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Q_iconIn terms of tax, what are the differences between incorporating a subsidiary company and establishing a branch office? If we were to estimate the tax required, how much difference would there be between them?

A_iconBelow are three situations that are typical comparisons, however, these are not always the case for businesses.

1. If deficit for the Japan entity is expected to continue ⇒ a branch office would be more advantageous
2. If the capital of the foreign company is more than 100 million Japanese yen ⇒ a subsidiary company would be more advantageous
3. If there are several limitations for deductible items in the foreign country ⇒ a subsidiary company would be more advantageous

★ Explanation ★

Although this is not always the case, below are common patterns companies encounter when it comes to the tax they are required to pay.

1. If deficit for the Japan entity is expected to continue ⇒ a branch office would be more advantageous

This is in the case that after establishing one’s base in Japan, upon commencement of business activities, losses (deficit) are incurred due to the necessary start-up costs, such as employment and initial investments. When settling accounts for the filing of corporate tax returns and the like, in the meantime, the head office will take the profit and loss of the Japan branch office. In such cases, if the Japan branch office is in deficit, the loss if offset with the foreign company’s taxable profit. This causes the income amount of the foreign company to decrease (aggregation of profit and loss), resulting in lower taxation for the foreign company in its home country.

【Example 1】

Let’s assume the following:

  • Revenue of a Japan entity is 3 million yen, with a total expense of 10 million yen.
  • The head office of entity’s foreign company has a revenue of 90 million yen, and a total expense of 60 million yen.
    • ⇒ The loss amounting to 7 million yen, in the case of a Japan branch office, can be offset with the foreign company’s head office, decreasing its net income amount by 7 million yen. As a result, the tax due to income for the foreign company can be decreased.
Japan Overseas
Revenue Expense Net Loss Revenue Expense Net Loss
Japan subsidiary company 3 million yen 10 million yen (7 million yen) 90 million yen 60 million yen 30 million yen
Japan branch office 3 million yen 10 million yen (7 million yen) 90 million yen 60 million yen 23 million yen
Japan
Revenue Expense Net Loss
Japan subsidiary company 3 million yen 10 million yen (7 million yen)
Japan branch office 3 million yen 10 million yen (7 million yen)
Overseas
Revenue Expense Net Loss
Japan subsidiary company 3 million yen 10 million yen (7 million yen)
Japan branch office 3 million yen 10 million yen (7 million yen)

2.If the capital of the foreign company is more than 100 million Japanese yen ⇒ a subsidiary company would be more advantageous

A corporation that has more than 100 million Japanese yen in capital is no longer considered a small-to-medium enterprise (SME) under the Corporation Tax Act. As a result, such a company would not be able to qualify for tax benefits that SMEs can avail of. For a branch office in Japan, since the basis for the capital would be the capital of the foreign company, if the foreign company’s capital is more than 100 million yen, the branch office would be treated as a non-SME, no matter how small-scale their Japan operations would be. Therefore, if their foreign company’s paid-in capital is more than 100 million yen, there would be more tax benefits in establishing a Japan company subsidiary with a paid-capital of less than 100 million yen.

Some of the tax benefits enterprises with less than 100 million yen in paid-in capital include the following:
  • (1) A reduced tax rate of 15% for annual income 8 million yen or less;
  • (2) Entertainment expenses up to 8 million yen annually can be fully deducted as expense;
  • (3) SMEs who file for blue-form tax returns can receive a refund as a result of carryback of loss from prior year;
  • (4) Low value depreciable assets less than 300,000 yen can be considered a deductible expense in full (maximum of 3 million yen per business year);
  • (5) They can be exempted from enterprise tax on a pro forma basis.
  • (6) They are excluded from the levying of taxation on retained earnings;
  • (7) They can qualify for various special write-offs and tax deductions;
  • (8) They can qualify for the preferable allowable ratios for deductible portion of bad debt provision;

Note: Items (1), (2), (3), (6) and (8) cannot be applied for wholly-owned subsidiaries of a parent corporation whose paid-in capital is more than 500 million yen (group taxation regime).

Furthermore, in the case of corporate inhabitant tax on a per capita basis, the larger the capital amount, the larger the tax payment would become. As such, it would be more advantageous if a foreign company would choose to establish Japan subsidiary company with smaller capital amounts. (The “capital amounts” normally includes capital reserve.)

For example, if the capital amount of the Japan entity is 5 million yen, and the foreign company’s capital amount total to 500 million yen
  • If the Japan entity were a subsidiary company, their payment for corporate inhabitant tax on a per capita basis would be around 70,000 yen per year (amount varies according to municipality);
  • If the Japan entity were a branch office, their payment for corporate inhabitant tax on a per capita basis would be around 290,000 yen per year;

This shows a difference of around 220,000 yen a year.

【Corporate Inhabitant Tax (per capita basis) Amounts】(as of April 2017)

The amounts below assume that a company located only in any of the specified districts in the Tokyo Metropolis area with less than 50 employees:

  • Capital amount of 10 million yen or less ⇒ 70,000 yen per year
  • Capital amount of 100 million yen or less ⇒ 180,000 yen per year
  • Capital amount of 1 billion yen or less ⇒ 290,000 yen per year
  • Capital amount of 5 billion yen or less ⇒ 950,000 yen per year
  • Capital amount of more than 5 billion yen ⇒ 1.21 million yen per year

Although rare, there are also cases where, in practice, the capital amount of the foreign company is not publicized. In such cases, it is important to conduct an interview with the top management of the home country regarding the capital amount (e.g. whether it is more than 1 billion, or 5 billion, and so on).

3. If there are several limitations for deductible items in the foreign country ⇒ a subsidiary company would be more advantageous

There are some items that are deductible items for subsidiary companies in Japan that are not considered as such in other countries or are limited in terms of amount and the like. For example, even if the full amount for some items can be considered deductible, when calculating the income attributable to a branch office at the foreign office, it is possible that not all deductible items can be included. In such a case, it would be better to be a subsidiary company to take advantage of the tax benefits in Japan.

【Example 2】

Inclusion of entertainment expenses as deductible expense (Japan-U.S. case)

Let’s assume the following:

  • The company’s business entity in Japan has a total entertainment expense of 3 million yen, and the business entity in the US has a total entertainment expense of 9 million yen
  • If the entity were a subsidiary company, its capital would be 6 million yen (the total entertainment expense can be a deductible item for subsidiary companies with capital no more than 8 million yen).
  • The US head office’s deductible entertainment expense can be up to half of the total entertainment expenses (according to US federal corporate tax laws).

⇒ A Japan subsidiary company that can claim all of their entertainment expenses as deductible expense would be able to reduce their income amount through having more tax-deductible expenses as compared to a Japan branch office. In our example, the subsidiary company has 1.5 million yen more in terms of deductible expenses compared to a branch office.

Capital Entertainment Expense (Japan) Entertainment Expense (US) Total deductible expense
Japan subsidiary company 6 million yen 3 million yen 9 million yen 7.5 million yen
(3 million yen + (9 million yen ÷2))
Japan branch office 6 million yen 3 million yen 9 million yen 7.5 million yen
(3 million yen + (9 million yen ÷2))
Japan subsidiary company
Capital 6 million yen
Entertainment Expense (Japan) 3 million yen
Entertainment Expense (US) 9 million yen
Total deductible expense 7.5 million yen
(3 million yen + (9 million yen ÷2))
Japan branch office
Capital 6 million yen
Entertainment Expense (Japan) 3 million yen
Entertainment Expense (US) 9 million yen
Total deductible expense 7.5 million yen
(3 million yen + (9 million yen ÷2))