In recent years the Japanese tax authorities have been auditing the declaration by Japanese resident individuals of awards of share options, restricted stock awards or similar stock based compensation made to them by the foreign parent company of their Japanese employer.
Restricted stock awards with a vesting periods of around three to five years have often been part of the compensation of Japan based employees of foreign groups in the financial sector. Stock options have been used to reward senior staff based in Japan across a range of industries.
Regrettably, however, the Japanese authorities have often found gaps in the reporting by individuals of such stock based compensation (below ‘Foreign Stock Based Compensation’) in their annual tax filings.
2012 tax reform
Given the above background the 2012 tax reforms introduced a new reporting requirement obliging Japanese companies and Japanese branches of foreign companies (collectively below ‘Japanese Entities’) to submit details of awards of Foreign Stock Based Compensation directly to the tax authorities.
These new measures should make it easier for the Japanese tax authorities to cross reference the individual tax filings of employees with the records provided by their employer and ensure that Japanese taxes are properly collected on share options, restricted stock awards and similar.
Awards of stock outside Japan
Awards of stock in a foreign company administered and delivered outside Japan have usually been outside the scope of Japanese individual income withholding tax. As a result the Japanese tax authorities would not routinely receive information about such awards from Japanese Entities employing the individuals concerned.
The Japanese resident individual receiving such an award would be obliged to file a Japanese tax return and report the relevant income rather than suffer withholding tax at the time of the award. However individuals who would normally be exempt from an annual Japanese tax filing requirement by virtue of the amount and sources of income they received may have often overlooked this obligation.
Awards from a foreign parent
Article 228 no 3 no 2 of the new Japanese Income Tax Law applies to certain defined rights (discussed below) granted by a defined ‘Foreign Parent Company’ (in Japanese 外国親会社等 or ‘gaikoku oya kaisha tou’) to Japanese tax resident officers or employees of Japanese Entities where the Foreign Parent Company owns directly or indirect 50 per cent or more of the issued shares of the employing company concerned (considering only voting shares).
Under this definition Foreign Parent Company awards of stock or similar rights made to employees of a joint venture Japanese subsidiary or Japanese branch of a foreign subsidiary may be within the scope of this reporting obligation as well as awards made to employees of a wholly owned Japanese branch or subsidiary.
What benefits are in scope?
This new reporting requirement applies to rights that allow an individual to receive shares for either no consideration or rights to acquire shares at a beneficial price and where, as a result, the individual will receive shares, cash or other economic benefits from the Foreign Parent Company concerned. Given this definition share options rights and restricted stock awards are clearly intended to be within the scope of the new regulations.
The inclusion of awards of “…cash or other economic benefits…” in the reporting requirement seems intended to cover situations where the employee does not receive stock directly but, for example, may be awarded the proceeds of sale of shares to which they were not entitled to receive directly or similar cases.
Phantom share schemes
Care should be taken to consider whether “phantom share schemes” that track the price of notional stock or similar arrangements not including the award of stock would be within the scope of these new requirements.
Also companies should consider whether subsidized employee share purchase schemes that are typically aimed at all staff and not just senior employees should be within scope of the new regulations.
Reporting requirements and timing
The Japanese Entity has to report the provision of Foreign Stock Based Compensation by 31 March of the year following the year in which it the amounts concerned were provided.
Note that this law does not itself define the time when the Foreign Stock Based Compensation is treated as provided. Care should be taken to consider such timing, especially in compensation schemes that may allow partial vesting of benefits.
Reporting requirement arise from 1 January 2013.