Apartments, Tokyo, Japan. Photo by Weiqi Xiong on Unsplash.

A Guide to Taxing Expats’ Non-Cash Compensation in Japan

Yoshio Yamaguchi

Foreign employees sent to work in Japan by an overseas company are sometimes called "expats." The salary structure for expats can differ from that of Japanese employees, with one notable difference being the inclusion of "economic benefits" or non-monetary compensation.

As a general rule, economic benefits are considered part of an employee's salary and are subject to income tax. However, it can be challenging to determine whether certain types of economic benefits are taxable as salary. Let's take a closer look at this issue.

Commuting Expenses (Season Tickets or Gasoline Costs)

Commuting expenses, such as transportation fares for the most economical and reasonable route and method based on various factors like fare, time, and distance, are not subject to income tax. These expenses are considered tax-exempt (Income Tax Act, Article 9, Paragraph 1, Item 5; Enforcement Order of the Income Tax Act, Article 20-2).

However, questions may arise about specific situations, such as whether commuting by bullet train (Shinkansen) or using express trains is covered or whether personal car use is exempt. For more details, please refer to the National Tax Agency website.

Travel Expenses

Travel expenses deemed ordinarily necessary for a work transfer are non-taxable (Income Tax Act, Article 9, Paragraph 1, Item 4). For expatriates, relocating to Japan is also non-taxable, provided it falls within the range of ordinarily necessary expenses.

However, even if classified as travel expenses, lump-sum payments made annually or monthly, without a clear connection to actual travel (so-called "flat-rate travel allowances"), or amounts that exceed what is considered ordinarily necessary, are not exempt from taxation.

Company Coverage of Income and Resident Taxes

When a company pays income or resident tax that an individual usually is responsible for, the amount covered by the company is considered taxable as employment income. As the employee’s income increases, so does the income tax and other taxes owed. If the company also covers this increase, it becomes unclear how much the employee should receive.

To resolve this issue, a gross-up calculation is required.

Home Leave (Travel Expenses for Returning to One's Home Country) – Individual Tax Ruling (Showa 50 Directive No. 6-1)

If an employer allows an employee to take home leave, typically after completing at least one year, and provides travel expenses for the trip, the non-taxable portion will be limited to what is considered economically reasonable. Under the Corporate Tax Act, these travel expenses can be recorded as deductible expenses, and the employee is not taxed on this benefit as income.

  • Typically, business class is permitted for long-distance travel, but first class is generally not accepted[2].
  • Travel expenses for home leave provided to a spouse or relatives who share the same household are also non-taxable.
  • As an alternative to home leave expenses, the travel costs for bringing a spouse and dependent relatives from the home country may also be considered non-taxable[3].
  • This home leave ruling applies to employees dispatched from the head office of a foreign corporation to its subsidiary in Japan. It does not apply to foreign individuals who come to Japan for personal reasons and are directly employed in Japan[1].
  • If a company officer returns to their home country several times a year, one trip may be treated as non-taxable, while the remaining trips would be subject to taxation[2].
  • In cases where expatriates and their accompanying family members take home leave at different times, past tax audits have revealed instances where the non-taxable treatment of home leave was denied.

Citations:

  • [1] "Non-Resident Taxation and Withholding Q&A" by Yasuhiro Yoshikawa, p. 332
  • [2] While there is no explicit legal basis, this practice appears to be based on established business customs.
  • [3] Ibid., p. 333

Company Housing and Rent

When a company provides housing, such as corporate housing or dormitories, for its employees, there is no deemed economic benefit to the employee if the rent collected from the employee is at least 50% of the equivalent market rental value (as stipulated in Basic Ruling 36-47 of the Income Tax Act). The specific method for calculating the equivalent rent is detailed in Article 36-41 of the Income Tax Act.

However, cash allowances for housing or rent paid directly by the employee under a personal rental contract are not considered company-provided housing. As a result, the total amount of such payments is subject to income tax as part of the employee's salary.

Provision of Company-Owned or Leased Vehicles (Corporate Lease Contracts)

If a vehicle leased by the company is necessary for business operations and is used exclusively for business purposes, the leasing cost of the vehicle and parking fees are not subject to taxation. However, any portion used for personal purposes may be subject to taxation.

Storage Fees for Furniture in the Employee’s Home Country

When a foreign corporation sends an American employee to work at its Japanese subsidiary, and the American corporation covers the storage fees for the employee’s furniture (non-resident) in the United States, the payment is considered domestic-source income in Japan.

Even though the payment was made abroad, it is subject to taxation in Japan. This is based on the rules outlined in International Transactions and Overseas Business Taxation, co-authored by Eiichiro Nakatani and published by Zeimu Kenkyukai (page 697).

Education Expenses for Children

As a general rule, education expenses for children are considered a form of economic benefit and are subject to payroll taxation. However, if a company donates to an international school and the child’s tuition is waived as a result, it appears that the economic benefit from the waived tuition may not be subject to taxation. For more information, please refer to my article, Navigating Tax Deductions for Director Salaries in Japan.

Furthermore, under corporate tax law, such donations are classified as contributions. Any amount exceeding the contribution deductible limit cannot be included as a deductible expense.

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