PRACTICAL LAW EMPLOYEE SHARE PLANS EMPLOYMENT AND EMPLOYEE BENEFITS VOL 2 MULTI-JURISDICTIONAL GUIDE 2012/13. The law and leading lawyers worldwide

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1 PRACTICAL LAW MULTI-JURISDICTIONAL GUIDE 2012/13 EMPLOYMENT AND EMPLOYEE BENEFITS VOL 2 The law and leading lawyers worldwide Essential legal questions answered in 22 key jurisdictions Comparative table AVAILABLE ONLINE AT

2 MULTI-JURISDICTIONAL GUIDE 2012/13 Japan Tadashi Ishii and Shinichi Kobayashi Baker & McKenzie (Gaikokuho Joint Enterprise) EMPLOYEE PARTICIPATION 1. Is it common for employees to be offered participation in an employee share plan? 2. Can employees be offered a share plan where the shares to be acquired are in a foreign parent company? It is common for Japanese companies whose shares are listed on stock exchanges in Japan to offer share options of its listed shares to its employees and the employees of its subsidiaries and affiliates. According to certain statistics, about 40% of Japanese listed companies have adopted share option plans and offered share options to its employees. Similarly, it is common for foreign parent companies, such as US Securities and Exchange Commission (SEC) filing companies, which implement various kinds of share plans in its home jurisdiction to implement such share plans in its Japanese subsidiaries or affiliates. The share plans implemented in the Japanese subsidiaries or affiliates relate to shares of the foreign parent company. While Japanese listed companies typically implement only share option plans, foreign parent companies implement more varied share plans which are offered to the employees of its Japanese subsidiaries and affiliates. The share plans must fully comply with applicable Japanese laws and regulations (particularly, the disclosure rule under the Financial Instruments and Exchange Act of Japan (FIEA)). In this regard, it should be noted that unlike share options granted by a Japanese listed company to its employees and the employees of its subsidiaries and affiliates, the Japanese Companies Act does not apply to share plans, including share option plans, implemented by a foreign parent company for the employees of its Japanese subsidiaries and affiliates. Further, the Japanese Labour Standards Law and other Japanese labour and employment related laws and regulations (that are strictly enforced to secure and enhance interests and benefits of employees) may not apply to share plans implemented by a foreign parent company and offered to employees of its Japanese subsidiary or affiliate. To this extent, foreign parent companies are able to implement various share plans for employees of its Japanese subsidiaries or affiliates with reasonable flexibility. Generally, it is lawful to offer participation in an employee share plan where the shares to be acquired are shares in a foreign parent company. It is common (but not a condition) for such shares to be listed and publicly traded on a stock exchange. SHARE OPTION PLANS 3. What types of share option plan are operated in your jurisdiction? The typical share option plan is the most common type of employee share option plan operated by foreign parent companies. Under the plan, share options are granted to Japanese employees for free at the time of grant and the exercise price is equal to or slightly below the market price of the shares on or immediately before the grant date. The share options granted usually vest in tranches with a typical vesting period of four years or longer. Conditions can be imposed on vesting, including continued employment and some other fact-based conditions. There may also be events that trigger the forfeiture of the share options. If the employee wants to exercise a vested option, the employee will have to pay the exercise price for the number of the shares that the employee wants to buy. Alternatively, the employee can pay the exercise price by the cashless exercise method. Under this method, the employee instructs the designated broker to immediately sell the shares that are the subject of the exercised option. The sale proceeds are used to pay the exercise price (and any applicable taxes). The remaining proceeds are paid to the employee. Share options granted by foreign parent companies are relatively popular and recognised in Japan. Grant 4. What rules apply to the grant of employee share option plans? For the purposes of this article, the discussion mainly focuses on the employee share plans implemented by foreign parent companies for the employees of its Japanese subsidiaries and affiliates in respect of shares of the foreign parent company that is listed on a stock exchange outside of Japan. Discretionary/all-employee. Unlike share options granted by a Japanese company, share options granted by a foreign parent company to the employees of its Japanese local subsidiary or affiliate could be designed and structured so that they do not constitute an integral part of the employment agreement in effect between the Japanese employee and the Japanese local entity. This article was first published in the Employee Share Plans multi-jurisdictional guide 2012/13 and is reproduced with the permission of the publisher, Practical Law Company.

3 This is to avoid application of Japanese labour related laws and regulations. Share options granted by a foreign parent company can be made in its discretion and there is no restriction on the foreign parent company in its selection of candidates to whom share options are granted. Non-employee participation. There is no law on the qualification or legal status of the participants to the share option plan granted by a foreign parent company. Non-employees, such as consultants and non-employee directors, can be offered share options. However, if share options are granted only to the employees and non-employee directors of a Japanese subsidiary that is 100% directly or indirectly (down to tier-two level) owned by a foreign parent company (and certain other conditions are satisfied), an exemption may be available in relation to securities filings that are required under the FIEA for share option grants exceeding certain thresholds (in terms of value and number of offerees). If share options are also offered to non-employees, such as consultants, this exemption cannot be applied ( see Question 30 ). Maximum value of shares. Legally, there is no limitation on the maximum value (exercise value) of the share options. Market value. There is no rule requiring that the exercise price must be equivalent to the market price of the shares at the date of the grant. is classified as remuneration income, in general, and is subject to progressive rates up to 50% (including both the income tax payable at the national level and the inhabitant tax payable at the local level, as applicable to Japanese resident taxpayers). In addition, a 2.1% surtax will apply from 1 January 2013 for 25 years. There may be limited or specific circumstances where the income is classified as retirement income if certain conditions are met, or as occasional income if no employment relationship exists. The local employer may have a withholding tax obligation in this regard, depending on whether the employer is involved in the payment of income for the plan (including the delivery of shares). The participant is generally required to file the income tax return and pay the income tax on the income associated with the share option plan. As to social security implications, see Question 5,. Exercise 8. What are the tax/social security implications of the exercise of the option? The exercise of the option is a taxable event. Such income is generally taxed as remuneration income ( see Question 7, ). 5. What are the tax/social security implications of the grant of the option? For income tax purposes, the grant is generally considered as a non-taxable event. Any benefits awarded to employees in connection with share options granted to them are not considered wages requiring social security contributions. Therefore, there is no social security contribution payable during the life of a share option plan (that is, upon grant, vesting, exercise and sale). Vesting s implemented by Japanese companies subject to the Japanese Companies Act may be classified as qualified share options, if certain conditions are met. In these circumstances, any income can be deferred and no income taxation occurs upon exercise (but subsequent transfer of shares is a taxable event). However, this treatment is not applicable to the share option plans implemented by foreign parent companies of Japanese subsidiaries or affiliates. This article does not therefore cover the qualified share option plans in detail. Tax liability is not recoverable. However, if the local employer is subject to the withholding tax obligation on the exercise, the employee can enjoy the tax credit for the withholding tax paid by the local employer. 6. Can the company specify that the options are only exercisable if certain performance or time-based vesting conditions are met? It is legally permissible and common, as a matter of practice, to impose time-based vesting conditions. Imposing performancebased conditions is also permissible, but objective criteria to measure the performance would be required. 7. What are the tax/social security implications when the performance or time-based vesting conditions are met? For Japanese income tax purposes, any income associated with the share incentive plans is subject to income tax when the income is substantially vested (that is, when a definite and enforceable right to receive payment arises). In the case of a share option plan, the exercise of the share option is a taxable event. Income generated For social security implications, see Question 5,. Sale 9. What are the tax and social security implications when shares acquired on exercise of the option are sold? Any subsequent transfer of shares is a taxable event. The income is classified as capital gain income subject to a separate tax at a flat rate of 20% (15% is for national income tax and 5% for local inhabitant tax, under relevant tax laws). In addition, the 2.1% surtax at the national level will apply for 25 years from 1 January If the shares are listed shares and certain conditions are met such as, for example, that the dividend/capital gain payments are made through a Japanese registered stock broker, then a lower tax rate may be available until 31 December For social security implications, see Question 5, Share option plan.

4 SHARE ACQUISITION OR PURCHASE PLANS 10. What types of share acquisition or purchase plan are operated in your jurisdiction? Payment for shares and price. Under the ESPP, prior payroll deduction is used to purchase shares at a certain discounted price. Under the RSU, shares are issued without any payment by the award grantee ( see Question 10, Restricted share unit (RSU) ). Employee share purchase plan (ESPP) Under the ESPP, eligible employees are offered participation in the ESPP implemented by foreign parent companies. Once enrolled, the employees contribute to the ESPP by payroll deductions of a certain amount determined in advance of the enrolment for the prescribed purchase period (commonly six months). Usually, on completion of the purchase period, the employees can purchase shares of the foreign parent company using the deducted and accumulated amount at a certain discount (for example, 15%) from the lower of either: The market price at the commencement of the purchase period. The market price at the end of the purchase period. Generally, the discounted portion is covered by the foreign parent company (or the Japanese local entity, as the case may be). Restricted share unit (RSU) An RSU award gives the right to receive shares of foreign parent companies on satisfaction of the applicable vesting requirements, such as continued employment for certain years at the Japanese subsidiary or affiliate. When an RSU award vests, the shares of the foreign parent company are automatically issued to the employee without any monetary payment by the employee, unlike a share option where the employees are required to pay an exercise price to acquire the shares or the ESPP where the prior payroll deduction is mandatory. Until vesting, the employee does not have shareholder voting rights and does not receive any dividends. At vesting, the shares are issued without further restrictions and the employee is free to sell the shares at any time. Acquisition or purchase 11. What rules apply to the initial acquisition or purchase of shares? ESPP and RSU Discretionary/all-employee. Just like the share options granted by a foreign parent company, implementing an ESPP and RSU for the employees of a Japanese local subsidiary or affiliate could be designed and structured so that they would not constitute an integral part of the employment agreement that is in effect between the Japanese employee and the Japanese local entity. Therefore, a foreign parent company can implement the ESPP and RSU in its discretion and there is no restriction on the foreign parent company in its selection of candidates to whom the awards are granted. Non-employee participation. Both ESPPs and RSUs can be offered to non-employee directors and consultants as well as employees. 12. What are the tax/social security implications of the acquisition or purchase of shares? For Japanese income tax purposes, any income associated with the share acquisition or purchase plan is also subject to income tax when the income is substantially vested. In the case of a share acquisition or purchase plan, the discount purchase is a taxable event and the income (discount portion) is generally classified as remuneration income subject to progressive rates up to 50% ( see Question 7 ). Under Japanese laws and legal practice, there is no concept that is exactly equivalent to the ESPP and RSU. Therefore, it is uncertain if any benefits awarded to employees in connection with an ESPP and RSU should be considered as wages that would be subject to social security contributions. Currently, the prevailing view is that like the benefits granted under the option plans, there is no social security contribution issue in connection with implementing ESPP and RSUs (that is, grant, vesting, purchase and sale). Vesting 13. Can the company award the shares subject to restrictions that are only removed when performance or time-based vesting conditions are met? ESPP Once an employee is enrolled in the ESPP and payroll deduction is commenced for any purchase period, it is not common that any time-based or performance-based conditions apply to the award of shares. RSU Time-based conditions are generally attached. Imposing performance-based conditions is also permissible, but objective criteria to measure the performance would be required. 14. What are the tax and social security implications when the performance or time-based vesting conditions are met? EPSS and RSU The vesting is a taxable event if the income is substantially vested. In the case of a typical share acquisition or purchase plan, the discount purchase is characterised as vesting and it is a taxable event. The income is generally classified as remuneration income and is subject to progressive rates up to 50% ( see Question 7 ). For social security implications, see Question 12. Maximum value of shares. Legally, there is no restriction in this respect for both ESPPs and RSUs.

5 Sale 15. What are the tax and social security implications when the shares are sold? EPSS and RSU Any subsequent transfer of shares is also a taxable event and the income is classified as capital gain income which is subject to separate taxation at the flat rate ( see Question 9, Share option plan ). For social security implications, see Question 12. PHANTOM OR CASH-SETTLED SHARE PLANS 18. What are the tax/social security implications when the award is made? For the purposes of income tax, the grant is generally considered as a non-taxable event. In relation to social security implications, although there remain some ambiguities, to the extent that phantom awards or SARs are granted in the absolute discretion of the foreign parent company without constituting an integral part of the employment agreement in effect between the Japanese employee and the Japanese local entity, social security contributions will not be payable in connection with the grant, vesting and payment. 16. What types of phantom or cash-settled share plan are operated in your jurisdiction? Phantom share plan Phantom share plans are sometimes awarded by foreign parent companies to the employees of its Japanese subsidiary or affiliate. In the typical phantom share plan, there is a promise to pay a cash amount that is equivalent to either the value of company shares or the increase in that value over a period of time. Share appreciation rights (SARs) A share appreciation right is sometimes awarded by foreign parent companies. It is similar to phantom shares, except that it provides the right to the monetary equivalent of the increase in the value of a specified number of shares over a specified period of time. As with the phantom award, this is normally paid out in cash, but it could be paid in shares. Compared to share options, ESPPs and RSUs, it is not so popular for foreign parent companies to grant phantom awards or SARs. Grant 17. What rules apply to the grant of phantom or cash-settled awards? Discretionary/all-employee. Similar to share options, ESPPs and RSUs, granting phantom awards and SARs by foreign parent companies to the employees of its Japanese local subsidiary or affiliate could be designed and structured so that they would not constitute an integral part of the employment agreement in effect between the Japanese employee and the Japanese local entity. Therefore, a foreign parent company could grant phantom awards and SARs in its discretion and there is no restriction on the foreign parent company in its selection of candidates to whom the awards are granted. Non-employee participation. Both phantom awards and SARs can be offered to non-employee directors and consultants as well as employees. Vesting 19. Can phantom or cash-settled awards be made to vest only where performance or time-based vesting conditions are met? There are no specific rules or regulations in this respect and it would be possible to design a plan incorporating time-based vesting conditions. Imposing performance-based conditions is also permissible, but objective criteria to measure the performance would be required. 20. What are the tax/social security implications when performance or time-based vesting conditions are met? For the purposes of income tax, the satisfaction of vesting conditions is a taxable event provided the income is substantially vested ( see Question 7, ). In the case of a phantom share plan or SARs, no exercise action is made and the vesting is a taxable event, in general. But, as a practical matter, the income is recognised on the payment date, unless the plan is artificially structured for income deferral purposes. The income is generally classified as remuneration income ( see Question 7, ). For social security implications, see Question 18. Payment 21. What are the tax and social security implications when the phantom or cash-settled award is paid out? See Question 20. Maximum value of awards. Legally, there is no restriction in this respect for both phantom awards and SARs.

6 CORPORATE GOVERNANCE GUIDELINES, MARKET OR OTHER GUIDELINES 22. Are there any corporate governance guidelines, market rules or other guidelines that apply to any of the above plans? There are no specific corporate governance, or other, guidelines or market rules concerning the share plans implemented by a foreign parent company for the employees of its Japanese subsidiary or affiliate. EMPLOYMENT LAW 23. Is consultation or agreement with, or notification to, employee representative bodies required before an employee share plan can be launched? When implementing an ESPP, which involves a provision for payroll deduction, it is necessary to enter into a written agreement with the labour union that represents a majority of employees party to the ESPP. If no such union exists, the terms must be agreed in writing with the employee who represents the majority of the participating employees. This is because under the Labour Standards Law of Japan, the salary must be paid directly to employees by cash and in full at least once a month. A written agreement with the labour union or the employee representative is one of the exceptions to this salary payment rule. 24. Do participants in employee share plans have rights to compensation for loss of options or awards on termination of employment? To the extent that share plans that are implemented by a foreign parent company for the employees of its Japanese subsidiary or affiliate are outside the scope of the employment agreement between the Japanese employee and the Japanese employer, there is no rule or regulation requiring that participants in share plans have rights to compensation for loss of options or awards on termination of employment. EXCHANGE CONTROL 25. How do exchange control regulations affect employees sending money from your jurisdiction to another to purchase shares under an employee share plan? 26. Do exchange control regulations permit or require employees to repatriate proceeds derived from selling shares in another jurisdiction? There are no requirements concerning the repatriation of funds. INTERNATIONALLY MOBILE EMPLOYEES 27. What is the tax position when an employee who is tax resident in your jurisdiction at the time of grant of a share option or award leaves your jurisdiction before any taxable event affecting the option or award takes place? Where an employee is resident in Japan at the time of the grant of the share option or award but leaves Japan before any taxable event, the part of the income corresponding to the employee s service period in Japan during the period from the grant date to the exercise date, is subject to Japanese income tax. In this case, the flat 20% rate applies as the employee is a non-resident. 28. What is the tax position when an employee becomes tax resident in your jurisdiction while holding share options or awards granted abroad and a taxable event occurs? An employee is generally classified as a Japanese resident taxpayer after the employee s arrival in Japan provided the employee s service contract is for one year or more. A person classifies as a non-permanent resident taxpayer if he resides in Japan five years or less out of the past ten years. In these circumstances, since the non-permanent resident s tax base is Japanese source income plus foreign source income paid in and remitted into Japan, if the income on exercise is paid in Japan or remitted into Japan, the entire exercise income is subject to the Japanese income taxation at the progressive tax rates ( see Question 7, Option plan ). If the income on exercise is paid outside Japan and not remitted into Japan, only the Japanese source portion (corresponding to the employee s service period in Japan during the period from the grant date to the exercise date) is taxable in Japan at the progressive tax rates. Notably under the US-Japan Income Tax Convention, the source rule is confirmed under Article 10 of the Convention Protocol. SECURITIES LAWS 29. What are the requirements under securities laws or regulations for the offer of and participation in an employee share plan? If the amount of payment made by a Japanese resident (such as a Japanese employee) to a non-resident outside Japan exceeds JPY30 million (or its foreign currency equivalent) in a single transaction (this includes payment of the exercise price for share options), this may have to be reported to the Bank of Japan after the transaction has taken place (as at 1 August 2012, US$1 was about JPY78.2). This reporting is required mostly for statistical purposes. It is a relatively simple process which is not timeconsuming. When implementing share option plans or ESPPs, a Securities Registration Statement (Form 7, 7-2 or 7-5) (SRS) must generally be filed with the Kanto Local Finance Bureau, a regional arm of the Financial Services Agency, 15 days (or seven days for Form 7-2) before the commencement of the offering if both of the following conditions are met ( FIEA ): The total number of the employees to whom share options are offered in Japan is 50 or more.

7 The total value of the share options (that is, the total value of the exercise price for share option plans and total amount of expected payroll deduction for ESPPs) offered to the employees in Japan is JPY100 million or more. If the total value of the share options is more than JPY10 million but less than JPY100 million, and the total number of employees to whom share options are offered is 50 or more, a Securities Notice (Form 6) must be filed. Also, according to the 2012 Japanese tax legislation, employees must report details of any assets held outside Japan as of 31 December, if the total net fair market value of such assets exceeds JPY50 million. The report is due by 15 March of the following year. 32. Are there any data protection requirements or obligations for an offer of and participation in an employee share plan? If an SRS is filed, a prospectus must be prepared and distributed to the employees when offering the share option plans and ESPPs. The costs and the time spent for completing securities filings vary depending on the type of the securities forms to be filed. Generally, it would take a foreign parent company at least one month to complete the filing process. There is no filing fee payable to the Japanese government. However, fees payable to the law firm and accounting firm for preparing and completing securities filings may be fairly substantial (possibly several millions of Japanese Yen). Generally grants of RSUs, phantom share plans and SARs do not trigger any filing requirements. 30. Are there any exemptions from securities laws or regulations for employee share plans? If so, what are the conditions for the exemption(s) to apply? If share options under the share option plans and ESPPs are granted by a foreign parent company only to the employees and non-employee directors of the Japanese subsidiary that is 100% directly or indirectly (down to tier-two level) owned by the foreign parent and certain conditions are met (such as, for example, the prohibition of transfer of the granted options), the filing of an SRS or Securities Notice may be dispensed with irrespective of the total number of the employees and the total value of the share options. This exemption is not available if the plan is also offered to nonemployees, such as consultants. Under the Personal Information Protection Law of Japan (PIPL), if the Japanese subsidiary or affiliate that employs the employees who are the participants of any employee share plan implemented by the foreign parent company meets certain conditions as provided in the PIPL, such subsidiary or affiliate must comply with various requirements or obligations under the PIPL. Such requirements or obligations include: Specifying the purpose(s) of handling employees personal data. Disclosing such purposes to employees. Securely and safely keeping the employees personal data. Prohibition of providing the employee s personal data to any third party without obtaining the employee s consent. Supervising the third party data processor to which all or any part of handling of the employees personal data is outsourced. In general, providing employees personal data to a securities broker that provides account management services for the participants of any employee share plan is permissible if either: The provision of such personal data is deemed to be within the purposes of handling personal data as originally specified and notified to the employees. Specific consent is obtained from the employees upon enrolment to the plan. FORMALITIES 33. What are the applicable legal formalities? OTHER REGULATORY CONSENTS OR FILINGS 31. Are there any other regulatory consents and filing requirements and/or other administrative obligations for an offer of and participation in an employee share plan? If a foreign company files an SRS ( see Question 29 ), the foreign parent company becomes a so-called continuous disclosure company under the FIEA and must file an Annual and Semi-annual Securities Report (Form 8, 8-2 and 10) on a continuous basis. New tax reporting requirements have been introduced in the 2012 Japanese tax legislation. If an offshore company owns 50% or more of the shares in the Japanese employer, the Japanese employer must report the information on the income derived from the offshore share/cash incentive plan on an annual basis. The information on income associated with the plan must be reported by 31 March of the year following the year in which the taxable income is realised from the plan. Translation requirements There is no rule or regulation that requires the relevant documents to be prepared in Japanese, except that the prospectus must be prepared in Japanese and distributed to employees if an SRS is filed. or online agreements There is no rule or regulation that prohibits employees from entering into binding agreements under share plans electronically. Witnesses/notarisation requirements Legal agreements are not required to be witnessed or notarised to be binding. Employee consent The employee s consent is not required in connection with actions required to administer his options or awards (however, see Question 23 ).

8 DEVELOPMENTS AND REFORM 34. Are there any current trends, developments and reform proposals that have or will affect the operation of employee share plans? Trends and developments See Question 32. Tax reporting obligations are imposed on both the local employer and local participant employees. These reporting requirements have been introduced for the Japanese tax authorities to easily capture the offshore income earned by local employees through offshore share incentive plans or other incentive plans for income tax purposes, and also to capture the offshore properties for inheritance tax purposes. Reform proposals At this stage, there is no information concerning any proposed 2013 Japanese tax legislation reforms. However, given the introduction of the reporting obligations under the 2012 Japanese tax legislation ( see Question 32 ), it is generally anticipated that no further substantial changes will be made in the 2013 tax legislation. TADASHI ISHII Baker & McKenzie (Gaikokuho Joint Enterprise) T F E tadashi.ishii@bakermckenzie.com W CONTRIBUTOR DETAILS SHINICHI KOBAYASHI Baker & McKenzie (Gaikokuho Joint Enterprise) T F E shinichi.kobayashi@bakermckenzie.com W Qualified. Japan, 1988 Areas of practice. Corporate; finance; securities. Qualified. Japan, 1993 Areas of practice. Tax.