the amount of director compensation serves as evidence of their livelihood and the stability of the business. Setting compensation extremely low may prompt requests for an explanation at renewal. For how the review works, see Business Manager visa renewal.

How TIMOA can help

Director compensation involves Companies Act resolutions, deductibility for corporation tax, withholding, social insurance and visas. The basics are to set the monthly amount within three months of the start of the fiscal year, keep the minutes and pay the same amount throughout that year.

Together with partner certified tax accountants, labor and social security attorneys and judicial scriveners, TIMOA supports the design of director compensation, preparation of shareholder meeting minutes, filing of notifications for pre-notified fixed-amount compensation, and withholding and social insurance procedures. For details, see our Accounting, Tax & HR page.