The term “employee shareholding association” itself appears in neither the Income Tax Act nor its Enforcement Order. Article 25-10-2 of the Order for Enforcement of the Act on Special Measures Concerning Taxation, however, defines a “shareholding association agreement” in its specified-account provisions. Here, the term is used as a common name for arrangements through which employees contribute funds to hold shares in the issuing company collectively.

Statutory definition

“A shareholding association agreement concluded by a resident or a nonresident with a permanent establishment (meaning an agreement under which officers (as defined in Article 2(xv) of the Corporation Tax Act; the same applies in the following item), employees and other persons prescribed by Ministry of Finance Order of a company issuing listed shares, etc. (hereinafter ‘employees, etc.’ in this item), together with other employees, etc. of that company, undertake to purchase its listed shares, etc. continuously under a specified plan without individual investment decisions).”

Article 25-10-2 defines “shareholding association agreement” in provisions governing acceptance of listed shares, etc. into specified accounts. Neither the Income Tax Act nor its Enforcement Order defines “employee shareholding association” or “shareholding association agreement”; this definition is confined to the specified-account context.

Overview

What legal form does an employee shareholding association take?

No tax provision directly determines the legal nature of an employee shareholding association itself. If the relationship among employee members constitutes a Civil Code partnership, the Civil Code provides: “A partnership agreement takes effect when each party promises to contribute and conduct a joint business,” and “Contributions may consist of labor.” For taxation of members where an employee shareholding association is formed as a Civil Code partnership, see Taxation of Civil Code Partnerships. The association's actual legal form depends on its rules.

Are company incentive contributions taxable?

Where a company contributes incentives or other amounts for employees belonging to a shareholding association, whether they constitute taxable revenue is a question under the general provisions of Income Tax Act Articles 28 and 36, rather than rules specific to shareholding associations. Article 36 states: “Unless otherwise provided, the amount to be treated as revenue or included in gross revenue in calculating each category of income for a year shall be the amount receivable in that year (where received in property other than money, rights or other economic benefits, the value of that property, rights or benefits).” Article 28 defines employment income as quoted above. This article does not apply those provisions to determine whether particular incentives constitute revenue or salaries, etc.

What happens when shares are acquired below market value?

Among acquisitions through employee shareholding associations, the statutory provision concerns calculation of revenue where certain rights are granted by the issuer. Article 84 of the income tax Order provides: “Where the issuing corporation grants rights listed in the following items that carry transfer restrictions or other special conditions (excluding grants in the capacity of shareholder, etc., limited to cases considered unlikely to harm other shareholders, etc. of the issuer), the value under Article 36(2) of the Act relating to those rights shall be the value of the shares acquired through exercise on the exercise date (...) less the amount specified in the relevant item.” Where a granted right to acquire shares is exercised and “the amount payable for the shares is favorable (excluding rights listed in the preceding two items),” the deduction is “the acquisition cost of the rights exercised plus the amount payable upon exercise.” The parenthetical exclusion for grants “in the capacity of shareholder, etc.” applies only where harm to other shareholders, etc. is considered unlikely. Its application to acquisitions through employee shareholding associations requires examination of the statutory wording.

What constitutes a “favorable amount”?

Income Tax Basic Circular 23–35 Common-7 explains Article 84's phrase “where the amount payable for the shares is favorable”: “The phrase in Article 84(3)(iii) of the Order means an amount below a value considered reasonable under generally accepted standards relative to the value of the issuer's shares under the circumstances on the date the payment amount is determined.” Note 1 states: “Whether the amount is below a value considered reasonable under generally accepted standards shall be determined by whether the difference between the share value and the amount payable for the shares is approximately 10% or more of the share value.”

How are dividends received through the association treated?

There is no primary source directly prescribing the income category for employee members receiving dividends from surplus on shares held by the association. The Income Tax Act's dividend income provisions are in Article 24, which states: “Dividend income means income relating to dividends from surplus received from corporations (excluding public interest corporations, etc. prescribed in Article 2(vi) (Definitions) of the Corporation Tax Act and associations without legal personality, etc.) (limited to dividends relating to shares or capital contributions (...), excluding ...) ...”

Points that require care in practice

• Whether company incentive contributions constitute employment income under Article 28 requires applying the general statutory definition to the particular facts; this article does not undertake that application.
• How Article 84's parenthetical exclusion—“excluding grants in the capacity of shareholder, etc. (limited to cases considered unlikely to harm other shareholders, etc. of the issuer)”—applies to acquisitions through employee shareholding associations requires individual examination of the statutory wording.
• Whether an employee shareholding association is a Civil Code partnership depends on its actual rules. The original rules must be examined.

Legal basis

• Article 28, Paragraph 1 of the Income Tax Act (Employment Income) / Quoted text: “Employment income means income from salaries, pay, wages, annual allowances, bonuses, and remuneration of a similar nature (referred to in this Article as ‘salaries, etc.’).”
• Income Tax Act, Article 36(1) (Revenue) / Quoted wording: “Unless otherwise provided, the amount to be treated as revenue or included in gross revenue in calculating each category of income for a year shall be the amount receivable in that year (where received in property other than money, rights or other economic benefits, the value of that property, rights or benefits).”
• Order for Enforcement of the Income Tax Act, Article 84(3), introductory wording (Value of restricted shares, etc.) / Quoted wording: “Where the issuing corporation grants rights listed in the following items that carry transfer restrictions or other special conditions (excluding grants in the capacity of shareholder, etc., limited to cases considered unlikely to harm other shareholders, etc. of the issuer), the value under Article 36(2) of the Act relating to those rights shall be the value of the shares acquired through exercise on the exercise date (...) less the amount specified in the relevant item.”
• Order for Enforcement of the Income Tax Act, Article 84(3)(iii) (Value of restricted shares, etc.) / Quoted wording: “Rights to acquire shares where the amount payable for the shares is favorable (excluding rights listed in the preceding two items).” “The acquisition cost of the rights exercised plus the amount payable upon exercise.”
• Income Tax Act, Article 24(1) (Dividend income) / Quoted wording: “Dividend income means income relating to dividends from surplus received from corporations (excluding public interest corporations, etc. prescribed in Article 2(vi) (Definitions) of the Corporation Tax Act and associations without legal personality, etc.) (limited to dividends relating to shares or capital contributions (...), excluding ...) ...”
• Civil Code, Article 667 (Partnership agreements) / Quoted wording: “A partnership agreement takes effect when each party promises to contribute and conduct a joint business.” “Contributions may consist of labor.”
• Order for Enforcement of the Act on Special Measures Concerning Taxation, Article 25-10-2(14)(xxiii) (Special provisions for calculating income, etc. from transfers, etc. of listed shares, etc. held in specified accounts) / Quoted wording: “A shareholding association agreement concluded by a resident or a nonresident with a permanent establishment (meaning an agreement under which officers (as defined in Article 2(xv) of the Corporation Tax Act; the same applies in the following item), employees and other persons prescribed by Ministry of Finance Order of a company issuing listed shares, etc. (hereinafter ‘employees, etc.’ in this item), together with other employees, etc. of that company, undertake to purchase its listed shares, etc. continuously under a specified plan without individual investment decisions).”

Relevant administrative guidance, Q&A, and cases

• Income Tax Basic Circular 23–35 Common-7 (Where the amount payable for shares is favorable) / Quoted wording: “The phrase ‘where the amount payable for the shares is favorable’ in Article 84(3)(iii) of the Order means an amount below a value considered reasonable under generally accepted standards relative to the value of the issuer's shares under the circumstances on the date the payment amount is determined.” “Whether the amount is below a value considered reasonable under generally accepted standards shall be determined by whether the difference between the share value and the amount payable for the shares is approximately 10% or more of the share value.”