Statutory definition

Article 228-2 of the Income Tax Act provides as follows:

...the stock company that issued or allotted [the stock acquisition rights] shall, pursuant to the provisions of Order of the Ministry of Finance, submit a written statement concerning the exercise of the stock acquisition rights by the individual or corporation that exercised them to the district tax office director by January 31 of the year following the year that includes the date of said exercise.

This provision obligates stock companies that have issued or allotted certain types of stock acquisition rights, such as those with favorable terms, to submit a statutory record (record concerning the exercise of stock acquisition rights) regarding individuals or corporations that have exercised such rights.

Overview

Which stock acquisition rights are subject to the return?

The scope of share options "specified by Cabinet Order" referred to in Article 228-2 of the Income Tax Act is provided for in Article 354 of the Order for Enforcement of the Income Tax Act.

The stock acquisition rights specified by Cabinet Order provided for in Article 228-2 (Records on Exercise of Stock Acquisition Rights) of the Act shall be the following stock acquisition rights:

• such stock acquisition rights under conditions or for an amount that are particularly favorable to the persons subscribing for them
• Stock acquisition rights to be issued or allotted as all or part of the consideration pertaining to the provision of services or other acts (excluding those falling under the preceding item).

There are two types: those considered to be particularly favorable conditions or amounts for persons subscribing to stock acquisition rights, and those considered to be consideration pertaining to the provision of services or other acts. The person required to submit and the submission deadline are as set forth in the wording of Article 228-2 shown in the definition of the provisions.

How is the value per share calculated?

Article 354 of the Order for Enforcement of the Income Tax Act defines not only the scope of the stock acquisition rights subject thereto, but also the scope of the "issuance or allotment specified by Cabinet Order" referred to in Article 228-2 of the Income Tax Act.

The issuance or allotment specified by Cabinet Order provided for in Article 228-2 of the Act shall be the issuance or allotment of share options in cases where the amount calculated by dividing the sum of the amount to be paid in by means of monies pertaining to the issuance or allotment of share options provided for in the same Article and the amount to be paid in upon the exercise of such share options by the number of shares to be delivered upon the exercise of such share options is less than the amount equivalent to the value per share of the stock of the stock company that issued or allotted such share options at the time of the resolution provided for in the same Article pertaining to the issuance or allotment of such share options.

Regarding the calculation method for the "value per share" to be compared with this calculated amount, Income Tax Basic Directive 23–35 Common-9 (Note) stipulates as follows:

This treatment shall apply mutatis mutandis to the "value per share of the stock of the stock company that issued or allotted the said share options" prescribed in Article 354, paragraph 2 ((Records Concerning Exercise of Share Options)) of the Cabinet Order.

For specific valuation methods depending on whether shares are listed, whether different classes of shares have been issued, and other factors, see Stock Option Exercise Prices and Share Valuation.

What happens in the case of tax-qualified stock options?

Regarding the treatment when shares are acquired under the application of Article 29-2 of the Act on Special Measures Concerning Taxation, Article 19-3 of the Order for Enforcement of the Act on Special Measures Concerning Taxation stipulates as follows:

Where an individual has acquired shares through the exercise of share options by taking advantage of the application of the provisions of the main clause of Article 29-2, Paragraph 1 of the Act, the provisions of Article 228-2 of the Income Tax Act pertaining to the exercise of such share options shall not apply to the stock corporation that made the book-entry transfer or delivery of such shares.

The exclusion from application is limited to "the portion relating to the exercise of the relevant share options." Apart from this, Article 29-2 of the Act on Special Measures Concerning Taxation establishes the following obligation for stock companies that have granted specified share options to submit reports based on the grant:

A stock company that grants specified stock acquisition rights to directors, etc., successors by right of inheritance, or specified workers pursuant to a contract based on a resolution of grant shall, as provided by Cabinet Order, submit a written report concerning the grant of such specified stock acquisition rights (hereinafter referred to in this Article as the "written report concerning the grant of specified stock acquisition rights") to the district tax office director by January 31 of the year following the year that includes the date of the grant.

Where is the withholding obligation for employment income located?

The obligation to withhold income tax on employment income is set forth in Article 183 of the Income Tax Act.

A person who pays salary, etc. (hereinafter referred to as "salary, etc." in this Chapter) prescribed in Article 28, paragraph (1) (earned income) within Japan to a resident shall, at the time of the payment, collect income tax on that salary, etc. and pay it to the State by the tenth day of the month following the month that includes the date of the collection.

Regarding tax withholding when the economic benefits derived from the exercise of non-tax-qualified stock options are classified as employment income, the National Tax Agency's Q&A explains as follows:

Regarding non-tax-qualified stock options (free issuance/favorable issuance type or trust type), when shares are delivered through the exercise of the stock options, it is necessary to withhold income tax related to employment income and pay it to the competent tax office of the taxpayer's jurisdiction.

The National Tax Agency's Q&A explains the treatment in cases where it is later discovered that the issuing company did not pay withholding income tax and decides not to seek reimbursement from the target person as follows:

“... (where reimbursement will not be sought), a benefit has been conferred. At the time of that decision, an additional payment of salary or remuneration is deemed to have been made with an after-tax net amount equal to the tax in question. Withholding income tax on the amount deemed paid must therefore be calculated by grossing up (Income Tax Basic Circular 221-1 and 181–223 Common-4).”

Regarding cases where withholding income tax cannot be paid in a lump sum, the National Tax Agency's Q&A explains as follows:

In addition, if you are unable to pay withholding income tax in a lump sum, by applying to the tax office, tax payment may be deferred, in principle, for a period of up to one year.

On the other hand, regarding the income classification when granted based on a contracting agreement or other similar agreements, the National Tax Agency's Q&A explains as follows:

Economic benefits pertaining to stock options granted as consideration for the provision of services based on an outsourcing contract or other similar contracts shall be classified as business income or miscellaneous income. Furthermore, in cases where the economic benefits pertaining to said stock options fall under remuneration, fees, etc., prescribed in Article 204 of the Income Tax Act, they shall be subject to withholding tax.

For the distinction between employment income, business income, and miscellaneous income, see Taxation of Non-Tax-Qualified Stock Options.

What happens when making payments to a non-resident or foreign corporation

If the person who exercised the right is a non-resident or a foreign corporation, the provisions concerning the obligation to withhold tax are set forth in Article 212 of the Income Tax Act.

A person who makes a payment within Japan of domestic source income (excluding those specified by Cabinet Order) listed in Article 161, paragraph 1, items 4 to 16 (Domestic Source Income) to a non-resident, or a person who makes a payment within Japan of domestic source income listed in items 4 to 11 or items 13 to 16 of the same paragraph to a foreign corporation, must withhold income tax on such domestic source income at the time of the payment and pay it to the national government by the tenth day of the month following the month that includes the date of the withholding.

Article 161 of the Income Tax Act defines the scope of Japan-source income. For details, see What Is Japan-Source Income?. Specific treatment is discussed in Non-Residents, Departure from Japan, and Stock Options.

Points that require care in practice

• To determine how to calculate the "value per share" referred to in Article 354 of the Order for Enforcement of the Income Tax Act in individual cases, it is necessary to check the nature of the shares, such as whether the target shares are listed or if class shares have been issued, based on the mutatis mutandis application of Income Tax Basic Directive 23–35 Common-9 (Note).
• The scope of exclusion from application under Article 19-3 of the Order for Enforcement of the Act on Special Measures Concerning Taxation is limited to the "portion pertaining to the exercise of the relevant stock acquisition rights." The relationship with the separate reporting obligation based on the grant, established under Article 29-2 of the Act on Special Measures Concerning Taxation, must be checked on a case-by-case basis.
• Whether it constitutes employment income or is subject to withholding income tax under Article 204 of the Income Tax Act as remuneration or fees depends on the nature of the contractual relationship that served as the basis for the grant. This determination itself is not covered in this article.

Legal basis

• Article 228-2 of the Income Tax Act (Records on the Exercise of Share Acquisition Rights) / Quoted text: "...a stock company that has issued or allotted [such rights] shall, when the said issued or allotted share acquisition rights have been exercised, pursuant to the provisions of Ordinance of the Ministry of Finance, submit a record regarding the exercise of the said share acquisition rights by the individual or corporation that made the exercise to the district tax director by January 31 of the year following the year that includes the date of the exercise."
• Article 354, Paragraph 1, Pre-amble of the Income Tax Act Enforcement Order (Written Report on the Exercise of Stock Acquisition Rights) / Cited wording: "The stock acquisition rights specified by Cabinet Order prescribed in Article 228-2 of the Act (Written Report on the Exercise of Stock Acquisition Rights) shall be the stock acquisition rights listed as follows."
• Article 354, Paragraph 1, Item 1 of the Order for Enforcement of the Income Tax Act (Written Report on Exercise of Stock Acquisition Rights) / Quoted wording: "said stock acquisition rights for which the conditions or amount are deemed to be particularly favorable to the person subscribing to the stock acquisition rights"
• Article 354, Paragraph 1, Item 2 of the Order for Enforcement of the Income Tax Act (Written Statement Concerning the Exercise of Stock Acquisition Rights) / Quoted text: "Stock acquisition rights to be issued or allotted as all or part of the consideration pertaining to the provision of services or other acts (excluding those falling under the preceding item)."
• Article 354, Paragraph 2 of the Order for Enforcement of the Income Tax Act (Written Notice Concerning Exercise of Share Options) / Quoted text: "The issuance or allotment specified by Cabinet Order prescribed in Article 228-2 of the Act shall be the issuance or allotment of share options in cases where the amount calculated by dividing the total of the amount to be paid in by means of monies pertaining to the issuance or allotment of the share options prescribed in the same Article and the amount to be paid in upon the exercise of the said share options by the number of shares to be delivered as a result of the exercise of the said share options is less than the amount equivalent to the value per share of the stock of the stock company that issued or allotted the said share options at the time of the resolution prescribed in the same Article pertaining to the issuance or allotment of the said share options."
• Article 19-3, Paragraph 36 of the Order for Enforcement of the Act on Special Measures Concerning Taxation (Non-Taxation, etc. of Economic Benefits Pertaining to Acquisition of Shares through Exercise of Stock Options Granted to Certain Directors, etc.) / Quoted text: "Where an individual has acquired shares through the exercise of stock options by applying the provisions of the main text of Article 29-2, Paragraph 1 of the Act, the provisions of Article 228-2 of the Income Tax Act pertaining to the exercise of such stock options shall not apply to the stock company that made the book-entry transfer or issuance of such shares."
• Article 29-2, Paragraph 6 of the Act on Special Measures Concerning Taxation (Non-Taxation, etc. of Economic Benefits Pertaining to Acquisition of Shares through Exercise of Stock Acquisition Rights Received by Specific Directors, etc.) / Quoted text: "A stock company that grants specified stock acquisition rights to a director, etc., a right-succeeding heir, or a specified worker pursuant to a contract based on a grant resolution shall, pursuant to the provisions of Cabinet Order, submit a written report on the grant of said specified stock acquisition rights (hereinafter referred to as a "written report on the grant of specified stock acquisition rights" in this Article) to the district director of the tax office by January 31 of the year following the year that includes the date on which the grant was made."
• Article 183, Paragraph 1 of the Income Tax Act (Obligation to Withhold Income Tax) / Quoted text: "A person who pays residents within Japan remuneration, etc. provided for in Article 28, Paragraph 1 (earned income) (hereinafter referred to as 'remuneration, etc.' in this Chapter) shall, at the time of the payment, withhold income tax from that remuneration, etc., and pay it to the State no later than the tenth day of the month following the month that includes the date of the withholding."
• Article 212, Paragraph 1 of the Income Tax Act (Obligation to Withhold Income Tax) / Quoted text: "A person who pays domestic source income listed in Article 161, Paragraph 1, Items 4 to 16 (Domestic Source Income) (excluding those specified by a Cabinet Order) within Japan to a non-resident, or a person who pays domestic source income listed in Items 4 to 11 or Items 13 to 16 of the same paragraph within Japan to a foreign corporation... shall, at the time of the payment, withhold income tax on such domestic source income and pay it to the State no later than the tenth day of the month following the month that includes the date of the withholding."

Relevant administrative guidance, Q&A, and cases

• Basic Income Tax Directive 23–35 Common-9 (Value of Shares under the Main Text of Article 84, Paragraph 3 of the Order) / Cited wording: "This treatment shall apply mutatis mutandis to 'the value per share of the stock of the stock company that issued or allotted the stock acquisition rights' prescribed in Article 354, Paragraph 2 ((Statement on the Exercise of Stock Acquisition Rights)) of the Order."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Question 4 / Quoted text: "For tax-unqualified stock options (free-of-charge/favorable issuance type or trust type), upon the delivery of shares through the exercise of stock options, it is necessary to withhold income tax related to employment income and pay it to the competent district tax office having jurisdiction over the taxpayer's location."
• National Tax Agency, "Taxation of Stock Options (Q&A)", November 2024 Final Revision, Question 4 / Quoted text: "...(if it is decided not to seek reimbursement), it results in the provision of a benefit, and at the time such decision not to seek reimbursement is made, it shall be deemed that an additional payment of salary or remuneration has been made in an after-tax net amount equivalent to that tax amount, and withholding income tax pertaining to the amount deemed to have been paid shall be calculated (gross-up calculation) (Income Tax Basic Directive 221-1, Income Tax Basic Directive 181-223 Common-4)."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 Latest Revision, Question 4 / Quoted text: "If withholding income tax cannot be paid in a lump sum, by applying to the tax office, tax payment postponement, etc., may be granted for a period generally within one year, in principle."
• National Tax Agency "Taxation on Stock Options (Q&A)", November 2024 Revised Edition, Common Preamble (Note 2) to Questions 1, 2, 3, and 6 / Quoted text: "Economic benefits related to stock options granted as consideration for the provision of services based on a contracting agreement or other similar agreements are classified as business income or miscellaneous income. In addition, if the economic benefits related to those stock options fall under remuneration, fees, etc., prescribed in Article 204 of the Income Tax Act, they shall be subject to withholding tax."