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Recent reforms impacting deductions of foreign stock compensation granted to directors

Japan Inbound Tax & Legal Newsletter May 2018, No. 28

Compensation paid to a director is, in principle, not deductible for Japanese corporate tax purposes.

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However, there are exceptions for the following:

  1. Fixed Compensation – compensation paid in equal installments at least monthly;
  2. Pre-Notified Compensation – compensation for which the company notifies the tax authority in advance regarding the compensation to be paid to a director; or
  3. Performance-Linked Compensation – compensation based on performance provided certain conditions are met. Generally, only publicly traded Japanese companies are eligible under this category.

Also, regardless of whether or not the compensation paid to a director falls under one of the above exceptions, if such compensation is considered as excessive, the excessive portion will be disallowed as a deduction.

Further, parent company stock compensation (e.g. stock options, restricted stock, etc.) granted to directors of a subsidiary was generally not eligible to qualify for one of the above exceptions. However, since the 2016 and 2017 tax reforms entered into effect, certain parent company stock compensation issued to directors of a Japanese subsidiary became eligible for deduction provided it can fall into one of the above mentioned exceptions.

Please note that the rules regarding the deductibility of stock compensation under Japanese corporate tax law discussed in this newsletter relate to stock compensation granted by a Japanese company. There are no specific tax laws addressing stock compensation granted by a foreign parent company. However, while there is some uncertainty, in practice and under the right circumstances, the rules for Japanese stock compensation may be applied to foreign stock compensation.

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