The agent PE under Japanese domestic tax law

One of more than two hundred and fifty bars clustered into the Golden Gai area in Shinjuku. Usually there is only seating for a half dozen or so people.

Japanese domestic tax law and related Tax Instructions include detailed regulations addressing when a person in Japan acting as an agent on behalf of a foreign company can create a taxable presence – a permanent establishment or ‘PE’ – of the foreign company in Japan.  Such an agent is referred to below as an ‘Agent PE’ of the foreign company, or in Japanese a ‘代理人PE’ or ‘dairi nin PE’).

These rules can create a Japanese tax liability for a non-Japanese company that, for example, did not establish a physical presence such as a branch in Japan but instead only sent its employees to Japan to negotiate sales contracts or undertake similar activities.  Understanding these regulations is often critical to understanding the tax exposures a foreign company may have to Japanese tax.

Basic Agent PE definition under the Japanese Corporation Tax law

Article 141-1-3 (link in Japanese) of the Japanese Corporation Tax Law (‘CTL’) has the basic definition of an Agent PE which is extremely brief, referring only to authority to conclude contracts.

The article defines an Agent PE as “…a person who is given the authority to conclude contracts in Japan on the account [of the foreign company] or persons resembling such a person as determined in cabinet orders…”.

The Agent PE issue in international tax

For readers who are not experts on international tax, the circumstances that these regulations are intended to address is that (in the absence of these rules) a foreign company may be able to do business in Japan through an agent without setting up a branch or similar fixed place of business in the country that would clearly require the foreign company to register for Japanese tax purposes.

The effect of these rules is to make a foreign company that has an Agent PE in Japan liable to Japanese tax on the profits earned through the agent.  Also, an agent in this context does not just include third parties but could include companies related to the foreign company or, as is quite commonly the case, the employees of the foreign company itself who come to Japan on business.

For example, again in the absence of these rules, if the agent had the authority to buy and sell inventory directly held by a foreign company then the foreign company may not themselves have an obligation to register in Japan for tax purposes and hence any profit made from such transactions would avoid Japanese taxation.

Note that the agent would, however, be taxed on the income he made from the agency.  However if the agent was, for example, an employee of the foreign company rather than being a third party receiving a commission for the activities they were involved in then such an employee would themselves typically not be earning income directly from the transactions on which they could be taxed.

Three types of Japanese Agent PE

Corporation Tax Law Enforcement Order (‘CTLEO’) article 186-1 (link in Japanese) has a much more comprehensive definition of Agent PE, identifying three different Agent PE varieties.  These are a ‘Habitual Agent PE’ a ‘Fills Order Agent’ and a ‘Secures Order Agent’ (in Japanese respectively the ‘常習代理人’ or ‘jyoushou dairinin’, ‘在庫保管代理人’ or ‘zaikohokandairinin and ‘注文取得代理人’ or ‘chumon shutoku dairinin’).

Independent Agent Exception

Before looking in detail at these three varieties of agent, note that article 186 includes, as an exception from being treated as an Agent PE of the foreign company, persons who are independent from the foreign company (below ‘Independent Agents’).

Article 186 exempts from inclusion in the three Agent PE definitions persons who “…are carrying out the activities of [their] business independently with respect to the foreign company and are carrying it out through normal methods…”.  In Japanese the phrase is “…その者が、その事業に係る業務を、当該各号に規定する外国法人に対し独立して行い、かつ、通常の方法により行う場合における当該者を除く…”.

The editor is not aware of any tax cases on the interpretation of the terms used in this exception.  The phrase “…carrying [the business] out through normal methods…” (in Japanese “…通常の方法により行う場合…”) is not enlightening.  However Tax Instruction 20-2-5 (link in Japanese) discussed below gives some guidance on this point.  Additionally this theory paper (link in Japanese) published by the Japanese tax college addresses Agent PE issues in more detail and will be the subject of a later article.

Independent Agents under Tax instruction 20-1-5

Under Tax Instruction 20-1-5 (link in Japanese) a person may be treated as an Independent Agent, and hence excluded from creating a PE for a foreign company, if they meet all of the following conditions:

  • When carrying out their activities the person (the possible agent) is not receiving detailed or comprehensive instruction from, can [themselves] exercise sufficient discretion over their activities and are legally independent from the foreign corporation
  • Through the use of their own knowledge and ability relating to the activities they undertake, the person is bearing risk and is economically independent from the foreign corporation
  • The person is themselves carrying on their normal business activities or processes.

Habitual Agent PE

CTLEO 186-1(a) defines a Habitual Agent PE as one who

“…for the purposes of a foreign company, in relation to contracts of its business (excluding contracts for the purpose of purchasing assets of the company) has the right to conclude contracts and who habitually exercises that right (excluding persons who are carrying out an identical or similar business as the foreign person and who, because of necessity that cannot be avoided arising out of the nature of that business, is carrying out the execution of contracts for the foreign company concerned)…”.

Tax instructions go on to look at the two key components of this definition – the right to conclude contracts and the habitual exercise of that right – in more detail.

Habitual Agent PE and the conclusion of contracts

Non tax experts may wonder whether, if an agent is not given the right to formally conclude contracts in Japan (for example, because the agent may be required to always return a contract to the country of the principle for approval and execution), this would avoid the creation of an Agent PE in Japan.

Similar to the commentary to the OECD Model Tax Treaty (the ‘OECD Commentary’) at article 5 paragraph 33, Japanese Tax Instruction 20-5-5 (link in Japanese) also recognizes that a person who is not given the actual right to execute a contract but who is “..given the authority to agree in substance the contents of the contract…” (in Japanese “…契約内容につき実質的に合意する権限を与えられている者…”) may be treated as an Agent PE if other conditions are met.

“…the authority to agree in substance the contents of the contract…”

Regrettably Japanese domestic law does not given any further guidance on to what extent the activities of an agent in Japan may be treated as “…agree[ing] in substance the contents of the contract…”.

The OECD Commentary can be looked to for some guidance on this issue and suggests that if the foreign company is only involved in approving a contract and does not participate in its negotiation this might suggest that the agent did participate in the negotiation of the contracts to the extent required to create a PE.

Note also that, even if the agent is not given the authority to execute a contract in the name of the foreign corporation, if the agent can still effectively legally bind the foreign corporation (perhaps through in substance committing the foreign corporation unavoidably to a contractual course of action or possibly acting as an undisclosed agent) this may also create a PE of the foreign corporation.

Audit of agent activities

In practice, given the subjectivity in assessing whether an agent was “…given the authority to agree in substance the contents of the contract…” for the above test, if the Japanese tax authorities had to examine whether an agent’s activities created a Habitual Agent PE they would likely carry out a ‘counterparty audit’ and interview the persons with whom the agent under investigation dealt with on behalf of the foreign corporation to understand the extent to which the agent was involved in any contract negotiation. Such action would be in addition to looking at relevant documentary evidence on the issue.

Habitual Agent PE and “…acting habitually…”

To be a Habitual Agent PE an agent of a foreign company must also habitually exercise their right to conclude contracts on their behalf (in the name of the foreign company or in substance as noted above).

Tax Instruction 20-2-6 (link in Japanese) adds some limited additional guidance to help understand whether an agent is acting habitually with respect to a foreign company by noting that, in addition to agents who have a single long term contract with a foreign company, an agent who repeatedly enters into short term contracts for the same foreign company can also be an Agent PE.

A limited exception from Habitual Agent PE status

Returning to CTLEO article 186, the article seems to include a useful exclusion from Habitual Agent PE status in exempting from such status “….persons who are carrying out an identical or similar business as the foreign person and who, because of necessity that cannot be avoided arising out of the nature of that business, is carrying out the execution of contracts for the foreign company concerned…”.

While in theory this passage could have broader scope, regrettably this exclusion is generally interpreted as being limited to applying to international flight ticketing for IATA members, as explained in Tax Instruction 20-2-7 (link in Japanese).

Relationship to residence or other status of the agent

Note that determination as to whether a person is an Agent PE is unrelated to their Japanese tax residence status or any other matters other than those specified in the above legislation or legislative interpretation.

It would be quite possible, for example, for an employee of a foreign company to be treated as giving rise to a Habitual Agent PE of his employer by making frequent business trips to Japan to negotiate contracts on behalf of his employer without the employee becoming tax resident in Japan.

Given that the test for authority to conclude contracts includes not just execution of the contract but also substantive involvement in negotiations, simply ensuring such a person executed contracts back in the country of his employer would not necessarily be a defense from PE status as well.

Fills Order Agent

CTLEO 186-1(b) defines a Fills Order Agent as a person who “…for the purposes of the foreign company, keeps a quantity of assets sufficient to respond to ordinary requests from customers and who delivers the assets concerned in response to their requests…”.

The Independent Agent exception described above can also be applied to a person who would otherwise be treated as a Fills Order Agent.  Tax Instruction 20-2-8 (link in Japanese) gives an example of a person who might typically be treated as a fills order agent, being a person who maintains a supply of airplane fuel in Japan to respond to demand from airlines.

Presumably a Japanese company that maintained storage and delivery of airplane fuel at Narita airport on behalf of foreign oil companies would, if not an Independent Agent, be treated as a Fills Order Agent of the foreign oil company who owned airplane fuel concerned.

Note that as illustrated by this article, many of Japan’s tax treaties modify the scope of the Fills Order Agent so reference should be made to the precise terms of the treaty concerned.

Secures Order Agent

CTLEO 186-1(b) defines a Secures Order Agent as a person who “…solely or mainly for the purposes of one foreign company (including the principal shareholders of the foreign company or other persons having a special relationship to the foreign company) habitually secures orders for the purpose of concluding contracts relating to its business, reaching agreement or carrying out other important parts of such activity…”.

The Independent Agent exception described above can also be applied to a person who would otherwise be treated as a Secures Order Agent.

Contrasting a ‘Secures Order Agent’ with a ‘Habitual Agent PE’

Given the above definitions a question arises as to what extent the definition of  Secures Order Agent overlaps with that of Habitual Agent.  This question is not answered in the Japanese tax law or instructions and there seems to be room for significant overlap in practice.

Some differences to note between the two definitions are that the Secures Order Agent definition explicitly notes that it includes acting for a foreign company and other related group companies.  The definition also explicitly notes that, not withstanding the Independent Agent exception, a person can act non-exclusively for a foreign company (and its related parties) and still be treated as a Secures Order Agent.

Many of Japan’s tax treaties (see the table in this article) modify the domestic law Secures Order Agent definition, so attention should be made to each treaty concerned.

Further issues

The above is a basic outline of the Agent PE definition under Japanese domestic tax law.

Other issues to be considered in later articles include examining in more detail the Independent Agent exception and considering the application of the Agent PE rules to commissionaire and similar arrangements.

After addressing these issues the site will address practical application of the rules to different businesses.


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