Overview of Taxation on Permanent Establishments

As a general rule, foreign companies are not required to file and pay Japanese Corporation Tax for Business Income (*). However, if a foreign company has a certain function in Japan that qualifies as a Permanent Establishment (PE), Japanese Corporation Tax will be imposed on the portion of the foreign company’s income attributable to that PE.

(*) The Business Income here refers to continuous economic activities such as the manufacturing and sale of products or the provision of services. Please note that income generated from investments, such as dividend, interest paid by Japanese companies, and certain capital gains on shares in Japanese companies, is subject to taxation in Japan even if the foreign company does not have a PE in Japan.

What Constitutes a Permanent Establishment

A PE refers to a specific place or function within Japan, such as a place of business management, branch, office, or workshop of a foreign company located in Japan. Therefore, if a foreign company rents an office in Japan and its employees conduct business activities at that office, the foreign company will generally be considered to have a PE.
As an exception, certain places in Japan that only engage in preparatory or auxiliary activities for the foreign company are excluded from being classified as a PE. These non-PE places are called Representative Offices, that contrast with the concept of PE.

The determination of whether a foreign company has a PE should be based on a comprehensive assessment of the company’s activities in Japan on a case-by-case basis. Below are examples of typical cases:

1. Cases Not Considered as PE (i.e., Considered as Representative Office)
   • When employees of a foreign company conduct market research in Japan (i.e., the step of determining whether or not to enter the Japanese market, before the decision is made).
   • The step of recruiting Japanese employees before starting business operations in Japan.
   • The step where employees of a foreign company promote their products or services (e.g., exhibitions) in Japan. (However, once negotiations with individual potential clients begin, this will transition into a PE.)
   • The step where employees of a foreign company obtain the necessary permits and licenses for their business activities in Japan.
2. Cases Considered as PE
   • The case where employees of a foreign company based at a Japanese office engage in sales activities with customers in Japan.
   • The case where employees of a foreign company based at a Japanese office provide after-sales services, such as maintenance and repairs, for products sold by the foreign company.

When foreign companies expand into Japan, it typically follows the steps of (a) market research, (b) recruiting Japanese employees and then (c) starting sales activities. If these steps are followed, it is generally considered that the foreign company will have a PE by the time it starts sales activity, at the latest.

The explanation above covers Direct PE (place of business management, branch, office, or workshop located in Japan). Please note that there are other types of PEs, such as Construction PE (certain site of construction work) and Agency PE (person authorized to conclude contracts on behalf of the foreign company).

Tax Implications of Having a Permanent Establishment

Japanese Corporation Tax is levied on the portion of a foreign company’s income attributable to its PE. This “PE-attributable income” refers to the income that would be allocated to the PE if it were assumed to be a separate and independent entity from the head office of the foreign company, considering factors such as:

• Risks borne by the foreign company’s head office, and those borne by the PE.
• Functions performed by the head office, and those performed by the PE.
• Assets used by the head office, and those used by the PE.
• Contracts concluded by the head office, and those concluded by the PE.

Therefore, a foreign company having a PE in Japan is required to calculate the income attributable to the PE and the corresponding Japanese Corporation Tax through the above analysis. The Japanese Corporation Tax return has to be filed (and its tax has to be paid) to the Japanese tax authority within two months following the end of the foreign company’s fiscal year (extension may be available in certain cases).

How to Respond if Your Company Has a Permanent Establishment

As mentioned above, if your company has a PE, an analysis to determine the income attributable to the PE will be required, which may incur both time and costs from accounting and tax perspectives. One option to reduce these burdens would be to establish a Japanese company (Japanese subsidiary). For further details on the tax treatment of PEs including branches, and Japanese subsidiaries, please refer to the following insight:
https://awitax.jp/insight/corporate/120/

Finally, please note that the above explanation is based on Japanese domestic tax law, and the tax treatment described above may be modified by tax treaties Japan has concluded with other countries.