foreign corporation and Non-resident When such a person conducts business in Japan,whether Japan can tax the business profits through tax return filingfirst depends on whether there is a permanent establishment in Japan. This is a foundational concept in international taxation.

Permanent Establishment is abbreviated as PE .

However, No PE Does Not Mean No Japanese Tax.There is income taxable domestic source income regardless of whether a PE exists(Article 164 of the Income Tax Act and Article 141 of the Corporation Tax Act).

Moreover, some income is fully dealt with through withholding, while other incomerequires a tax return even after withholding. The statute determines this by income type. For example, rental consideration for Japanese real estate and consideration for transfers of land in Japan remain subject to aggregate taxation without a PE (Articles 164(1)(ii) and 161(1)(v) and (vii) of the Income Tax Act).Treating Withholding as the End of the Matter Can Result in Failure to File.

PE status primarily determines the scope of tax return-based taxation of business profits.

Statutory definition

Article 2, paragraph (1), item (viii)-4, of the Income Tax Act. Article 2, item (xii)-19, of the Corporation Tax Act uses substantially the same wording, restricted to foreign corporations.

Permanent establishment means the following. However, where a treaty concluded by Japan to avoid double taxation or prevent tax evasion on income contains different provisions, for non-residents or foreign corporations entitled to that treaty, it means an establishment defined as a permanent establishment under that treaty, limited to one situated in Japan.

(a) A branch, factory, or other fixed place of business of a non-resident or foreign corporation in Japan prescribed by Cabinet Order

(b) A construction or installation site, a place of related supervisory services, or equivalent prescribed by Cabinet Order, of a non-resident or foreign corporation in Japan

(c) A person in Japan authorized to conclude contracts on behalf of a non-resident or foreign corporation, or an equivalent person prescribed by Cabinet Order

Three Types

The Cabinet Order divides fixed-place PEs into places of management, branches, offices, factories, or workshops; mines, oil or gas wells, quarries, or other extraction sites; and other fixed places of business. The third category is a catch-all, so the definition is not limited to formally labeled branches.

Under domestic law, a construction PE covers worklasting more than one year. Where contracts are split into periods of one year or less,if avoiding PE status is recognized as a principal purpose of the splitting,the periods are aggregated (paragraph (3)). A proviso applies.

The First Point to Check: Treaties Take Priority over Domestic Law

The Proviso to the Definition Is the Most Important Part in Practice.

For persons entitled to the treaty, tax treaty if its provisions differ from domestic law, the treaty definition takes precedence.Eligibility for Treaty Benefits Is Itself a Separate Hurdle.

The Cabinet Order provisions above describe domestic law when no treaty applies. Treaty wording differs by country and generation. Some treaties use a different construction PE duration, and whether they have been modified by the MLI also varies.

Authentic treaty texts are available in the Ministry of Foreign Affairs treaty database. For post-MLI content, consult materials published by the Ministry of Finance.

PE Status Cannot Be Determined Until the Other Country Is Known.That is the starting point.

Preparatory and Auxiliary Activities Are Excluded

Even where a place exists, if its activities are onlypreparatory or auxiliarypreparatory or auxiliary to the business, it is excluded from PE status (Article 4-4(4) of the Corporation Tax Act Enforcement Order and Article 1-2(4) of the Income Tax Act Enforcement Order), unless the anti-fragmentation rules discussed below apply.

The statute lists facilities and stocks for storage, display, or delivery, and places used solely for purchasing or collecting information, but the introductory proviso limits the exclusion to activities of a preparatory or auxiliary character.Falling Within the List Is Necessary but Not Sufficient for Exclusion.

Paragraph (5) also prevents dividing activities among multiple places or related persons to make each appear preparatory or auxiliary.

Points that require care in practice

Several Issues Cannot Be Resolved by Reading the Statute Alone. Common Examples Follow.

• Is a Warehouse a PE?Storage-only facilities are listed for exclusion, but whether the activities are merely preparatory or auxiliary is a separate question.
• Is a Subsidiary a PE?Being a separate legal entity and constituting a parent's PE are separate questions. Employees' activities and use of the subsidiary's office matter.
• Is a Sales Agent a PE?Independent agents acting in the ordinary course are excluded, but the exclusion has a proviso.
• Is a Representative Office a PE?An office limited to liaison and information gathering may qualify for exclusion, but actual activities determine the result.
• Can a Remote Employee Create a PE?Whether the home is a fixed place of business is one issue. If the employee is involved in concluding contracts, a separate agency PE issue also arises.
• What If Construction Looks Likely to Exceed One Year?Check the treaty's duration threshold first.

Each of theseThe Issue Is How the Statutory Wording Applies. A determination requires both the facts and the treaty terms.

If a PE Is Found to Exist, Filing Obligations Arise for Domestic-Source Income Including PE-Attributable Income, and Tax May Be Assessed Retroactively.Consult us before acting where the position is uncertain.

Legal basis

• Article 2, Paragraph (1), Item (viii)-4, of the Income Tax Act (Definitions)
• Article 2, Item (xii)-19, of the Corporation Tax Act (Definitions)
• Article 1-2 of the Order for Enforcement of the Income Tax Act (Scope of Permanent Establishments)
• Article 4-4 of the Corporation Tax Act Enforcement Order (Scope of Permanent Establishments)
• Article 161(1) of the Income Tax Act and Article 138(1) of the Corporation Tax Act (Domestic-Source Income)
• Income Tax Act, Article 164 (Methods of Taxation of Nonresidents)
• Article 141 of the Corporation Tax Act (Tax Base)
• Permanent establishment provisions of the relevant tax treaties

An individual determination requires review of the treaty with the other country and the actual activities.