Statutory definition

Earned income means income pertaining to salaries, pay, wages, annual allowances, and bonuses, as well as salaries and wages of a similar nature (hereinafter referred to as "salaries and wages, etc." in this Article). (Article 28 of the Income Tax Act)

Regarding the economic benefits when shares are acquired by exercising a trust-type stock option, Question 3 of the National Tax Agency's "Taxation on Stock Options (Q&A)" explains that these are classified as employment income. The term "trust-type stock option" itself is not a term used in the statutory provisions, but rather a designation used in the National Tax Agency's Q&A.

Overview

How do trust-type stock options work?

Question 3 of the National Tax Agency's "Taxation of Stock Options (Q&A)" illustrates the mechanism of trust-type stock options using the following steps ① to ⑤ in an example.

• (1) The issuing company or the representative director, etc., of the issuing company entrusts money to a trust company to establish a trust (corporate taxation trust) (at the time of the establishment of the trust, there are no beneficiaries or deemed beneficiaries).
• (2) The trust company purchases the issuing company's transfer-restricted stock options at an appropriate fair market value (50).
• (3) The issuing company shall designate officers and employees who have contributed to the company during the trust period as beneficiaries of the trust, and grant the stock options managed as trust assets to such officers and employees.
• (4) Officers and employees shall acquire shares of the issuing company by exercising stock options.
• (5) Officers and employees shall sell the shares acquired by exercising stock options.

(National Tax Agency, "Taxation on Stock Options (Q&A)", Question 3)

Do tax implications arise when the trust purchases stock options and when officers and employees are designated as beneficiaries?

Please check the original documents published by the National Tax Agency regarding the tax implications of the trust creation itself (① above). Regarding ② and ③, the Q&A explains as follows:

If the trust company purchases the stock options at fair market value (50), no economic benefit arises, and therefore no tax liability is incurred. (National Tax Agency, "Taxation on Stock Options (Q&A)", Question 3)

No taxation arises regarding the economic benefits when an issuing company grants stock options managed as trust property by designating officers and employees as beneficiaries (Article 67-3, Paragraph 2 of the Income Tax Act). (National Tax Agency, "Taxation on Stock Options (Q&A)", Q3)

This ③ has the following note attached.

"Officers and employees shall take over the 50 borne by the trust at the time of purchase as the acquisition cost (Article 67-3, Paragraph 1 of the Income Tax Act)." (National Tax Agency, "Taxation on Stock Options (Q&A)", Question 3)

Why is the economic benefit at the time of exercise considered employment income?

Regarding the timing when officers and employees acquire shares by exercising stock options, the Q&A explains as follows:

When officers and employees exercise such stock options to acquire shares of the issuing company, the economic benefit is classified as employment income (Articles 28 and 36(2) of the Income Tax Act, and Article 84(3) of the Order for Enforcement of the Income Tax Act). (National Tax Agency, "Taxation on Stock Options (Q&A)," Question 3)

Regarding the reason for treating it as employment income, the Q&A presents two views side by side and clarifies that the latter is adopted.

While some argue that the economic benefits mentioned above do not constitute remuneration for services and are "not taxable as salary" due to reasons such as the trust granting stock options to executives and employees, or the trust acquiring stock options for value,
"In effect, due to reasons such as the issuing company granting stock options to its officers and employees, and the officers and employees bearing no financial burden, the above-mentioned economic benefit corresponds to consideration for labor services and 'is subject to taxation as salary.'" (National Tax Agency, "Taxation on Stock Options (Q&A)," Question 3 (Note 3))

For the method of valuing the shares acquired at exercise, see Stock Option Exercise Prices and Share Valuation.

How is the payment of withholding income tax handled?

The Q&A states the following in Question 4:

“For non-tax-qualified stock options (granted without charge, on favorable terms, or through a trust), income tax on employment income must be withheld when shares are delivered upon exercise and paid to the tax office with jurisdiction over the place of tax payment.” (National Tax Agency, “Taxation of Stock Options (Q&A),” Question 4)

Regarding the case where it is later discovered that payment had not been made and the issuing company decides not to seek reimbursement, the Q&A states 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).” (National Tax Agency, “Taxation of Stock Options (Q&A),” Question 4)

Regarding cases where payment cannot be made in a lump sum, the Q&A states the following:

If withholding income tax cannot be paid in a lump sum, by applying to the tax office, tax payment postponement or similar relief may be granted, in principle, for a period of up to one year. (National Tax Agency, "Taxation on Stock Options (Q&A)", Question 4)

Can trust-type stock options qualify as tax-qualified stock options?

Question 12 of the Q&A states as follows:

Regarding trust-type stock options, if they meet the following requirements, they will be recognized as tax-qualified stock options (National Tax Agency, "Taxation on Stock Options (Q&A)", Question 12).

• (1) In trust-type stock option trust agreements, as a principle, the trustee of the trust is not permitted to exercise the stock options or transfer them to a third party at its own discretion.
• (2) Trust-type stock options shall be granted free of charge to directors and others of the issuing company.
• (3) The exercise of trust-type stock options must be carried out during the period from the day on which two years have elapsed from the day on which the beneficiaries pertaining to the trust-type stock options are designated (beneficiary designation date) to the day on which ten years have elapsed from the beneficiary designation date (...).
• (4) The annual total amount of the exercise price upon the exercise of trust-type stock options shall not exceed 12 million yen (Note).
• (5) The exercise price per share for the exercise of trust-type stock options shall be equal to or greater than the equivalent value per share at the time of concluding the agreement pertaining to the grant of the beneficial interest in the trust.
• (Note) Regarding "at the time of concluding the contract pertaining to the grant of trust beneficial interests," if the date of concluding the contract pertaining to the grant of trust beneficial interests has not passed six months from the beneficiary designation date, the beneficiary designation date may be used instead.
• (6) That the transfer of trust-type stock options and their trust beneficiary rights is prohibited for directors and other officers.
• (7) That the delivery of shares upon the exercise of trust-type stock options is carried out in a manner that does not violate the matters specified in Article 238, Paragraph 1 of the Companies Act.
• (8) Regarding the shares acquired through the exercise of stock options, satisfying either of the following requirements:
  • (a) Custody is entrusted to a financial instruments business operator or similar institution.
  • (b) The shares acquired through the exercise (limited to restricted shares) shall be managed by the issuing company.

(National Tax Agency, "Taxation on Stock Options (Q&A)", Question 12)

Points that require care in practice

• You need to check the original documents published by the National Tax Agency to see what kind of taxation relationship arises as a corporate taxation trust at the time the trust is established (① above).
• Whether each trust agreement meets the requirements of Question 12, including the presence or absence of trustee discretion and how the beneficiary designation date is determined, cannot be known without reviewing the contents of the respective trust agreement.
• How to calculate the value of the shares themselves acquired at the time of exercise is based on the method indicated in Q&A Question 5 of the National Tax Agency, but the specific application requires checking the circumstances of each individual share.

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.’).”
• Article 36, Paragraph 2 of the Income Tax Act (Amount of Revenue) / Quoted text: "The value of things other than money, rights, or any other economic benefits under the preceding paragraph shall be the value at the time of acquiring said things or rights, or enjoying said benefits."
• Article 84, Paragraph 3, Main Clause of Enforcement Order of the Income Tax Act (Value of Restricted Stock, etc.) / Quoted text: "Where a person has been granted any of the rights set forth in the following items by the issuing corporation, which are subject to restrictions on the transfer of such rights or other special conditions (...), the value under Article 36, Paragraph 2 of the Act pertaining to such rights shall be the amount obtained by deducting, from the value of the shares acquired through the exercise of such rights on the date of such exercise (...), the amount specified in the following items according to the classification of the rights set forth in each such item."
• Article 67-3, Paragraph 1 of the Income Tax Act (without a title) / Quoted text: "If, as a result of a resident becoming a beneficiary (...) prescribed in Article 13, Paragraph 1 (Attribution of Assets and Liabilities Belonging to Trust Property and Revenues and Expenses Attributable to Trust Property) of a corporate taxation trust (limited to trusts set forth in Article 2, Item 29-2, (b) (Definitions) of the Corporation Tax Act), the relevant corporate taxation trust ceases to fall under the trusts set forth in Article 2, Item 29-2, (b) of the same Act (...), the amount of various incomes for each year of the relevant resident shall be calculated on the premise that the assets and liabilities belonging to the trust property have been succeeded to from its trustee corporation (...) based on the book value immediately before the time it ceased to fall under such trusts, at the amount specified by Cabinet Order (referred to as the "book value equivalent amount" in Paragraph 3)."
• Article 67-3, Paragraph 2 of the Income Tax Act (no heading) / Quoted text: "Where the resident referred to in the preceding paragraph is deemed to have taken over the assets and liabilities pursuant to the provisions of that paragraph, the amount of profit generated by such takeover shall not be included in the gross receipts in the calculation of the amount of various income for the year that includes the date on which the resident took them over."

Relevant administrative guidance, Q&A, and cases

• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Question 3 / Quoted text: "(1) The issuing company or a representative director, etc., of the issuing company entrusts money to a trust company to establish a trust (corporate taxation trust). (At the time of establishing the trust, no beneficiary or deemed beneficiary exists.)" "(2) The trust company purchases restricted stock options of the issuing company at fair market value (50)." "(3) During the trust period, the issuing company designates officers and employees who have contributed to the company as beneficiaries of the trust, and grants the stock options managed as trust property to such officers and employees." "(4) The officers and employees exercise the stock options to acquire shares of the issuing company." "(5) The officers and employees sell the shares acquired by exercising the stock options."
• National Tax Agency, "Taxation of Stock Options (Q&A)", November 2024 latest revision, Question 3 / Quoted text: "If the trust company purchases the said stock options at an appropriate fair market value (50), no economic benefit arises, and therefore no tax implications will result."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Question 3 / Quoted text: "No tax implications arise regarding the economic benefits when the issuing company grants stock options managed as trust assets by designating officers and employees as beneficiaries (Article 67-3, Paragraph 2 of the Income Tax Act)."
• National Tax Agency, "Taxation on Stock Options (Q&A)", revised November 2024, Question 3 (Note) / Cited wording: "Officers and employees shall inherit 50, which the trust bore at the time of purchase, as the acquisition cost (Income Tax Act Article 67-3, Paragraph 1)."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Question 3 / Quoted text: "When officers and employees exercise the stock options in question to acquire shares of the issuing company, the economic benefits thereof shall be classified as employment income (Income Tax Act Articles 28, 36(2), Income Tax Act Enforcement Order Article 84(3))."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Q3 (Note 3) / Quoted text: "- Although there is a view that the above economic benefits do not constitute consideration for services and 'are not taxed as salary' for reasons such as the trust granting stock options to officers and employees, and the trust acquiring stock options for value, - in substance, for reasons such as the issuing company granting stock options to officers and employees, and officers and employees bearing no financial burden, the above economic benefits constitute consideration for services and 'will be taxed as salary.'"
• 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 on Stock Options (Q&A)", November 2024 Last Revision, Question 4 / Quoted text: "(If it is decided not to seek reimbursement,) it results in the provision of an economic benefit. At the time of deciding not to seek reimbursement, it shall be treated as an additional payment of salary or remuneration in an amount equivalent to the net-of-tax amount corresponding to that tax liability, and withholding income tax pertaining to the amount thus deemed to have been paid shall be calculated (gross-up calculation) (Income Tax Basic Directive 221-1, Income Tax Basic Directive 181-223 Joint-4)."
• National Tax Agency, "Taxation on Stock Options (Q&A)", last revised November 2024, Question 4 / Quoted text: "If withholding income tax cannot be paid in a lump sum, by filing an application with the tax office, tax payment postponement or the like may be granted, in principle, for a period of up to one year."
• National Tax Agency "Taxation on Stock Options (Q&A)", November 2024 Revised Edition, Question 12 / Cited phrasing: "Trust-type stock options will be recognized as tax-qualified stock options if they satisfy the following requirements."
• National Tax Agency "Taxation on Stock Options (Q&A)", November 2024 Last Revision, Question 12 (1) / Quoted text: "In the trust agreement pertaining to the trust-type stock option, as a rule, the trustee of the trust is not permitted to exercise the stock option or transfer it to a third party at its own discretion."
• National Tax Agency "Taxation on Stock Options (Q&A)", November 2024 Last Revision, Question 12 (2) / Quoted wording: "Trust-type stock options are granted free of charge to directors and other officers of the issuing company."
• National Tax Agency, “Taxation of Stock Options (Q&A),” last revised November 2024, Question 12 (3) / Quoted text: “Trust-type stock options must be exercised during the period beginning two years after the date on which the beneficiaries of the trust-type stock options are designated (the beneficiary designation date) and ending ten years after that date (or fifteen years if the issuing company is a stock company incorporated less than five years earlier, is not an issuer of shares or similar securities listed on a financial instruments exchange, and satisfies the other requirements).”
• National Tax Agency, "Taxation of Stock Options (Q&A)", November 2024 final revision, Q12 (4) / Quoted text: "The annual total of the exercise prices at the time of exercise of the trust-type stock options shall not exceed 12 million yen (Note)."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Question 12 5 / Cited wording: "The exercise price per share for the exercise of trust-type stock options shall be equal to or greater than the value equivalent per share at the time of concluding the contract pertaining to the grant of the beneficial interest in the trust."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Q12 ⑤ (Note) / Quoted text: "Regarding 'at the time of concluding the contract pertaining to the grant of trust beneficial interests,' if the date of concluding the contract pertaining to the grant of trust beneficial interests is less than 6 months from the beneficiary designation date, the beneficiary designation date may be used instead."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Q12 ⑥ / Quoted text: "Directors, etc., are prohibited from transferring the trust-type stock options and their trust beneficiary rights."
• National Tax Agency, "Taxation on Stock Options (Q&A)", November 2024 final revision, Q12-7 / Quoted text: "The delivery of shares related to the exercise of trust-type stock options is carried out without violating the matters specified in Article 238, Paragraph 1 of the Companies Act."
• National Tax Agency, "Taxation on Stock Options (Q&A)", last revised November 2024, Question 12 (8) / Quoted text: "With respect to shares acquired through the exercise of stock options, either of the following requirements must be met." "A. Entrustment of custody is made with a financial instruments business operator, etc." "B. The issuing company manages the shares acquired through the exercise (limited to restricted shares)."