How to Decide Executive Remuneration

Executive remuneration (役員報酬 Yakuin Houshuu) is the remuneration paid to the executives of a company. Executives of a stock company are defined as “directors,” “accounting advisors,” and “auditors” under Japanese Companies Act.

If you are the only shareholder of the company, you can decide your own executive remuneration. However, there are different rules for executive remuneration than for employee salaries. If the amount of executive remuneration is not decided in accordance with such rules, it may not be recognized as deductible expense under corporate tax law.

So, there is a risk that both the company paying the executive remuneration and individuals receiving it will be taxed (double taxation risk).

This article explains how to set executive remuneration.

How to Decide Executive Remuneration

Rule 1: Decide by Articles of Incorporation or Resolution of Shareholders’ Meeting

Under the Companies Act, executive remuneration must be determined either by the articles of incorporation or by a resolution of the shareholders meeting.

However, many small- and medium-sized companies do not stipulate executive remuneration in their articles of incorporation, and even if they do, most of them state that it is to be decided by a resolution of a shareholders meeting. Therefore, executive remuneration is generally decided at shareholders meetings.

In some cases, the amount of each executive’s remuneration is decided at the shareholders meeting, but in other cases, the total amount of executive remuneration is first decided at the shareholders meeting, and then the breakdown of each executive’s remuneration is decided at the board of directors meeting (or by the directors if there is no board of directors in the company). In this case, minutes must be prepared and kept for each of these meetings. The minutes may be checked in the event of a tax audit, etc., so do not forget to keep them.

For information about Shareholders’ meeting and Board meeting, please refer to our previous article.

How to hold Shareholders Meeting in JapanWhen and how to hold Shareholders Meeting and Board Meeting in Japan....

Rule 2: Determine before Deadline and Do not Change the amount

The amount of executive remuneration must be determined within three months of the date of incorporation for the first year of business. Thereafter, executive remuneration can be determined for each fiscal year, but the amount of remuneration can only be changed within three months of the start of the fiscal year (beginning of the fiscal year). Once decided, the amount of executive remuneration is basically fixed for one year (at least until the end of the fiscal year).

Double Taxation Risk

Corporate income tax is levied on a company’s “income,” not on its sales. Income can be calculated using the ” gross income minus deductible expense” formula.

However, if the two rules above regarding executive remuneration are not followed, executive remuneration may not be recognized as deductible expense, and corporate tax will be imposed even on the portion paid as executive remuneration.

At the same time, the executive remuneration received as an individual is naturally subject to income tax, so the same executive remuneration will be taxed twice, once for corporate tax and once for income tax.

We definitely want to avoid this awful situation.

Can Companies pay bonus to Executives?

Salaries that have been pre-fixed and filed (事前確定届出給与 Jizen Kakutei Todokede Kyuuyo)

In principle, bonuses paid to executives are not deductible expenses, but by notifying the tax office in advance, they can be recognized as deductible expenses as Salaries that have been pre-fixed and filed called 事前確定届出給与(Jizen Kakutei Todokede Kyuuyo). Specifically, in order for the bonus to be recognized as deductible expense, the company must submit a “Notification of Advance Fixed Salary” to the local tax office and pay the amount stated in the notification on the payment date as per the notification.

The deadline for submitting the notification to the tax office is within one month from the date of the shareholders meeting resolution .,etc. regarding the bonus, or within four months from the date of the beginning of the accounting period (the beginning of the fiscal year), whichever is earlier. In the case of a new corporation that has just been established, the deadline for submission is within two months from the date of establishment.

Executive bonuses are not deductible expense unless they are paid in accordance with the notification form described above. If the payment is made one day later or in a different amount by mistake, the entire amount of the executive’s bonus may not be deductible. Thus, executive bonuses are risky and should be avoided.

For more details, please refer to the website of National Tax Agency.

Can executive remuneration and bonuses be linked to performance?

In order to use performance-linked pay, the amount of remuneration must be calculated based on the designated index and be stated in the annual securities report. Therefore, this is not applicable to unlisted companies whose shares are not publicly traded.

So if the performance of an executive is really good, it should be reflected to the fixed executive remuneration of the next fiscal year.