Navigating Tax Deductions for Director Salaries in Japan

While employee salaries are generally considered deductible expenses for tax purposes without special requirements, director compensation differs. Because it can be used to adjust corporate income through deliberate increases or decreases, tax laws stipulate specific requirements for it to be deductible.

Director compensation can only be recognized as a deductible expense if it falls under one of the following categories:

• Fixed Monthly Compensation
• Advance Notice Compensation
• Performance-Linked Compensation

This article explains the two categories that often pose challenges in practice: Fixed Monthly Compensation and Advance Notice Compensation.

Fixed Monthly Compensation

Definition

Fixed Monthly Compensation refers to payments made in the same amount each month. If the payment amounts vary, the increased or decreased amounts are not recognized as deductible expenses. Specifically, any non-uniform part of the payment is not deductible.

Example:

For a December fiscal year-end, a mid-year increase affects monthly amounts from January to December, with the non-deductible portion highlighted in orange.

For a December fiscal year-end, a mid-year decrease results in monthly amounts from January to December, with the non-deductible portion highlighted in orange.

However, if a compensation revision is made for one of the following reasons, it can be recognized as deductible:

• Regular Revision
• Extraordinary Revision Due to Special Circumstances
• Revision Due to Deteriorated Business Performance

Regular Revision

If a revision is made based on a resolution at a shareholders' meeting held within three months from the beginning of the fiscal year, it is considered Fixed Monthly Compensation and fully deductible.

Example:

For a December fiscal year-end, if an increase in director compensation is approved at the regular shareholders' meeting on March 25, the increased amount will be paid starting from the end of April, covering each month from January to December, with the increase applied from April onward.

It’s important to note that companies must determine the compensation amount for directors within three months of establishment only for the first fiscal year. This determined amount cannot be altered during that initial year.

Extraordinary Revision Due to Special Circumstances

A revision made due to a change in a director's position or a significant change in job responsibilities is considered Fixed Monthly Compensation, even if it is not a "Regular Revision" within three months from the beginning of the fiscal year. Incidental events prompt such revisions and are not intended for income adjustment.

Examples include cases where a director is hospitalized and unable to perform some or all of their duties or the vice president takes over as president after the president steps down.

Revision Due to Deteriorated Business Performance

A reduction in director compensation due to significant business downturns, necessitating a decrease in compensation to maintain relationships with third-party stakeholders, is also recognized as Fixed Monthly Compensation. While a reduction is allowed for poor business performance, an increase is not.

Examples:

1. The director's compensation must be reduced to take responsibility for worsening financial conditions for many shareholders.
2. A 20–30% reduction in director compensation is necessary in negotiations with banks to reschedule loan repayments.

Advance Notice Compensation

Definition

While the Fixed Monthly Compensation rule applies to monthly salaries, bonuses paid outside the regular monthly salary are only deductible by filing an advance notice. Advance Notice Compensation refers to bonuses pre-determined for a specific amount at a specified time, declared in advance to the tax office. If the actual payment differs from the declared amount, the difference and the entire amount are considered non-deductible.

There may be a question as to whether the unpaid portion of the salary will be deductible if part of the salary is recorded as an unpaid expense. In such cases, the deductibility depends on whether the bonus is substantively part of the compensation, whether the declared amount was the determined amount, and whether there was a formal agreement specifying the payment at a particular time for the director's role.

This is judged case-by-case (National Tax Agency, Information on Legal Interpretation > Corporate Tax > Director Compensation, etc.).

Filing Deadline

When adopting the Advance Notice Compensation rule, the designated filing must generally be submitted by the earlier of the following dates:

1. One month after the date of the shareholder resolution that established the compensation arrangement
2. Four months after the start of the accounting period

For newly established companies, the filing deadline is two months from the date of establishment.

Summary

Director compensation can only be deducted if it meets the requirements for Fixed Monthly Compensation, Advance Notice Compensation, or Performance-Linked Compensation.

Director compensation should be the same each month to avoid unfavorable tax consequences. If a revision is necessary, it should occur within three months from the start of the fiscal year. Bonuses are not deductible unless an Advance Notice Compensation arrangement specifying the amount and payment date is filed with the tax office.

Further Reading

To learn more about considerations such as company name, type, capital, structure, address, share restrictions, and executive compensation, please read my article, Key Decisions for Establishing a Subsidiary in Japan.