Japan income tax: Former senior executive accused of evading Japanese income tax on stock option gains

A former senior executive of a Japanese subsidiary of a major US pharmaceutical company has been accused of evading taxes on the gains arising from the exercise of stock options granted by the subsidiary's U.S. parent. The Tokyo Regional Taxation Bureau (TRTB) has accused the executive of underpaying ¥60 million in Japanese income taxes (approximately US $670,000).

As mandated by the TRTB, the former executive has filed amended income tax returns for the years in question, as well as paid the additional taxes due. However, even after submitting these amended returns and paying all taxes due, as well as penalties (which can be as high as 35% of the tax underpayment amount) and interest, the executive remains potentially liable for criminal penalties.

This is the most recent in a series of cases involving Japanese executives attempting to evade income tax due on stock option gains. In 2008, two former executives of the local Japanese entities of U.S. multinational companies were found guilty of failing to report stock option gains. Although many of the details surrounding these prior cases remain undisclosed, including how the income underreporting was discovered, the TRTB showed an exceptional ability to track the underreporting in both cases. One possible source for tracking underreporting of stock option income is through the use of corporate disclosure statements and information obtained in tax audits.

Action

- Employers should refocus their compliance efforts in Japan to ensure proper controls are implemented and any company reporting and withholding obligations are met.

- Employers should inform employees of the recent action taken by the TRTB and ensure employees understand their responsibility to report and pay taxes on all income (including stock option gains and any capital gains realized from subsequent sale of the underlying shares).

- Employers should develop and distribute employee communications or provide educational information with respect to the taxation of share-settled awards.