Caution Needed When Reducing Executive Salaries

Introduction

Prices of energy, food, and other commodities continue to rise. If a company is expected to perform in a way that was not anticipated in its original business plan due to sudden changes in the external environment, such as higher prices or a weaker yen, is a reduction in executive salaries permissible?

Soaring Prices and Sharp Depreciation of the Yen

In 2022, the invasion of Ukraine by Russia has triggered a continued surge in energy prices, food prices, and other commodities. In addition, the sharp depreciation of the yen has accelerated this trend.

Many companies have begun to revise their executive salaries downward, mainly due to deterioration in their business performance, which was not anticipated at the beginning of their fiscal years.

The question arises as to whether it is permissible to reduce executive salaries with some flexibility (elasticity), as was the case at the beginning of the spread of the novel coronavirus.

General Treatment of Executive Salaries

In principle, only "salaries paid to corporate executives at regular intervals of one month or less, and of the same amount for each period of the fiscal year (regular salaries)" are allowable as expenses for corporate tax purposes.

The general rule is that executives' salaries for the fiscal year are determined at the general meeting of shareholders held within two or three months of the beginning of that fiscal year, and no changes are made until the next general meeting of shareholders.

In the case of a reduction of executives' salaries during a fiscal year, unless the revision falls under the category of "reasons for revision due to worsening business performance (significant worsening of business conditions or other similar reasons)," the lower salaries will not be recognized as expenses in the calculation of corporate tax.

For example, it has been confirmed that temporary cash flow issues, or simply not meeting goals in the business plan, do not fall under the above-mentioned category of "reasons for revision due to worsening business performance.”

Example of revisions due to worsening business performance

1. In regards to shareholder relations as a result of deteriorating business performance, the company is forced to reduce the amounts paid due to management responsibility.
2. In loan rescheduling discussions with a bank with which the company does business, the company is forced to reduce the amount of the loan.
3. A situation in which a reduction in the amount of executive salary is formulated within a business condition improvement plan due to a deterioration in business performance, financial condition, or cash flow, and there is a need to maintain the trust of business partners and other stakeholders.

Flexibility in Operations Not Expected

At the beginning of the spread of the novel coronavirus two years ago, the National Tax Agency allowed fairly flexible operations because many companies had to revise executive salaries downward due to decreases in sales caused by the pandemic, and because it was an unknown virus.

However, while some companies may decide to revise executive salaries during the current fiscal year due to significant decreases in sales, current (recurring) income, etc., because of the recent price hikes and other circumstances, at present, mere deterioration in performance due to such price rises alone is not considered a "reason for revision due to worsening business performance.”

If your company is considering a reduction in executive salaries in response to a deterioration in business performance caused by the recent price hikes and/or other factors, you need to consider the matter carefully. In order for a reduction in executive pay to be recognized as a "reason for a revision due to worsening business performance," it will likely be necessary to prepare a variety of circumstantial evidence.

Reviewing Transactions with Tax-exempt Businesses

Introduction

With the start of the invoice system, there has been a movement among businesses that do business with tax-exempt businesses to review the contract amounts. When reviewing contracts with tax-exempt businesses, attention must be paid to the Antimonopoly Act and the Act against Delay in Payment of Subcontract Proceeds, Etc. to Subcontractors (the Subcontract Act). Penalties are also provided for violations of the law. What kind of contract terms and conditions should be used?

There is No Problem in Reviewing the Terms of the Transaction Itself

According to the Q&A, reviewing the terms and conditions of transactions with tax-exempt businesses as suppliers on the occasion of the implementation of the invoice system is not in itself an immediate problem.

In addition, if a tax-exempt business operator chooses to remain a tax-exempt business operator with the understanding that it can become a taxable business operator, and if both parties agree on a transaction price during renegotiation, it does not seem to be a problem under the Antimonopoly Act even if the transaction price is consequently lowered. The key is whether or not both parties agree.

In Cases of Violations of Laws or Regulations, Levies and/or Publication of Violators’ Names

On the other hand, if the renegotiation is only a formality, and a significantly lower price is set solely for the convenience of the purchasing entity, and the tax-exempt entity is forced to accept it out of concern for the impact on future transactions, this could be problematic under the Antimonopoly Act as an abuse of a dominant bargaining position.

In the event of a violation of laws and regulations, a company may be subject to measures such as the imposition of levies under the Antimonopoly Act or the publication of the company’s name, etc., under the Subcontract Act.

Specifically, it is highly likely that a problem will arise if the procurement side unilaterally forces a price reduction by saying, "We will not pay the amount equivalent to consumption tax from now on," or "We cannot do business with you in the future unless the amount is ○○yen.”

If you are a victim of such unilateral coercion to reduce the price, please consider using the consultation services of the Fair Trade Commission or the Small and Medium Enterprise Agency regarding the Subcontract Act.

There is a transitional measure that allows 80% of the amount equivalent to purchase tax for the first three years after the introduction of the invoice system, and 50% for the following three years. Therefore, it seems desirable under the Antimonopoly Act to reduce the transaction price in stages in accordance with the transitional measures, rather than reducing the amount equivalent to the consumption tax all at once.

When reviewing the terms and conditions of transactions with tax-exempt businesses, please be very careful not to violate the Antimonopoly Act, the Subcontract Act, or other laws and regulations.

How to Get Loans Without Management Co-signer Guarantees

Introduction

What conditions must a business owner fulfill in order to obtain a loan without a personal co-signature? The following is an explanation according to the guidelines.

Three Requirements for Obtaining Financing without Co-signatures

For loans to small and medium-sized enterprises, banks often require company managers to become co-signers, but the downside of this is that it makes it difficult for successors to emerge. This is because many people do not like the idea of becoming a co-signer after taking over the business as a successor.

1. Clear separation in the relationship between a corporation and its management;
2. The Company's Performance and Financial Position are Good, and There Are No Concerns about It Repaying the Bank Accurate corporate financial information, timely and appropriate information disclosure to the bank, and transparency of management.
3. The Financial Statements of the Company are Accurately Understood, Timely and Appropriate Information Disclosure is Made to the Bank, and Management Transparency is Ensured.

1. Clear Separation in the Relationship between a Company and Its Management

One of the reasons why banks require managers to be co-signers is to prevent moral hazard, whereby if the company's assets are transferred to the manager personally after receiving a loan from the bank, the manager can accumulate personal wealth even if the company is unable to repay the bank.

As a requirement when a manager does not become a co-signer, the Guidelines Concerning Management Guarantees require the establishment of a system to ensure that the exchange of assets and funds between a company and its management does not exceed the scope that is socially acceptable and appropriate. Specifically, the company must not provide loans to the individual manager, and the individual manager's personal expenses, such as food and beverages, travel and transportation expenses, etc., must not become company expenses.

2. The Company's Performance and Financial Position are Good, and There Are No Concerns about It Repaying the Bank

One of the reasons banks require managers to be co-signers is to supplement the weak creditworthiness of the company with the managers' personal assets.

In order for a bank to provide a loan without the manager being a co-signer, the company must have sufficient creditworthiness.

3. The Financial Statements of the Company are Accurately Understood, Timely and Appropriate Information Disclosure is Made to the Bank, and Management Transparency is Ensured

Financial statements of small and medium-sized companies are often seen as less credible. Some companies seeking loans may try to obtain them from banks by window dressing their financial statements. Under the Guidelines Concerning Management Guarantees, in order for a business owner not to become a co-signer, it is a requirement that the financial statements and other financial statements submitted to the bank be proven accurate, and that the transparency of management be ensured.

Specifically, the following are required: the submission of account breakdown statements as well as balance sheet (BS) and profit & loss(PL) figures, and periodic reports to the bank through trial balance and cash flow statements in addition to the annual report of the main financial statements.

If a company presently meets these three requirements, it can negotiate with its bank to immediately remove the management guarantee(s). Since it cannot be expected that a financial institution itself would recommend that a borrowing company remove the management guarantee, the company should actively negotiate with the bank.