Summary of recent requests from the Japanese government
At the end of 2021, the Ministry of Justice and the Ministry of Internal Affairs and Communications issued a notice addressed to foreign companies that are registered or notified in Japan as telecommunications carriers regarding the registration obligations of foreign companies. The notice refers to the Ministry of Justice's guidance on the registration obligations of foreign companies under the Japanese Companies Act,1 and requests foreign companies that are not in compliance with their registration obligations to promptly apply for registration.
In addition, on 29 March 2022, the Ministry of Justice issued a notice to 48 foreign IT service providers that appear to be noncompliant with their registration obligations, urging them to register in accordance with the Companies Act. If a company refuses to register, it is requested to provide reasons and relevant information as to why it did not register.
In the past, many foreign companies did not fulfil their registration obligations unless they had a physical presence in Japan, presumably because the authorities did not proactively regulate registration compliance. However, with the growth of e-commerce via the internet, it has become easier for foreign companies to provide services in Japan without a physical presence. At the same time the lack of registration makes it difficult (particularly for consumers who receive services directly from foreign companies) to obtain adequate relief if problems arise and to ascertain the company's business information (e.g., company representative, business size, etc.), which in turn hinders proper tax administration. It is assumed that these issues led to the above request by the Ministry of Justice.
Although at this point it appears that these notices are only being issued to foreign corporations that are registered or notified as telecommunications carriers, the registration requirement of foreign companies under the Companies Act applies, regardless of whether a company is registered or notified as a telecommunications carrier. Accordingly, this recent policy shift to tighten the monitoring on the registration obligations could theoretically have an impact on foreign companies in all industries that do business with Japanese customers.
Legal framework under Japanese law
(1) Companies Act
- When a foreign company "intends to carry out transactions continuously" "in Japan," it must appoint a local representative in Japan (at least one of whom must have an address in Japan)2 and make a registration as a foreign company at a competent Legal Affairs Bureau within 3 weeks after it appoints a local representative for the first time. A foreign company will be prohibited from carrying out business in Japan until it has registered as a foreign company.3 It should be noted that even if a foreign company has a subsidiary in Japan and the subsidiary is registered under the Companies Act, the foreign company itself is not exempt from the obligation to register, as long as it carries out transactions in Japan. The representative has the statutory authority to represent and bind the foreign company for any and all matters in connection with the company's business in Japan,4 and any internal restrictions imposed on such authority of the representative cannot be asserted against a bona fide third party.5
- The purpose of this foreign company registration system under the Companies Act is understood to be a means to allow a counterparty to deal with disputes arising from transactions in Japan and facilitate filing of lawsuits in Japan.
- The definition of the phrase "in Japan" here is interpreted to be (potentially) applicable to cases where foreign companies do not have any physical presence (e.g., an agent or branch office) in Japan and conducts transactions exclusively via the internet, if such company continuously conducts transactional activities targeting Japanese customers via internet or other means (e.g., soliciting Japanese customers by creating an easily accessible website in the Japanese language). On the other hand, there is a prevailing view that this definition does not apply if Japanese individuals or corporations proactively access the website of foreign companies to conduct transactions, and the foreign companies do not conduct any targeted activities to Japanese customers or markets (e.g., the foreign company does not have a Japanese website, and Japanese individuals or corporations are accessing the company's regular website also used by customers outside of Japan).
- The phrase "intend to carry out transactions continuously" is interpreted as continuous transactional activities with Japanese customers by a foreign company under a certain business plan formulated by the foreign company. Activities that do not go beyond an incidental one-off transaction, market research or information gathering are not considered to fall under this definition.
- In determining whether or not the business conducted by a foreign company falls under both of the above definitions, it is necessary to consider the specific circumstances of each case.
- Where the business conducted by a foreign company falls under both of the above definitions:
- if the foreign company does not establish a branch office in Japan, the foreign company must be registered at the domicile of the representative in Japan;6 or
- if the foreign company establishes a branch office in Japan, the foreign company must be registered at the location of the branch office.7
- Failure to comply with the above registration requirements may result in a civil fine of up to JPY 1 million being imposed on the representative or manager of the foreign company in Japan.8
- In addition, a person (e.g., the foreign company's representative in Japan, the foreign company itself) who continuously conducts business in Japan without registering as a foreign company (in violation of Article 818, Paragraph 1 of the Companies Act) (i) may be subject to a civil fine equivalent to the amount of the registration and license tax for the establishment of the company and (ii) may also be jointly and severally liable with the foreign company to perform any obligations to the counterparty that arose as a result of the business in Japan.9 Furthermore, if a foreign company fails to comply with a written warning from the Minister of Justice, the court may, upon petition by the Minister of Justice or other stakeholders, issue an order prohibiting the continuation of the business in Japan, an order to close the place of business, or even an order to commence liquidation of the assets of the foreign company.10
(2) Telecommunications Business Act
- Under the latest Telecommunications Business Act, which was revised in 2020, when a foreign corporation provides telecommunications services from a foreign country to customers in Japan (specifically, when it is clear that the intention is to provide services to the domestic market from the perspective of the language of the service, etc.), the company is required to register or file a notification in the same way as a domestic telecommunications carrier.
- Further, such foreign companies are required to designate a domestic representative or domestic agent and inform the Minister of Internal Affairs and Communications when making such registration or notification. The domestic representative or agent is expected to receive notifications from the Minister on behalf of the foreign company and serve as a contact point between the Ministry of Internal Affairs and Communications and the foreign company. In other words, the domestic representative under the Telecommunications Business Act is a representative or agent only with respect to telecommunications services.
- A foreign company that fails to appoint a representative/agent may have its name published on the internet and other media.
Practical impacts of registering a foreign company
(1) Companies Act
When a foreign company is registered, as is generally required for Japanese corporations, an update on the registration must be made when there is a subsequent change in the registered matters or when a new registration matter arises. Please refer to the website of the Ministry of Justice11 for specific matters requiring registration by a foreign company.
If a foreign company that is a business entity similar in form to a Japanese joint stock company (kabushiki-kaisha, KK) is registered, a public notice of the equivalent balance sheet must be made in Japan without delay after the
completion of the necessary procedures, similar to those required for the approval of financial statements for a Japanese joint stock company.12
(2) Impact on civil proceedings
Under the Code of Civil Procedure, a lawsuit against a foreign company may be filed in Japanese court when the lawsuit relates to the business of the foreign company's office located in Japan or its business in Japan.13 In particular, for businesses conducted via the internet, Item 5 of Article 3-3 of the said Code plays an important role in recognizing jurisdiction over a foreign company with respect to a case relating to its business in Japan, even if the foreign company does not have any physical presence in Japan. In this respect, whether a foreign company is deemed to engage in business in Japan is highly fact-specific. Regardless of whether the foreign company has a designated and registered representative in Japan, as a matter of fact, it has long been recognized that Japanese courts can have jurisdiction for a lawsuit filed against a foreign company conducting business in Japan using the internet.
However, when filing a lawsuit against a foreign company that has no registered representative in Japan, it is necessary to obtain a certificate of qualification from the public authority of the country where the foreign company is located. Litigation materials, such as the complaint and evidence, must be translated from Japanese to the local language and served internationally to the location of the foreign company14, which usually requires considerable time and expense. After a complaint is filed with the Japanese court, it can take more than six months until the trial for a lawsuit against a foreign company begins. In contrast, when a foreign company is registered in Japan, it is possible to obtain a certificate of qualification in Japan, and even if the company does not have a business office, etc. in Japan, it is sufficient to serve litigation materials and other necessary documents in the Japanese language using the address of the representative in Japan, thus eliminating the abovementioned burden of filing a lawsuit against a foreign company. Japanese consumers, trade counterparts and the like who have been hesitant to file lawsuits against foreign companies due to such burden will be able to file lawsuits against foreign companies much more easily, and foreign companies may see an increase in lawsuits brought by Japanese consumers after they are registered in Japan.
(3) Tax considerations
From a Japanese tax perspective, registration of a representative in Japan under the Companies Act could potentially create permanent establishment ("PE") risk. The existence of a PE in Japan is determined based on the specific facts and circumstances of a particular taxpayer. In this context, while registration under the Companies Act may not, in and of itself, be considered to immediately or automatically trigger a PE in Japan, such a registration may be a factor taken into account by the Japanese tax authorities in making the factual PE determination. Given this, careful attention should be paid to the PE considerations of registration under the Companies Act. Depending on the circumstances of a particular taxpayer, there may be ways for the foreign company to comply with its obligations under the Companies Act and the Telecommunications Business Act, while mitigating the risk of a PE being created.
As background, a brief explanation of the Japanese tax treatment of PEs is as follows.
First, a foreign company is liable to pay Japanese corporate tax on its Japanese domestic source income,15 and where a foreign company conducts business via a PE, income attributed to the PE is considered to be Japanese domestic source income which is taxable in Japan.16
Second, the term "permanent establishment" is defined17 to be: (a) a branch office, factory or any other fixed place for conducting business which is held by a foreign corporation and is located in Japan (a so-called "fixed place of business PE")18; (b) a place held by a foreign corporation and located in Japan where the foreign corporation carries out construction or installation work or provision of services for directing and supervising such work or any other place as being equivalent thereto (a so-called "construction PE");19 or (c) a person assigned to Japan and authorized by a foreign corporation to conclude a contract on behalf thereof or any other person equivalent thereto (a so-called "dependent agent PE").20
The definition of PE under Japanese domestic law was expanded by 2018 Japanese tax legislation in order to be consistent with the new PE definition under the Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting ("MLI") (or BEPS Action Item 7 discussions by the OECD). The expanded PE definition for categories (a) and (c) above can be summarized as follows (as the relevant PEs in this case would be (a) and (c)):
- Activities such as storage, display, and delivery were excluded from the scope of a fixed place of business PE in Japan. Under the tax legislation, where such activities go beyond the nature of preparatory and auxiliary with respect to a foreign company carrying out its business activities in Japan, such activities would constitute a PE in Japan of that foreign business.21
- A person who engages in activities "relating to" the conclusion of a contract regarding the transfer of ownership of the assets of a foreign company has been added to the scope of "dependent agent PE". This provision appears to expand the scope of dependent agent PE to cover a person who is not necessarily a bona fide agent (e.g., a contract concluding agent) and, in a practical sense, appears to be aimed at capturing so-called "commissionaires", the use of which was targeted by the BEPS project.22
- In addition to the above, a person who works mostly or exclusively for one or two "closely related" (defined as having a greater than 50% relationship) principals will be excluded from the scope of the "independent agent" exception.23
That said, Japanese domestic tax law clarifies that where the PE provision under domestic law differs from that of a treaty applicable to a taxpayer, the PE provision under the applicable treaty will still apply. This is the so-called "treaty override doctrine", which has traditionally been applicable for Japanese tax purposes by virtue of Article 98(2) of the Constitution of Japan.24 Accordingly, in the case where an applicable treaty exists, then the definition of a PE under the treaty should apply. Some treaties were also amended in light of the MLI or BEPS Action Item 7 discussions by the OECD.25
In view of the above, a relevant issue for tax purposes in relation to the registration of a representative in Japan would be the broad authority given to the registered representative under the provisions of the Companies Act. Depending on the specific circumstances of the foreign company, there is a potential risk that the representative in Japan may be considered to fall within the definition of a dependent agent-type PE, or a fixed place of business PE (based on the location of the representative in Japan) described above. If such an assertion is made by the Japanese tax authorities, this would give rise to a taxable presence (and filing obligations) for the foreign company in Japan.
In this context, foreign companies that have received a notice from the Ministry of Justice, or that are otherwise considering whether the registration requirement applies to them, should consider the PE implications of registration. As a first step this may involve identification of the current business model in Japan, including the detailed operation of the Japanese subsidiary, if any (and interactions between the foreign affiliates and the Japanese subsidiary), and consideration of the applicable PE definitions under the domestic tax law or the applicable tax treaty. If a PE risk is identified, there may be several solutions or steps that can be taken to mitigate this risk.
For example, as the tax law is silent on the corporate tax treatment of the registration of a representative in Japan, there may be a possibility to consider a tax ruling request in this regard (although the Japanese tax authorities would not easily accept a ruling request which involves many factual matters). On the other hand, as mentioned above, only income attributable to a PE is taxable in Japan, and such income attributable to a PE would be determined broadly based on the functions, assets and risks associated with the activities giving rise to the PE. Considering this, in order to identify the attributable income to a PE (or to justify that no or only nominal attributable income should be calculated), performing a sort of the TP analysis would also be worthwhile to consider.
Possible future developments and implications
As mentioned above, foreign companies have historically not sufficiently fulfilled their registration obligations due to the administrative burden and costs for maintaining and updating registries, as well as the reluctance to disclose a financial statement in Japan. Another factor is that there have been no known cases of sanctions to date, such as fines being imposed for violations of registration obligations (also, even if there were to be such a sanction, it would be as low as JPY 1 million).
However, with the rapid increase in cross-border B2C and B2B transactions due to the growth of the digital economy in recent years, the Japanese government has been amending laws and enacting new ones to impose legal restrictions on foreign tech companies. The recent issuance of notices by the Ministry of Internal Affairs and Communications and the Ministry of Justice appears to be in line with this trend.
Although recipients of the notices issued by the Ministry of Justice are currently limited to foreign tech companies that are registered or notified as telecommunications carriers, the Companies Act states that a company is obligated to register (whether it is a telecommunications carrier or not) as long as it satisfies the conditions under the Companies Act. Accordingly, it is possible that the Japanese government may extend a similar request to companies in other industries, especially in industries with strict requirements to protect their domestic customers and/or counterparties. Therefore, foreign companies that engage in certain business activities with Japanese customers/counterparties need to carefully monitor future escalation in the level of the Japanese government's enforcement of this registration obligations, reexamine whether or not they are required to register under the Companies Act in light of their business activities, and closely examine the potential impacts and implications.
2 Companies Act, Article 817, Paragraph 1.
3 Companies Act, Article 818, Paragraph 1.
4 Companies Act, Article 817, Paragraph 2.
5 Companies Act, Article 817, Paragraph 3.
6 Companies Act, Article 933, Paragraph 1(1).
7 Companies Act, Article 933, Paragraph 1(2).
8 Companies Act, Article 976, Paragraph 1.
9 Companies Act, Article 818, Paragraph 2.
10 Companies Act, Article 827, Paragraph 1(4) and Article 822, Paragraph 1.
12 Companies Act, Article 819, Paragraph 1; Article 214 of the Ordinance for Enforcement of the Companies Act.
13 Japan Code of Civil Procedure, Article 3-3, Items 4 and 5.
14 See Japan Code of Civil Procedure, Article 108.
15 See Japanese Corporate Tax Act, Article 4(3) and 8(1).
16 See Japanese Corporate Tax Act, Article 138(1)(i). Similarly, in the case where a PE exists, the attributable income is also subject to the local corporate inhabitants tax, enterprise tax, and special corporate enterprise tax (collectively, local taxes). The current Japanese effective tax rate (including local taxes) is around 34% (or around 30% if the factor-based enterprise tax applies to a company, i.e., non-small medium sized enterprise for enterprise tax purposes, whose registered capital exceeds JPY 100 million).
17 See Japanese Corporate Tax Act, Article 2(12-19).
18 Generally, a place "at the disposal of the enterprise" which exists for "a certain duration" constitutes a fixed place of business.
19 This PE category would be not relevant here.
20 Indeed, a person in Japan, other than an independent agent, who acts on behalf of an enterprise who "has and habitually exercises" the authority to conclude contracts in the name of the enterprise or plays the principal role leading to the conclusion of certain contracts falls within the scope of the dependent agent.
21 See Japanese Corporate Tax Act Enforcement Order, Article 4-4(4).
22 See Japanese Corporate Tax Act Enforcement Order, Article 4-4(7)
23 See Japanese Corporate Tax Act Enforcement Order, Article 4-4(8)
24 In addition, Article 2 (12-19) of the Japanese Corporate Tax Act stating the PE definitions further clarifies that, if an applicable tax treaty concluded by Japan contains any provisions that are different from what is provided under the domestic tax law, the definition of a permanent establishment under the treaty shall apply.
25 For example, under the Japan-Netherlands Tax Treaty ("NL Treaty"), the definitions of PE were expanded in 2019 due to the MLI/BEPS, and Article 13 of the MLI (Artificial Avoidance of Permanent Establishment Status through the Specific Activity Exemptions) and Article 15 of the MLI (Definition of a Person Closely Related to an Enterprise) are embedded into the NL Treaty.