Director’s Compensation in Japan: A Key Step When Starting a Company

Hi, my name is Taisei Koshida, and I am a certified public accountant and licensed tax accountant in Japan.

I support foreign entrepreneurs and small business owners with accounting and tax matters in Japan, with support available in English.

When you establish a company in Japan, one of the important decisions you need to make early is the amount of director’s compensation (Yakuin Hoshu).

This is not simply a question of how much salary you want to receive. Director’s compensation affects the company’s taxable income, your individual income tax, social insurance, cash flow, and sometimes the company’s financial results.

For a newly established company, you should determine the director’s compensation within three months after incorporation. Once the amount has been determined, you generally cannot freely change it during the fiscal year while maintaining full deductibility for corporate tax purposes.

For this reason, I recommend considering the amount carefully at the beginning rather than deciding it only from a tax-saving perspective.

Director’s Compensation Should Generally Be Set Within Three Months

Under Japanese corporate tax rules, director’s compensation generally needs to meet specific requirements to be deductible for corporate tax purposes.

For a newly established company, you should generally determine the director’s compensation within three months after incorporation.

Once the monthly amount has been determined, freely increasing or decreasing it during the fiscal year can cause part of the compensation to become non-deductible for corporate tax purposes, except in certain circumstances permitted under Japanese tax rules.

In practice, this means that you should not wait until later in the year, see how much profit the company makes, and then freely adjust the director’s compensation to reduce the company’s taxable income.

For more details about the rule requiring director’s compensation to generally remain the same each month, see Under Japanese Tax Law, Director’s Compensations Must Be the Same Each Month.

Consider the Company’s Expected Profit

When deciding the amount of director’s compensation, one of the first things to consider is the company’s expected profit.

Director’s compensation is generally an expense of the company if the applicable tax requirements are met. Therefore, a higher director’s compensation reduces the company’s taxable income, while a lower amount leaves more profit in the company.

However, I do not recommend simply setting the compensation as high as possible to reduce corporate tax.

Showing a profit in the first fiscal year can be helpful for future bank financing and may also be relevant for visa renewals and other business purposes.

If you set the director’s compensation too high and the company makes a large loss as a result, that may not be the best outcome even if it reduces the company’s current corporate tax.

Consider How Much You Actually Need for Living Expenses

Another important point is how much money you actually need personally.

For example, suppose you set your director’s compensation at JPY 100,000 per month because you want to keep your individual income tax and social insurance low.

However, if you actually need JPY 500,000 per month for your living expenses, you may eventually start withdrawing additional money from the company.

That additional withdrawal is not automatically additional salary or a deductible company expense. Depending on how it is handled, it may instead create an amount receivable from the director or another accounting issue.

For that reason, setting an unrealistically low director’s compensation only to reduce tax or social insurance can create another problem later.

The amount should be realistic for both the company and your personal life.

Consider Corporate Tax, Individual Income Tax and Social Insurance Together

Director’s compensation moves income from the company to the individual, so looking only at the company’s corporate tax does not give you the whole picture.

If the director’s compensation increases, the company’s taxable income generally decreases, but the director’s individual taxable income increases. Social insurance contributions may also increase.

If the compensation is lower, the opposite may happen: the company retains more taxable profit while the director’s individual income is lower.

The amount that produces the lowest tax is not necessarily the best amount for the business.

When determining director’s compensation, I recommend considering several factors together:

• Expected company profit
• Company cash flow
• The director’s actual living expenses
• Corporate tax
• Individual income tax
• Social insurance
• Future bank financing
• Future business plans

The appropriate amount therefore depends on the actual situation of both the company and the director.

Do Not Wait Until the End of the Fiscal Year

One mistake is to think that you can wait until the company’s profit becomes clear and then decide how much director’s compensation to pay.

Japanese corporate tax rules generally do not allow you to freely adjust director’s compensation at the end of the fiscal year simply to reduce taxable profit.

That is why director’s compensation should be considered at the beginning of the business rather than at the end of the year.

Of course, a newly established business cannot predict its first-year profit perfectly. The purpose is not to make a perfect forecast. It is to make a reasonable estimate based on the information available and decide an amount that makes sense for both the company and the director.

Director’s Compensation Is One of the First Tax Decisions After Incorporation

Director’s compensation is not the only tax matter that needs attention soon after establishing a company in Japan.

The Blue Form application and the decision about consumption tax and the Qualified Invoice System also need to be considered early.

For these three important initial tax matters, see Starting a Company in Japan: 3 Essential Tax Steps for Foreign Entrepreneurs.

For a broader overview covering company setup, fiscal year selection, bookkeeping, payroll, withholding tax, consumption tax, corporate tax, tax audits, and international transactions, see Starting & Running a Business in Japan: Tax and Accounting Guide for Foreign Business Owners.

Accounting and Tax Support for Foreign Business Owners in Japan

My main areas of expertise are accounting and taxation.

I assist foreign entrepreneurs and small businesses with accounting in Japan, corporate tax returns, director’s compensation, consumption tax, payroll-related tax matters, and corporate tax planning, with support available in English.

When discussing director’s compensation, I consider not only the company’s corporate tax but also the director’s individual income tax, social insurance, cash needs, and the company’s future plans.

I do not try to handle every professional field myself. When necessary, I work with judicial scriveners for company registration, administrative scriveners for visa matters, social insurance specialists, and other professionals.

If you are establishing a company in Japan and need assistance deciding the director’s compensation or setting up the company’s accounting and tax procedures, please contact me through the inquiry form.

Contact Koshida Accounting and Tax Office