Accounting & Taxes

1. Definition of SME Corporations and SME Operators in Japan

SME corporations and SME operators under tax law are primarily determined by their capital amount. Under the Corporation Tax Act and related tax systems, corporations with a capital of 100 million yen or less generally fall under the category of SME corporations, etc. (SME operators, etc.).

However, 100% subsidiaries (corporations under full control) of so-called large corporations with a capital of 500 million yen or more are excluded from SME operators, etc., even if their own capital is 100 million yen or less.

In other words, even if a Japanese subsidiary has a small capital amount, it may not be considered an SME corporation if its parent company is very large.

2. Impact of the Parent Company's Capital Amount

The size (capital amount) of the foreign parent company directly affects whether the Japanese subsidiary qualifies as an SME corporation.

As mentioned earlier, under Japanese tax law, subsidiaries fully controlled by a large corporation with capital of 500 million yen or more are excluded from SME corporation incentives.

"Full control" refers to cases where the large corporation directly or indirectly holds 100% of the issued shares of the Japanese subsidiary.

For example, if a foreign parent company has capital of 500 million yen or more and holds 100% of the shares of a Japanese subsidiary, the Japanese subsidiary will not be recognized as an SME corporation, even if its capital is 10 million yen or 100 million yen or less. This is because, under the Japanese tax system, the Japanese subsidiary is considered part of the larger corporate group, and SME incentives do not apply.

This exclusion does not apply if the parent company's capital is less than 500 million yen, or if the parent company does not fully own the Japanese subsidiary.

For example, if the foreign parent company has capital of less than 500 million yen, the Japanese subsidiary can qualify as an SME corporation as long as it meets the capital requirement of 100 million yen or less.

Also, if the shares of the Japanese subsidiary are held by multiple investors or not 100% by the parent company, it may no longer fall under "full control by a large corporation" and may qualify as an SME corporation.

Even if the parent company is a large, listed company, the shareholder structure is still an important factor when determining SME corporation status.

3. Key Points for Structuring Investment Schemes

When establishing a Japanese subsidiary, whether it qualifies for SME benefits depends on how its capital and ownership are structured. The following points should be considered when designing the investment scheme.

Setting the Capital Amount: It is essential to keep the capital of the Japanese subsidiary at 100 million yen or less. If the capital exceeds 100 million yen, it falls outside the scope of SME corporations and many tax incentives become unavailable.
Adjusting Shareholding Ratio: If the parent company is a large corporation (capital of 500 million yen or more), SME status may still be maintained by avoiding a 100% ownership structure.
Utilizing an Intermediate Holding Company: In some cases, instead of the foreign parent company directly owning the Japanese operating company, an alternative is to set up a small intermediate holding company in Japan and place the operating company under its umbrella.

Whether SME corporation status applies can depend on how capital and shareholding are adjusted. It is important to optimize the investment structure in a tax-efficient way when entering the Japanese market.

For more complex structures, be sure to consult a qualified tax accountant and confirm that the arrangement aligns with the interpretations of the Japanese tax authorities.

4. Changes in Tax Incentives Based on Determination Criteria

Tax incentives and overall tax burden can vary greatly depending on whether a Japanese subsidiary is classified as an SME corporation.

If the company qualifies as an SME corporation, it is eligible for various tax benefits. If it does not qualify (i.e., is treated as a large corporation), these special provisions are not available, and the regular tax rules apply.

The main differences include:

Reduced Corporate Tax Rate Measures: SME corporations receive a reduced tax rate on annual income up to a certain threshold. Currently, income up to 8 million yen per year is taxed at a reduced rate of 15%. Large corporations, on the other hand, are taxed at a flat rate of 23.2%, with no preferential treatment for lower income amounts.
Restrictions on Use of Losses: Large corporations can only use carry-forward losses to offset up to 50% of the income in a given fiscal year. In contrast, SME corporations can offset losses against 100% of their income.
Application of Size-Based Taxation (Gaikē Hyōjun Kazei): Companies with capital over 100 million yen are subject to size-based corporate enterprise tax, which is calculated not just on income but also on business scale factors like capital and total payroll.

As shown above, companies that do not qualify as SME corporations face higher overall tax burdens due to higher rates, loss deduction limits, and additional local taxes.

It is important to determine your company's classification in advance and run simulations to evaluate the impact.

5. Main Incentive Systems That Become Unavailable

If a Japanese subsidiary does not qualify as an SME corporation, it cannot make use of various tax benefits intended for SMEs.

Examples of incentive systems available only to SME operators include:

Reduced Corporate Tax Rate: As mentioned above, income up to 8 million yen per year is taxed at a reduced rate of 15%.
Carry-back Refund of Losses: SMEs filing blue-form returns can apply current-year losses against prior-year profits and receive a corporate tax refund when in deficit.
Tax System to Promote Investment by SMEs: SMEs making certain capital investments can apply a special depreciation of 30% of the acquisition cost.
SME Management Enhancement Tax System: For certain capital investments that improve productivity or efficiency, SMEs can apply 100% immediate depreciation or a fixed tax credit.
Special Provision for Inclusion of Entertainment Expenses, etc., as Deductible Expenses: SMEs can deduct up to 8 million yen of entertainment expenses annually.
Special Provision for Small-Sum Depreciable Assets: SMEs can immediately expense assets under 300,000 yen in value, up to a total acquisition cost of 3 million yen per year.
Other Tax Credit Incentives: SMEs may also enjoy more favorable R&D tax credit limits, as well as relaxed requirements and higher deduction rates for wage increase tax incentives.

These tax systems offer significant advantages. Losing access to them by being classified as a large corporation can result in a higher tax burden and may influence investment decisions.

6. Comparison of Tax Burdens between SME Corporations and Large Corporations

How much do tax burdens differ between SME corporations and large corporations? Here's a comparison.

[Comparison of Corporate Tax Rates]
SME corporations are taxed at 15% on income up to 8 million yen and 23.2% on the portion above that. Large corporations are taxed at a flat rate of 23.2% on all income.

As a result, the lower the income, the lower the effective tax rate for SMEs. For example, with annual taxable income of 8 million yen, the corporate tax for an SME would be about 1.2 million yen, compared to about 1.86 million yen for a large corporation—a difference of roughly 660,000 yen.

When income is in the hundreds of millions of yen, the benefit of the lower rate on the first 8 million yen becomes less significant.

[Comparison of Corporate Enterprise Tax Burden]
Companies with capital over 100 million yen are subject to size-based taxation and must pay enterprise tax even when unprofitable. SME corporations, however, incur no enterprise tax if they report no profit or are in deficit. This makes SME status more favorable during periods of weak performance.

The overall structure of corporate tax and enterprise tax differs between SMEs and large corporations, with SMEs generally enjoying a lighter tax burden.

Under current rules, even foreign-affiliated companies can qualify for SME incentives if the conditions are met. Confirm eligibility and structure your investment accordingly.

7. Points to Note for Companies with a Foreign Parent Company

Japanese subsidiaries with a foreign parent company should be aware of specific points when determining SME corporation status.

As noted above, subsidiaries 100% controlled by a parent company with capital of 500 million yen or more do not qualify as SME corporations. When the parent company is foreign, its capital is denominated in foreign currency, so the exchange rate at the fiscal year-end affects the SME determination.

Whether the Japanese subsidiary qualifies depends on whether the foreign parent's capital, converted at the fiscal year-end exchange rate, reaches 500 million yen or more.

It’s also important to consider tax risks common in foreign group structures, such as transfer pricing and thin capitalization rules.

8. Summary

SME corporation status in Japan is a key tax consideration for foreign-affiliated subsidiaries. Whether reduced tax rates and other incentives apply depends on capital and ownership structure. Qualifying can significantly reduce the tax burden, while non-qualification may result in higher costs.

Careful planning from the early stages, including the design of the investment scheme, is essential. Companies should stay up to date on tax reforms and consult with experts to ensure compliance and effective structuring.