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  1. Introduction

    Due to the effects of the COVID-19 pandemic on the economy, many companies have resorted to reducing their officers’ remuneration to offset any decrease in sales, as well as to ensure that their other employees also remain stable. On the other hand, other companies have done the opposite, increasing their officers’ remuneration to compensate for the decrease in remuneration that occurred during the state of emergency in Japan, which took place within the same fiscal year. If such changes in officers’ remuneration occur within the fiscal year, it can still be considered a “regular fixed remuneration” but the issue is whether it can be considered as deductible expenses. In this article, we will take a look at the regulations in-place for officers’ remuneration, and whether or not changes in the regular fixed remuneration can be considered as deductible expenses.

  2. About Officers’ Remuneration

    Officers’ remuneration, as the name suggests, refers to “remuneration that is paid to the officers of a company”. The term “officer” is defined differently in the Companies Act, and in tax laws. You may see below that the tax laws generally define an officer as “someone who can exert influence on the company’s decisions”. In other words, because officers are in positions where they can decide their own remuneration, the Companies Act and the relevant tax laws aim to prevent them from “overindulging”.

  3. Regulations on Officers’ Remuneration

    As mentioned above, to prevent any overcompensation of officers, the Companies Act (Article 361) states that the financial benefits received by officers must either be prescribed in the articles of incorporation or fixed by a resolution at a shareholders meeting. Under tax laws, in principle, officers’ remuneration is not considered a deductible expense. However, the following 3 forms of remuneration are considered deductible as these cannot be unjustly changed (whether increased or decreased) by the officers themselves.

    ① Regular fixed remuneration
    Regular fixed remuneration refers to compensation that is paid at least once within a fixed period no longer than a month, with the same amount paid for each period. No notification to the tax office is necessary. To determine whether the compensation is considered regular fixed remuneration, it must meet the following criteria:

    ② Pre-determined/pre-reported salaries for executives
    Pre-determined/pre-reported salaries for executives refers to remuneration reported to the tax office by a certain date. The report that is submitted indicates the date and time of payment, and the amount to be paid. The due date for filing is either ① within one month from the shareholders’ meeting where the resolution for the remuneration was made, or ② within four months from the beginning of the accounting period, whichever comes first.

    ③ Profit-based compensation
    Profit-based compensation refers to compensation paid based on “profit-related indicators” indicated in the Annual Securities Report. Family-owned companies cannot use this form of compensation.

  4. Cases where Regular Fixed Remuneration can be Changed

    The changing (either increase or decrease) of regular fixed remuneration adopted by many companies due to COVID-19 has become a contested issue. In principle, regular fixed remuneration must be set either within the first 3 months from the start of the fiscal year or following a resolution at a shareholders meeting, Any changes made to the amount outside this period or method of determination, except for certain circumstances, would mean that it no longer meets the requirements to be considered as “regular fixed remuneration” and it can no longer be deductible.

    The “special circumstances” refers to the following cases:

  5. Change in Regular Fixed Remuneration due to COVID-19
    • ① For changes made within 3 months from the start of the fiscal year

      Under the current circumstances, if a change in executive compensation was made within three months from the beginning of the fiscal year, as a general rule, it would be within the scope of a “regular revision” and will still be considered regular fixed remuneration.

      For companies that end their fiscal year in February or March, since the impact of COVID-19 became apparent in mid-February and the emergency declaration was lifted at the end of May, it would fall within three months from the beginning of their fiscal year. Thus, any revision within that period will be recognized as a regular revision and will be considered regular fixed remuneration.

    • ② For decreasing remuneration outside the period mentioned in ①

      The point in question here is whether or not the reduction of regular fixed income falls under the condition mentioned in item ② (Revision due to financial decline).

      The National Tax Agency has provided the following two examples:

      Reference: National Tax Agency’s FAQ regarding their response to prevent the spread of the novel coronavirus infection and the immediate tax treatment of tax return filing and payments

      Therefore, we can see that companies adopt a flexible approach not only in the event of worsening business performance, but also in the event that business performance is expected to worsen due to worsening economic environment, even if numerical indicators such as sales have not actually deteriorated significantly at present.

    • ③ For increasing remuneration outside the period mentioned in ①

      On the other hand, if a second revision were to be made during the fiscal year to restore the amount of remuneration to its original amount, would it be considered as an in item ③ (extraordinary revision)? In this case, no. If an increase in remuneration was made simply because the performance of the company has returned to normal, it is not considered as an extraordinary revision and the increase is considered non-deductible. To qualify as an extraordinary revision, there must be a significant change in the director’s duties.

      For example, a director who used to work at many sites and shops as a site manager was forced to close his shops due to the impact of the new coronavirus and his remuneration was reduced because the work was no longer needed. Following the lifting of the state of emergency in Japan, the business has reopened, and the director will resume his duties as usual. This case in which the remuneration level is changed back to its original amount would be considered a “significant change in job description”.

      Furthermore, in the case of special circumstances mentioned in item ① (extraordinary revision), reduction in remuneration for an officer who is unable to perform his or her duties due to illness caused by COVID-19 is recognized as a special reason. Changing back the director’s pay to its original amount once the director is able to perform his or her duties again will also be considered a “significant change in job description” and will continue to be considered regular fixed remuneration.

  6. Conclusion

    This time, we discussed whether or not changes made to officers’ remuneration (regular fixed income) due to the effects of COVID-19 would still be considered as deductible expenses. Officers’ remuneration can have a huge impact on one’s company, and one should be aware of the tax regulations that concern it. While many companies are navigating this unprecedented situation caused by COVID-19, we hope that you can use this article as a reference for companies that have been forced to reduce their officers’ remuneration or are considering changes to their remuneration in order to keep the company afloat.