Statutory definition

Where a domestic corporation receives the provision of services from an individual, and where a restricted stock option (meaning a stock option subject to restrictions on transfer or other conditions, as specified by Cabinet Order; hereinafter the same shall apply in this paragraph) that meets the following requirements (hereinafter referred to as a "specified stock option" in this Article) is granted with respect to the amount of expenses pertaining to the provision of such services (...) on the day on which an event arises whereby the amount that should be included in the amount of revenue pertaining to employment income or other income specified by Cabinet Order as prescribed in the Income Tax Act of said individual or the amount that should be included in the gross revenue arises for said individual pursuant to the provisions of the Income Tax Act and other laws and regulations concerning income tax with respect to the provision of such services (referred to as an "employment income, etc. taxation event" in the following paragraph), the provisions of this Act shall apply on the presumption that the provision of such services has been received on that day.

Article 54-2 of the Corporation Tax Act provides that where a domestic corporation receives services from an individual and specified stock acquisition rights are granted in respect of the cost, the services are treated as received on the date a taxable event relating to employment income or other specified income occurs. The deduction is thus deferred from the grant date to the date of that taxable event. The individual’s income classification is discussed in Taxation of Non-Tax-Qualified Stock Options; this article focuses on the deduction available to the issuing company.

Overview

What is a "specified share acquisition right" and what is a "restricted share acquisition right"?

Article 54-2 of the Corporation Tax Act refers to stock acquisition rights subject to the special exception for inclusion in deductible expenses as "specified stock acquisition rights," and stipulates that they must meet the following requirements: "that payment in exchange for the said restricted stock acquisition rights is offset by a claim generated by the said individual as consideration for the provision of the said services." "In addition to what is listed in the preceding item, that the said restricted stock acquisition rights are recognized as substantially being consideration for the provision of the said services." The latter is structured to catch cases other than the former by stating "in addition to what is listed in the preceding item," and does not require the fulfillment of both.

The scope of the prerequisite "stock acquisition rights with transfer restrictions" is defined by Article 111-3 of the Ordinance for Enforcement of the Corporation Tax Act: "The stock acquisition rights specified by Cabinet Order provided for in Article 54-2, Paragraph 1 of the Act (Special Provisions on the Business Year of Attribution of Expenses Involving Stock Acquisition Rights as Consideration, etc.) shall be those subject to restrictions on the transfer of rights and other special conditions prescribed in Article 84, Paragraph 3 of the Ordinance for Enforcement of the Income Tax Act (Value of Shares with Transfer Restrictions, etc.)." The same article does not define the contents itself, but outlines the scope by referencing Article 84 of the Ordinance for Enforcement of the Income Tax Act.

If a taxable event regarding salary or the like does not occur for the individual, what happens to the issuing company's expenses?

Article 54-2 of the Corporation Tax Act provides as follows: "In the case prescribed in the preceding paragraph, if a taxable event relating to salaries, etc. does not occur with respect to the individual referred to in the same paragraph regarding the provision of services referred to in the same paragraph, the amount of expenses incurred by the domestic corporation receiving the provision of such services resulting from the receipt of the provision of such services or the amount of loss resulting from being unable to receive all or part of the provision of such services shall not be included in the amount of deductible expenses in the calculation of the amount of income of the domestic corporation for each business year." Whether or not a taxable event relating to salaries, etc. occurs determines the deductibility itself.

The same article continues, "In the case prescribed in the preceding paragraph, when a specified stock option (including a succeeded stock option) is extinguished, the amount of profit resulting from such extinction shall not be included in the amount of gross revenue in calculating the amount of income for each business year of the corporation that issued these stock options," for cases where tax events regarding salaries, etc., do not occur.

Do stock options for corporate officers fall under Article 34 of the Corporation Tax Act first?

When the recipient of specified stock acquisition rights is an officer, the framework of Article 34 of the Corporation Tax Act applies. This Article treats officer compensation that does not fall under certain categories as non-deductible in calculating the amount of income, and lists as one of those categories "compensation provided based on a provision to the effect that, at a prescribed time for the duties of that officer, money in a determined amount, shares (including contributions; hereinafter the same applies in this paragraph and paragraph (5)) or stock acquisition rights in a determined number, or specified restricted shares prescribed in Article 54, paragraph (1) (Special Provisions on Business Year of Attribution of Expenses with Restricted Shares as Consideration) or specified stock acquisition rights prescribed in Article 54-2, paragraph (1) (Special Provisions, etc., on Business Year of Attribution of Expenses with Stock Acquisition Rights as Consideration) pertaining to monetary claims in a determined amount are to be delivered, which falls under neither regular fixed-amount compensation nor performance-linked compensation," and also defines performance-linked compensation as "performance-linked compensation prescribed in paragraph (1) means compensation in money, shares, or stock acquisition rights in an amount or number calculated on the basis of indicators of profits, share market prices, or other indicators of the performance of the domestic corporation referred to in that paragraph or a corporation having a control relationship with it; and compensation in specified restricted shares or successor restricted shares prescribed in Article 54, paragraph (1), or specified stock acquisition rights or successor stock acquisition rights prescribed in Article 54-2, paragraph (1), where the number of shares or stock acquisition rights acquired without consideration or extinguished varies for reasons other than the period of service." Compensation by means of specified stock acquisition rights may also fall under this category of performance-linked compensation.

Article 71-3 of the Ordinance for Enforcement of the Corporation Tax Act provides, "excluding salaries paid through specified restricted stock or succeeding restricted stock prescribed in Article 54, paragraph (1) of the Act (Special Provisions on Business Years for Attribution of Expenses Incurred as Restricted Stock) or specified share options or succeeding share options prescribed in Article 54-2, paragraph (1) of the Act (Special Provisions on Business Years for Attribution of Expenses Incurred as Share Options, etc.)," thereby excluding salaries paid through specified share options.

Why are shares (Article 54) and share options (Article 54-2) in separate articles?

When shares are delivered, Article 54 of the Corporation Tax Act applies, and when share acquisition rights are delivered, Article 54-2 of the same Act applies. While their structures are parallel, there are differences in terminology. Article 54 of the Corporation Tax Act provides that "the application of the provisions of this Act shall be made on the assumption that the provision of such services was received on the date when it is determined that the amount to be included in the revenue amount pertaining to the amount of employment income or other income specified by Cabinet Order prescribed in the Income Tax Act, or the amount to be included in the gross revenue amount (referred to as the 'taxable employment income, etc.' in the following paragraph and paragraph (3)), will arise with respect to the said individual pursuant to the provisions of the Income Tax Act and other laws and regulations relating to income tax," and uses the date on which it is determined that the "taxable employment income, etc." will arise as the benchmark.

In contrast, the standard stipulated for share acquisition rights under Article 54-2 of the Corporation Tax Act is, as mentioned above, the "date on which the grounds for taxation pertaining to salaries, etc., occurred." Article 54, which is based on the "date on which the amount of taxation pertaining to salaries, etc., is determined to have arisen," and Article 54-2, which is based on the "date on which the grounds for taxation pertaining to salaries, etc., occurred," differ in both terminology and reference dates.

How do tax-qualified stock options relate to the issuing company's tax deductions?

Article 29-2 of the Act on Special Measures Concerning Taxation provides for tax-qualified stock options ("specified stock acquisition rights" under the same Article) as follows: "If a person acquires shares pertaining to said specified stock acquisition rights by exercising said stock acquisition rights in accordance with the contract pertaining to said stock acquisition rights (limited to those in which the following requirements are specified in the contract pertaining to said stock acquisition rights (or the requirements listed in items 1 to 6 inclusive, in cases where said stock acquisition rights were granted to said directors, etc.); hereinafter referred to as 'specified stock acquisition rights' in this Article), income tax shall not be imposed on the economic benefits pertaining to the acquisition of said shares." This is a provision stipulating that income tax "shall not be imposed" on the individual who is the holder of the rights.

Article 54-2 of the Corporation Tax Act, by contrast, determines whether and when an expense is deductible by reference to whether a “taxable event relating to employment income or other specified income” occurs for the individual. These provisions belong to different statutes and have distinct requirements. Their definitions of “specified stock acquisition rights” are also separate. For tax-qualification requirements, see What Are Tax-Qualified Stock Options?.

Points that require care in practice

• Whether the issued stock acquisition rights fall under "being recognized as substantially consideration for the provision of such services" is not determined by an enumerated list of criteria in the statutory provisions, but rather depends on a review of the circumstances surrounding the issuance and the contents of the contract.
• The date of the “taxable event relating to employment income or other specified income” must be checked together with the income-recognition rules under the Income Tax Act. For treatment at exercise and transfer, see When Are Stock Options Taxed?.
• The determination of whether the requirements of Article 29-2 of the Act on Special Measures Concerning Taxation are met and the determination of whether expenses are deductible based on Article 54-2 of the Corporation Tax Act are separate and must be confirmed in light of the respective provisions.

Legal basis

• Article 54-2, Paragraph 1 of the Corporation Tax Act (Special Provisions, etc., on the Business Year for Attribution of Expenses Compensated by Stock Acquisition Rights) / Quoted text: "Where a domestic corporation receives the provision of services from an individual, and with respect to the amount of expenses pertaining to the provision of such services, restricted stock acquisition rights (meaning stock acquisition rights subject to restrictions on transfer or other conditions, specified by Cabinet Order; hereinafter the same shall apply in this paragraph) that fall under any of the following requirements (hereinafter referred to as 'specified stock acquisition rights' in this Article) are delivered (...), the provisions of this Act shall apply on the premise that the provision of such services was received on the day on which an event arises for the individual whereby the amount to be included in the revenue amount pertaining to the amount of employment income or other income specified by Cabinet Order prescribed in the Income Tax Act of said individual or the amount to be included in the gross revenue amount pursuant to the provisions of the Income Tax Act and other laws and regulations relating to income tax arises with respect to the provision of such services (referred to as a 'taxable event for employment income, etc.' in the following paragraph)." "Offsetting being made by using a claim arising for said individual as consideration for the provision of said services in lieu of payment in exchange for said restricted stock acquisition rights." "In addition to what is listed in the preceding item, said restricted stock acquisition rights are substantially recognized as consideration for the provision of said services."
• Article 54-2, Paragraph 2 of the Corporation Tax Act (heading same as above) / Cited text: "In the case prescribed in the preceding paragraph, if no salary, etc., taxation event occurs for the individual referred to in that paragraph with respect to the provision of services referred to in that paragraph, the amount of expenses incurred by the domestic corporation receiving the provision of such services as a result of receiving the provision of such services, or the amount of loss resulting from the inability to receive all or part of the provision of such services, shall not be included in the amount of deductible expenses in the calculation of the amount of income of the domestic corporation for each business year."
• Article 54-2, Paragraph 3 of the Corporation Tax Act (Heading: same as above) / Quoted text: "In the case prescribed in the preceding paragraph, if specified share options (including succeeded share options) have been extinguished, the amount of profit resulting from such extinguishment shall not be included in the amount of gross revenue in the calculation of the amount of income for each business year of the corporation that issued those share options."
• Article 111-3, Paragraph 1 of the Order for Enforcement of the Corporation Tax Act (Scope of Stock Acquisition Rights with Transfer Restrictions, etc.) / Quoted text: "The stock acquisition rights specified by Cabinet Order provided for in Article 54-2, Paragraph 1 of the Act (Special Provisions, etc., Concerning the Business Year of Attribution of Expenses with Stock Acquisition Rights as Consideration) shall be those subject to restrictions on the transfer of rights and other special conditions provided for in Article 84, Paragraph 3 of the Order for Enforcement of the Income Tax Act (Value of Shares with Transfer Restrictions, etc.)."
• Article 54, Paragraph 1 of the Corporation Tax Act (Special Provisions for Fiscal Year of Attribution of Expenses with Restricted Stock as Consideration) / Cited text: "The provisions of this Act shall apply on the assumption that the services were received on the date on which it is determined that, for the said individual, an amount to be included in the revenue amount pertaining to employment income or other income specified by Cabinet Order prescribed in the Income Tax Act, etc. of the said individual pursuant to the provisions of the Income Tax Act and other laws and regulations relating to income tax, or an amount to be included in the gross revenue amount (referred to as 'taxable salary, etc. amount' in the following paragraph and paragraph 3), arises with respect to the provision of the said services."
• Article 34, Paragraph 1, Item 2 of the Corporation Tax Act (Non-Deductibility of Officers' Compensation) / Quoted wording: "compensation that is paid based on a provision to the effect that, for the officer's duties, money in a determined amount, a determined number of shares (including equity investments; hereinafter the same shall apply in this paragraph and paragraph 5) or share options, or specified restricted shares prescribed in Article 54, Paragraph 1 (Special Provisions for Business Years for Inclusion in Expenses of Expenses Involving Restricted Shares as Consideration) pertaining to monetary claims in a determined amount or specified share options prescribed in Article 54-2, Paragraph 1 (Special Provisions for Business Years for Inclusion in Expenses of Expenses Involving Share Options as Consideration, etc.) shall be delivered at a prescribed time, and which does not fall under either regular fixed-amount compensation or performance-linked compensation"
• Article 34, Paragraph 5 of the Corporation Tax Act (Non-Inclusion in Deductible Expenses of Executive Compensation) / Quoted text: "Performance-linked compensation provided for in Paragraph 1 means compensation in the form of money, shares, or stock acquisition rights, calculated or determined based on indicators showing profit conditions, indicators showing market price conditions of shares, or other indicators showing the business performance of the domestic corporation under the same paragraph or a corporation having a control relationship with said domestic corporation, as well as compensation in the form of specified restricted shares or succession restricted shares provided for in Article 54, Paragraph 1, or specified stock acquisition rights or succession stock acquisition rights provided for in Article 54-2, Paragraph 1, in which the number of shares or stock acquisition rights acquired without compensation or extinguished fluctuates due to reasons other than the period of service."
• Article 71-3, Paragraph 1 of Japan's Order for Enforcement of the Corporation Tax Act (Amount of Expenses, etc. Related to Remuneration Paid Based on Provisions to Deliver a Determinate Number of Shares) / Cited text: "excluding remuneration by means of specified restricted stock or succeeding restricted stock prescribed in Article 54, Paragraph 1 of the Act (Special Provisions for Business Year of Attribution of Expenses with Restricted Stock as Consideration) or specified share acquisition rights or succeeding share acquisition rights prescribed in Article 54-2, Paragraph 1 of the Act (Special Provisions, etc. for Business Year of Attribution of Expenses with Share Acquisition Rights as Consideration)"
• Act on Special Measures Concerning Taxation, Article 29-2(1), main clause (Exemption, etc. from income tax on economic benefits arising from shares acquired through exercise of stock acquisition rights granted to certain directors and others). Quoted text: “If shares relating to the specified stock acquisition rights are acquired through exercise of those stock acquisition rights (limited to rights whose agreement stipulates the following requirements, or requirements in items (i) through (vi) where the rights are granted to the director or other eligible person; hereinafter in this Article referred to as ‘specified stock acquisition rights’) in accordance with that agreement, income tax is not imposed on the economic benefit arising from the acquisition of those shares.”