Severance Payment to Representative Director Who Wasn’t Fully Retired Denied as Deductible Expense

Introduction

In a ruling on a dispute over whether money paid in connection with a change of division of labor from representative director to director constituted severance pay, the National Tax Tribunal dismissed the taxpayer's request for review and ruled that the government's disposition was proper.

Monies paid to a representative director who leaves a company completely are recognized as severance pay, but if a director remains with their company in a different capacity, then consideration paid as ‘severance pay’ may not be recognized as such, so considerable caution should be exercised.

Adjudication Summary

In this case, a taxpayer engaged in the real estate leasing business filed a final corporate income tax return, claiming as a deductible expense the ‘severance pay’ paid to the firm’s former representative director, who retired from his position as representative director and became a director without representative rights. As a result, the tax office determined that the said money was not deductible for tax purposes, and implemented a correction of corporate income tax. A dispute arose over this point.

In principle, so long as the amounts paid are not unreasonably high, severance pay to officers is deductible as tax-deductible expenses. Even if a director has not actually retired, if the director's position or duties have changed dramatically, such as a significant decrease in salary after a change in the division of responsibilities, then the director is considered to have "substantially retired" (Basic Corporate Tax Instruction 9-2-32), and the retirement/severance pay is deductible as a tax-deductible expense.

(3) When, after a change in the division of labor, etc., the salary of an officer (excluding someone who is deemed to occupy a major role in the management of the company even after the change in the division of labor, etc.) has dramatically decreased (generally by 50% or more).
https://www.nta.go.jp/law/tsutatsu/kihon/hojin/09/09_02_07.htm

However, there have been cases in which money paid as a result of changes in the division of labor was not recognized as severance pay.

In what cases are such payments not considered to be ‘severance pay’?

The Tribunal Found that even after Changes in the Division of Duties, the Officer Remained in a Key Position

The Tribunal held that even in the case of a change in the division of responsibilities of an officer - for example, when a full-time director becomes a part-time director who doesn’t occupy a major position in the management - it is appropriate to treat the severance/retirement payment paid to the officer at the time of such change in the division of responsibilities as severance pay under the Corporate Tax Law.

However, the Tribunal then ruled that, in light of the facts of this case, the former representative director's position as an officer or the nature of his duties had not in fact been significantly altered as a result of the change in the division of duties, and thus there were no "circumstances like that of actual retirement". Therefore, since the money in this case could not be considered to be actual ‘severance pay’, it was determined that the corrective action taken by the tax office was appropriate.

Be Careful if not Fully Retired

In this case, the former representative director was in charge of the management of company funds as well as accounting operations before and after the change in division of duties, and continued to play a central role in those same positions after the revision of duties. In addition, the individual was treated as a full-time employee, and his salary remained unchanged after the change in division of responsibilities.

As mentioned above, this case may be an extreme one, but there have been more than a few cases in which money paid as a result of changes in the division of labor duties was not recognized as severance pay. If your company makes what are intended to be severance payments as a result of changes in the division of responsibilities, please do so with the utmost care.

This issue does not arise if the severance pay is paid when the employee leaves the company completely (as a matter of fact, not merely as an appearance), instead of when there is a change in the division of responsibilities. From a tax risk perspective, it is preferable to pay severance pay at the time of complete resignation.

Beware of Omissions in Recording Company Housing Rent as Non-taxable Sales

Introduction

In order to avoid payroll taxes on the rent of company housing rented by a corporation, the employee who moves in may pay a portion of the rent.

There are many cases where rent received from employees is treated as advances (not subject to consumption tax) or as negative land rent (negative non-taxable purchases).

Company Housing Rent Received from Employees is Considered Non-Taxable Sales

Rent for housing is exempt from consumption tax. Even if the lessee does not use the residence himself/herself but instead subleases it to a third party, the rent received by the lessee from the sublessee is also exempt from taxation if it is clear in the contract, etc., that the property is being subleased as a residence.

This "housing" includes company housing and employee dormitories. If a corporation rents a property from a real estate owner as company housing for its employees, the rent paid by the corporation to the real estate owner is not deductible as a tax-exempt purchase. If a corporation subleases company housing to employees, the rent received from employees is also tax-exempt as housing rent, and should be recorded as non-taxable sales for the corporation.

The same treatment applies whether a corporation receives money from employees as part of company housing rent, or deducts a certain amount from the monthly salary paid to employees; all of such money received/deducted constitutes non-taxable sales. For example, if a corporation pays 100,000 yen as company housing rent each month and collects 20,000 yen per month from an employee, the 100,000 yen constitutes a non-taxable purchase, while the 20,000 yen is included in non-taxable sales. You might think that since both are tax-exempt, they are not related to the amount of consumption tax, but this is not actually the case.

Impact on Taxable Sales Ratio

By treating company housing rent received from employees as a negative tax-exempt purchase by the corporation, there is a possibility that non-taxable sales will be omitted. Specifically, when company housing rent is received from employees, it is offset against the “rent paid” account that the corporation pays to the real estate owner, - i.e., the "rent paid = non-taxable purchase" is treated as a negative figure. This results in the omission of the recording of tax-exempt sales for that portion of the rent.

For company housing rent received from employees, even if a journal entry is recorded to reduce the rent paid to the property owner as "cash / rent paid" instead of "cash / miscellaneous income (rent received)," it must be recorded as non-taxable sales for consumption tax purposes.

If non-taxable sales are omitted, the taxable sales ratio will be higher, which may result in errors such as over-applying tax credits for purchases.

Please note that housing allowances paid to employees as salary, rather than rental of company housing, are non-taxable and do not affect the calculation of consumption tax, so please keep both methods in mind, as a set.

Complex Cases in Practice, and How to Handle Them

Furthermore, in practice, there are cases where the accounting treatment is complicated, such as when there is a separate agreement between the corporation and the employee regarding rent payment, or when multiple company housing units are leased in a lump sum. For example, if considering treating company housing expenses as cash advances (temporary payments) or as expense reimbursements, it is necessary to verify thoroughly whether or not the treatment is consistent with the treatment of non-taxable sales, and whether there are any errors in the use of different account types.

Accurate classification accounting is required at all times, especially in companies where circumstances are prone to change, such as cases where employees are repeatedly transferred into and out of the company within a short period of time due to personnel changes, or when company housing is used by employees posted overseas while temporarily returning to their home countries. In such cases, it is important to ensure that there is thorough coordination among the departments in charge, as well as periodic checks to prevent errors and omissions.

After Admissions to Nursing Homes (Special Exception for Small Residential Lots, etc.)

Introduction

The special exception for small residential lots, etc. is a system that reduces the valuation of land by 80%, significantly reducing inheritance taxes on the land. Basically, the land on which a decedent's residence is situated is eligible.

If a property is eligible for the special exception for small residential lots, etc., the owner can greatly reduce the valuation of the land their residence is located on, which tends to be highly valued. Today, more and more elderly people are entering nursing homes, so it is necessary to understand the applicable relationship.

Basically Applicable even if the Owner was in a Nursing Home

The special exception for small building lots, etc., applies to a house, etc. that was used as the residence of a decedent, etc. (including relatives living with them) immediately prior to the commencement of inheritance.

The same residential land, etc. includes residential land, etc. used as the site of a house (owned by the decedent, etc.) in which the decedent resided until immediately before it was no longer used for the decedent's residence as a result of admission to a nursing home. Therefore, even if the decedent died after entering a nursing home, the residential land, etc. of the house in which the decedent resided until immediately before it was no longer used for their residence is subject to this special exception.

On the Other Hand, If The House was Reconstructed

It is quite possible that the decedent's home may have deteriorated while the decedent was in the nursing home, and the family members who continue to reside in the home may reconstruct/rebuild the house. If the decedent did not live in the rebuilt house, and died while residing in the nursing home, there is some concern that the house would not qualify as a "house used for the decedent's residence" because it is physically different from the house in which the decedent resided before entering the nursing home.

Applicable Even if the Residence Is not Physically Identical

This special provision applies to residential land, etc. that was used for the decedent's residence immediately prior to the commencement of inheritance. Although this special provision applies only to "residential land, etc." that was used for the decedent's residence, it is not necessary that the residence where the decedent lived before they entered the nursing home, and the residence afterwards, to physically be the exact same residence. This special provision is a mechanism that takes into account the continuity of the family's residence after the decedent's death. It would not be in line with the purpose of the system to exclude heir(s) from using this exception simply because his/her home had been rebuilt. In addition, even if the decedent was not residing in the home immediately prior to the commencement of the inheritance while it was being rebuilt, the property is treated as if the decedent had resided in the house. So their heir(s) are allowed to apply for this special exception.

Regarding the Residential Site If Rebuilding Was Done After the Decedent’s Admission to a Nursing Home

From this perspective, even if a residence is rebuilt after the decedent’s admission to a nursing home and ultimately the decedent did not reside in the rebuilt home, the site of the residence would fall under the category of "residential land, etc. used for the decedent's residence immediately before the commencement of inheritance”, and would be eligible for this special exception.

Therefore, if the spouse of the decedent, or a "relative who lived together in the decedent's home”, etc., who meets certain requirements, acquires the residential land, etc. of the home by inheritance or other means, it will fall under "residential land for specified residential use, etc.”, and this special provision can be applied.

Preparation of Procedures and Documents

In many cases, to prove that the decedent was admitted to a nursing home, an occupancy agreement, receipts from the facility, etc. are prepared. In addition, if the construction contract, design drawings, and certificate of registered matters of the building are kept as documents to support the history of the reconstruction of the house, it will be easier to claim the application of the special exception when filing inheritance tax returns. It should be noted that certain other requirements may be necessary regarding the nursing home resident and the heirs themselves. Make sure to check the requirements in advance, and prepare the necessary documents.