Japan taxes stock options in one of two ways. A non-qualified option is taxed when exercised: the difference between the market price and the exercise price is employment income, added to salary and taxed at progressive rates of up to about 56% including inhabitant tax. Any later gain on sale is a capital gain taxed at 20.315%. In 2005 the Supreme Court settled that exercise gains on options granted by a US parent to an employee of its Japanese subsidiary are employment income, not the lightly taxed occasional income some taxpayers had claimed.
A tax-qualified option is not taxed at exercise. Tax arises only on sale, and the whole gain is a capital gain at 20.315%. To qualify, the option must be granted free by the company or its subsidiary to its directors or employees, be non-transferable, carry an exercise price at least equal to market value at grant, be exercisable from two to ten years after the grant resolution (15 years for unlisted companies under five years old), and stay within an annual exercise limit. The 2024 tax reform raised that limit from 12 million yen to 24 million yen for unlisted companies under five years old and 36 million yen for unlisted companies aged five to twenty and companies within five years of listing. Because the issuer must be a Japanese company, options over a foreign parent's shares are always non-qualified.
Options granted by a foreign parent are usually not withheld through Japanese payroll, so the employee must file a tax return. The Japanese subsidiary or branch must report each exercise to the tax office by 31 March of the following year.
What it means for a foreign employer
- Your options are taxed at the top rate. A senior Japan employee exercising options over your shares pays employment income tax on the full spread. Plan sell-to-cover arrangements around exercise.
- Make sure people file. Exercise gains are reported to the tax office by the employer, so an employee who forgets to declare them will be found. Offer tax return support for anyone with equity.
- Unvested options are a cost of moving. Candidates leaving a company with options in the money expect them to be addressed. Build a complete picture of what they forfeit before framing the offer.
- Japanese start-ups now compete with qualified options. The higher limits make domestic start-up packages more attractive to senior talent than they were.
Sources
- Income Tax Act, Article 28, and Article 228-3-2 (report on benefits granted by a foreign parent).
- Act on Special Measures Concerning Taxation, Article 29-2 (tax-qualified stock options), as amended by the 2023 and 2024 tax reforms.
- Supreme Court, Applied Materials case, 25 January 2005.
- National Tax Agency, Q&A on taxation of stock options (revised November 2024).