Permanent Establishment (PE) in Japan: The 3 Types and PE Risk

“We don’t have a branch in Japan, so we have no PE” — is that really true?

This is one of the first tax questions a foreign corporation or non-resident faces when doing business in Japan. Many companies sell or provide services into Japan directly from overseas, without setting up a Japanese entity or establishing a residence here. But having no branch is not the same as having no permanent establishment (PE).

This article explains the three types of PE under Japanese domestic law, the criteria for each, and the PE risks that foreign-affiliated companies and non-residents commonly run into in day-to-day operations.

The taxation that follows after a PE is found to exist — calculating attributable income, filing obligations, and documentation — is covered separately in our article on the corporate income taxation of PEs (English version to be added later).

What Is a PE? The “No PE, No Tax” Principle

How Foreign Corporations and Non-Residents Are Taxed

For foreign corporations and non-residents, a PE primarily determines whether their business profits are subject to tax in Japan.

Category	Taxation of business profits
With a PE	Self-assessment (filing) on business profits attributable to the PE
Without a PE	Business profits are not subject to tax in Japan

This is the principle known as “No PE, No Tax.”

This principle, however, applies specifically to business profits. Investment income such as royalties, interest, and dividends should remain subject to withholding tax on each payment regardless of whether a PE exists, and that withholding completes the tax obligation (see our withholding tax series, articles 4–8 — English versions to be added later).

How Tax Treaties Modify the PE Definition

The basis for PE taxation is found in both domestic law (the Corporation Tax Act and the Income Tax Act) and in tax treaties. Where a treaty is in force with the other country, the treaty’s definition of PE should take precedence over domestic law (see our introduction to tax treaties — English version to be added later).

Because a treaty might either broaden or narrow the definition of PE, confirming the content of the relevant treaty is essential. This is particularly important for construction PEs, where treaties with Asian countries frequently set stricter (shorter) thresholds than domestic law.

The Three Types of PE

Under Japanese domestic law (the Corporation Tax Act and the Income Tax Act), PEs fall into three types: fixed place of business PE, construction PE, and agency PE. Where a tax treaty is in force with the other country, the treaty’s PE definition takes precedence over domestic law, so checking the content of the relevant treaty is always essential alongside the domestic law analysis.

Fixed Place of Business PE

This is the most basic type, referring to a state in which business is carried on through a fixed place.

The Broad Reach of a “Fixed Place of Business”

A common misconception in practice is “no branch, no PE.” In fact, anything that functions as a base for business activities — a server, a hotel room, an exhibition-and-sales stand — should fall within the meaning of a “fixed place of business.”

What matters is that the place is “at the disposal of” the enterprise. Ownership is not required: leased premises, and premises provided free of charge, should both be included. Even a case where an employee of a foreign corporation, or a non-resident, continuously uses a corner of a customer’s office might be treated as a fixed place of business PE.

Warehouses also call for care. Previously, only warehouses used by a warehousing business were treated as a PE. Currently, even a warehouse that a goods-selling business uses solely to store and deliver its own products might constitute a PE if it carries out an essential part of the business.

Excluded Activities (Preparatory or Auxiliary)

The following activities should be excluded from a fixed place of business PE as preparatory or auxiliary:

• Display of goods, market research
• Advertising

The “liaison office that does no sales activity and only gathers information and coordinates communication” model is designed to fall within this exclusion.

Activities That Do Not Qualify as Preparatory or Auxiliary

In practice, the line between what is and is not “preparatory or auxiliary” is where disputes arise. The following activities are not regarded as auxiliary and should be considered to carry a high PE risk:

• Alignment with the business purpose: the place serves the same purpose as the core business of the foreign corporation or non-resident
• Activities of substance: activities requiring a significant portion of the enterprise’s assets or employees
• After-sales service: maintenance and repair of machinery and equipment sold to customers (other than the mere delivery of replacement parts)
• Specialised procurement: purchasing goods that require specialised skill or knowledge
• Central management functions: acting as a regional headquarters
• Provision of services to third parties: providing services externally

Where an “information gathering only” or “auxiliary functions only” explanation diverges from the actual facts, the PE risk should rise considerably.

The Anti-Fragmentation Rule

The anti-fragmentation rule, introduced in the 2018 tax reform, is also important.

Where an enterprise operates at multiple places in Japan, or operates in cooperation with related parties such as group companies, the activities should be assessed as a whole even if each individual activity is, on its own, “preparatory or auxiliary” — provided those activities together form complementary parts of a cohesive business operation. If the combination, taken as a whole, goes beyond the scope of “preparatory or auxiliary,” each place might itself constitute a PE.

The scheme of “spreading functions across several locations and dressing each one up as an auxiliary activity” no longer works easily under the current rules.

Construction PE

This is a PE that arises where construction or installation work continues beyond a certain period.

Domestic Law: More Than 12 Months

The threshold under Japanese domestic law (the Corporation Tax Act) is “more than one year (12 months).” As noted below, however, treaties frequently shorten this threshold, so confirming the relevant treaty is indispensable.

Shortened Thresholds under Tax Treaties

Particularly in treaties with Asian countries, the construction PE threshold is often set stricter (shorter) than under domestic law. A further feature is that many treaties include not only the construction work itself but also related supervisory activities (supervisory PE) in the period calculation.

The principal countries whose treaties shorten the threshold below domestic law (more than 12 months) are as follows.

Country	Threshold	Notes
Thailand	More than 3 months	Shortest threshold among these countries
India	More than 6 months	Construction/installation/assembly plus supervisory activities
China	More than 6 months	More than 6 months in total within any continuous 12-month period
Vietnam	More than 6 months	Construction/installation/assembly and supervisory activities
Indonesia	More than 6 months	More than 6 months in total within a 12-month period (one tax year)
Malaysia	More than 6 months	Construction/installation work and supervisory activities
Singapore	More than 6 months	Construction/installation work and supervisory activities
Korea	More than 6 months	Construction/installation work and supervisory activities

Contract Splitting

The construction PE period requirement has long been the target of schemes that deliberately split a contract into several short-term contracts to avoid triggering a PE.

The current rules set out a clear counter-measure against such contract splitting. Specifically, where a contract for construction/installation work, or for the supervisory services relating to it, is split into two or more contracts and the work period under each resulting contract becomes one year or less, the work periods under the split contracts should be aggregated for the period test if “ensuring that the worksite does not constitute a PE was one of the principal purposes of the splitting.”

This treatment should not apply where the contract was split for legitimate reasons. Whether there is an economically rational reason is the dividing line in practice.

Note: Service PE

Japanese domestic law has no provision that constitutes a PE on the basis of the duration of service provision. Service PE is a treaty-specific concept — not a category under domestic law — and in practice arises primarily when Japanese companies provide services in Asian countries and face PE assessment by the local tax authorities there.

For reference, an overview of service PE provisions in key treaties is set out below.

Country	Threshold	Covered activities
Thailand	More than 6 months in total within any 12-month period	Services through employees etc. (including consultancy)
China	More than 6 months in total within any 12-month period	Consultancy services through employees etc.
Vietnam	More than 6 months in total within any 12-month period	Services through employees etc. (including consultancy)
Indonesia	More than 6 months in total within one tax year	Consultancy services, or supervisory services relating to construction
Australia	More than 12 months	Supervisory or consultancy activities connected with construction

Agency PE

Even without a branch or a worksite, a PE should exist where a foreign corporation has an agent in Japan (a dependent agent) who repeatedly exercises the authority to conclude contracts.

The Broad Meaning of “Concluding Contracts”

The interpretation of “concluding contracts” is not limited to formal signing. Even without signature or sealing of a contract document, substantively agreeing the terms of a contract should be included within “concluding.”

Where the person in charge on the Japanese side leads the negotiations with the customer and the reality is that “all that remains is for the headquarters or the principal overseas to sign as a formality,” there might be a risk of an agency PE.

Independent Agents and the 50% Test

An agency PE applies only to dependent agents; an agent of independent status (an independent broker or intermediary, etc.) is outside its scope.

Under the rules, a person with a “special relationship” should not be treated as an independent agent. Specifically, this covers a relationship in which more than 50% of the issued shares are held, directly or indirectly (parent–subsidiary, sister companies, etc.). Where sales activities are carried out through a subsidiary, that subsidiary is not an “independent agent,” and a risk of an agency PE arises.

Commissionaire Arrangements and BEPS

In the past, schemes using a commissionaire (a party that transacts in its own name but at the risk and for the account of the foreign corporation or non-resident) were widely used to change the formal contracting party and avoid PE taxation.

In response, the OECD reviewed the definition of an agency PE under BEPS Action 7, directing that a PE should be constituted even without formal contract-concluding authority where a person “plays the principal role in the conclusion of contracts that are concluded for the enterprise.” Japan incorporated this approach into domestic law in its 2019 amendments.

Common PE Risks in Practice

Case 1: Long-Term Stay in Japan by Headquarters Staff or a Non-Resident Consultant

Where a person from overseas stays long-term under the name of a “business trip” and is involved in negotiating and concluding contracts with customers, a PE might be created as an agency PE. Even where the formal arrangement is that “the official signing is done overseas by the headquarters or the principal,” a PE might still be constituted if that person is the substantive party forming the agreement.

Case 2: PE Risk Through Secondees

Where an employee seconded from the overseas headquarters to the Japanese subsidiary is, in substance, acting for the headquarters, an agency PE through the secondee might become an issue.

Case 3: The Japanese Subsidiary Treated as the Headquarters’ Agent (for Overseas HQ Staff)

This case is particularly relevant to the tax and finance staff on the overseas headquarters side of a foreign corporation that has a Japanese subsidiary.

Specifically, the following transaction patterns can become problematic:

• The Japanese subsidiary negotiates with Japanese customers and substantively decides the terms of the contract, but the contracting party is the overseas parent
• The Japanese subsidiary transacts in its own name as a commissionaire, but all of the economic risk and profit or loss is attributed to the parent
• The Japanese subsidiary has decision-making power over the sales terms, price, and quantity of the parent’s products and substantively binds the parent

In such cases, the Japanese subsidiary might be regarded as a “dependent agent that substantively concludes contracts for the parent,” and a filing obligation in Japan might be triggered for the parent. Even where the Japanese subsidiary already pays corporate income tax, taxation of the parent should arise separately.

Because a more-than-50% shareholding parent–subsidiary relationship constitutes a “special relationship,” the subsidiary’s separate legal personality alone cannot avoid this risk.

Case 4: Functional Fragmentation Within a Group (Anti-Fragmentation)

Some try to manage risk on the assumption that “if functions are divided among group companies, each one remains an auxiliary activity.” With the introduction of the anti-fragmentation rule, however, where the activities among group companies are judged to perform complementary functions as a cohesive business operation, the whole might constitute a PE even if each individual activity is auxiliary.

Case 5: Digital Business and Whether a Server Constitutes a PE

A server located in Japan might itself constitute a fixed place of business PE. Under the current interpretation, a PE might not be constituted where there is no maintenance staff in Japan, but the international debate over the taxation of the digital economy (Pillar One, etc.) is ongoing, and developments should be watched closely.

Practical Steps to Manage PE Risk

Record and Document Activities and Periods

The basis is to record and document the matters relevant to a PE determination — the degree of involvement in contract negotiations and the reality of decision-making. What is examined is not only who the formal contracting party is, but where the substantive agreement is formed.

Confirm Treaty Content with the Other Country in Advance

The criteria for construction PEs differ significantly from treaty to treaty. Particularly for projects and engineer dispatch toward Asian countries, it is essential to confirm the relevant treaty in advance and to manage the periods involved.

Take a Bird’s-Eye View of the Group’s Activities in Japan

As a response to the anti-fragmentation rule, organise all of the activities the group carries out in Japan (including those of the company itself, related companies, secondees, and long-term business travellers) and consider whether, viewed as a whole, they exceed “preparatory or auxiliary.”

Clarify Contracting Parties and Authority

Documenting the scope of authority of staff on the Japanese side (the degree of involvement in negotiation and agreement-forming) should help to contain the risk of an agency PE being created.

Key Takeaways

• Under Japanese domestic law, PE falls into three types — fixed place of business PE, construction PE, and agency PE. A PE might be created even without a formal branch, through a worksite, a dependent agent, or even a corner of a customer’s office used on a continuing basis.
• The construction PE period test is “more than 12 months” under domestic law, but treaties with Asian countries frequently shorten it to “more than 6 months” or “more than 3 months,” and avoidance by contract splitting should not be permitted given the statutory counter-measure.
• For agency PEs, “concluding contracts” is not limited to formal signing — involvement in substantively forming the agreement is what is examined — and parent/subsidiary and sister companies are not treated as independent agents.

The assumptions “we have no branch, so we have no PE” and “it’s only a short business trip, so there’s no problem” increasingly do not hold under the current rules. We recommend confirming which type your own (or your company’s) activities fall under, with the support of a tax professional.

The taxation that follows after a PE is established — calculation of attributable income, filing obligations, and documentation of internal dealings — is covered in detail in a separate article (English version to be added later).