How to Establish a Corporation (Company) Overseas? Explaining the Types and Key Points

In Japan, where market growth has stagnated and the population is declining, it is expected that competition among companies will become even more intense in the future. Some business leaders may be considering expanding their operations to larger markets overseas, broadening their horizons beyond the domestic scene.

For Japanese companies looking to conduct business abroad, there are various options beyond establishing a corporation, such as setting up overseas branches or representative offices, each with its own form and personalityistics. This article will explain the methods for establishing a corporation overseas and the different types of companies. We will also introduce the advantages and disadvantages, as well as key points to consider when setting up a foreign corporation, so please use this as a reference.

Methods of Establishing a Corporation (Company) Overseas

To establish a corporation overseas, you must follow the rules and application procedures of the country you plan to enter. Since laws and systems vary by country, the methods of application and conditions for establishment differ accordingly. In other words, there are as many application methods as there are countries.

As various procedures in the local country can be time-consuming and labor-intensive, it is advisable to seek support from professionals such as lawyers.

Types of Corporations (Companies) That Can Be Established Overseas

There are four main types of corporate entities (companies) that can conduct business overseas:

• Local Corporation
• Foreign Branch
• Representative Office
• GEO (Global Employment Organization)

Here, we will explain the details of each type.

Local Subsidiaries

A local subsidiary refers to a corporation established in a foreign country by a Japanese company, and it is a common structure for overseas expansion. As it becomes a separate entity independent from the company in Japan, it can engage in different business activities.

In establishing a local subsidiary, it is necessary to follow the local laws for incorporation procedures and corporate registration, as well as to prepare and process articles of incorporation and internal regulations. Adopting the local wage system may also allow for the potential reduction of labor costs.

For corporate tax filing, it is sufficient to file according to the local laws, and there is no need to file in Japan. If the subsidiary is established in a country with lower tax rates than Japan, it may benefit from the difference in tax rates.

Overseas Branches

An overseas branch is considered an extension of the head office located in Japan, and similar to establishing a domestic branch, it is necessary to register the establishment of the branch with the Legal Affairs Bureau that has jurisdiction over the head office. In many cases, overseas branches can use the same articles of incorporation and internal regulations as in Japan, and accounting can also be conducted in the same manner. Therefore, when compared to setting up a local subsidiary, the initial effort and financial costs can be reduced. If the overseas expansion does not go well and results in losses, the liabilities of the branch can be offset against the profits of the head office.

Unlike representative offices, overseas branches have the attractive capability to conduct sales activities. Profits from overseas branches are subject to declaration and taxation in Japan. However, if profits are generated by the overseas branch, it is also necessary to declare them locally. In this case, by utilizing the ‘Japanese Foreign Tax Credit System’ in Japan, a portion of the tax can be deducted.

Liaison Offices

Liaison offices are, in principle, not permitted to engage in sales activities. The functions that can be performed by a liaison office include the following:

• Market research
• Information gathering
• Administrative communication with the Japanese head office

Liaison offices are strictly intended as a preparatory step before establishing a local subsidiary or an overseas branch, and they are also not allowed to open bank accounts. Furthermore, since they do not generate profits, they are not obligated to pay taxes.

GEO (Global Employment Outsourcing)

GEO (Global Employment Outsourcing) refers to the service of outsourcing operations abroad. Also known as international employment representation, it is a form of overseas expansion that has been gaining attention recently.

Employment agencies providing GEO services hire personnel locally, and these employees can then conduct business activities within that country. Furthermore, GEO service companies manage human resources, taxation, and legal affairs in accordance with local laws on behalf of their clients.

One of the attractive features of GEO is that it eliminates the need for the procedures required to set up a branch or incorporate a company, thus saving time and effort. When utilizing GEO, finding a reliable GEO service provider becomes crucial.

Advantages of Establishing a Foreign Corporation (Company)

When establishing a foreign corporation, not understanding the potential advantages and disadvantages can lead to failure. Here, we will explain in detail the benefits of setting up a foreign corporation.

Expanding into New Markets

While many industries in Japan are mature, it is likely that the market size will shrink in the future due to population decline. At present, some companies may be struggling to turn a profit. However, by entering markets outside of Japan, these companies can find new opportunities for success.

Depending on the product or service, there may be no competitors in certain foreign markets. Even if the prospects seem dim in Japan due to excessive competition, there could be significant profit potential abroad.

Cost-Effectiveness

For instance, labor costs in the Asian region tend to be lower than in Japan. The rent for stores and offices is also more affordable. Furthermore, the ability to use local raw materials without tariffs is another attractive point.

By keeping labor and material costs low, it is possible to reduce the cost of goods manufactured compared to producing the same items in Japan. However, it is important to be aware that labor costs may rise due to economic growth and improvements in education levels in the country of entry. Planning with consideration for future increases in labor costs will be crucial.

Some Countries Have Lower Barriers for Approval and Regulation

While Japan has various licensing systems and business regulations, there are many countries abroad with fewer regulations compared to Japan. There may be cases where a business that could not be conducted in Japan due to regulations can operate without issues overseas.

Tax Saving Strategies

If a company generates profits in a country with lower corporate tax rates than Japan, it can reduce its tax burden, thus serving as a tax saving strategy. The effective corporate tax rate in Japan, which includes corporate, local, and enterprise taxes, is approximately 30%, which is high by global standards. For example, Iceland has a 20% rate, the United Kingdom 19%, and Hungary 9%, indicating that there are many countries with lower corporate tax rates than Japan.

However, it is important to be aware of the “Japanese Anti-Tax Haven Measures” and the “Japanese Transfer Pricing Taxation System.” The Anti-Tax Haven Measures are regulations designed to address tax avoidance through the use of foreign subsidiaries. If a subsidiary is established in a tax haven, it may be subject to Japanese corporate tax. The Transfer Pricing Taxation System is a tax regime that prevents the transfer of income overseas.

If these systems are not taken into consideration, there is a risk of substantial additional tax assessments from the national tax authorities at a later date.

Tax Avoidance: The act of reducing tax liability through artificial or irrational transactions that are not subject to taxation under normal circumstances.

Tax Haven: A country or region with no or minimal taxation, such as the British Cayman Islands, the Virgin Islands in the Caribbean, and the state of Delaware in the United States.

Expansion of Information Sources and Networks

By establishing a base overseas, there is a greater likelihood of obtaining valuable information directly from the local area. Your network of contacts is also likely to expand. Even if it is a non-sales representative office, you can acquire information that would not be accessible unless you are on the ground, which can facilitate your company’s international expansion. Additionally, depending on the country of entry, there may be religious taboos or other considerations, but strategies to address these can also be developed.

If you can identify the unique needs and latest trends of the local market, you can develop a business that caters to them, thereby contributing to your company’s profits.

Increasing Variety of Available Currencies

The more countries in which you establish a corporation, the greater the variety of currencies you can use. If you have transactions with local banks, there is no need to exchange Japanese yen into foreign currency for transactions. As a result, you can avoid transaction fees and ensure speedy processing.

Furthermore, since Japanese interest rates are among the lowest in the world, holding foreign currencies can be more advantageous. By diversifying your funds across multiple currencies, you can also hedge against the risk of a weaker yen.

Expanding the Range of Funding Options

In Japan, when starting a business, it is common to seek financing from financial institutions if you do not have personal funds. However, it is also true that it can be difficult for companies without a track record to secure loans.

In some countries abroad, ‘direct financing’ by investors is more developed, which likely broadens the range of funding options compared to Japan.

The Disadvantages of Establishing a Foreign Corporation

Understanding the disadvantages of establishing a foreign corporation can enable you to hedge risks. Here, we will explain the drawbacks of setting up a business overseas.

Unique Risks Associated with Overseas Operations

Operating overseas inherently carries various risks that can affect your business, such as the potential for work to cease or profits to decline due to the country’s specific circumstances. For instance, during the COVID-19 pandemic, some countries implemented lockdowns. Depending on the country, you may also need to consider the risks of terrorism or war.

Political, social, economic conditions, and public safety differ from Japan, introducing various country risks. When dispatching Japanese employees to high-risk areas, measures such as securing safe housing and enhancing welfare benefits may be necessary. Gathering information in advance is crucial in this regard.

Country-Specific Tax Compliance is Required

One of the disadvantages of establishing a foreign corporation is the need for country-specific tax compliance. You will need to learn about the local accounting practices and tax laws, which can be time-consuming and costly. There will also be an increase in various procedures and applications in accordance with local laws.

Necessity to Use Financial Institutions Different from Japan

Since a foreign corporation is a separate entity from the Japanese headquarters, it may not be eligible for financing from Japanese financial institutions. It is advisable to consider financing options, such as utilizing financial institutions and support systems unique to the overseas location when establishing a foreign corporation.

Dispatching Employees from Japan Can Be Costly

Dispatching employees from Japan to a foreign corporation is also a disadvantage due to the associated costs. The costs involved in employee dispatch include:

• Overseas assignment allowance
• Children’s education allowance
• Hardship allowance
• Family accompanying allowance
• Single assignment allowance
• Moving expenses
• Housing allowance

Hardship allowance: An allowance for guaranteeing safety against regional dangers

Even if the goal of establishing a foreign corporation is to take advantage of lower labor costs, failing to fully consider expenses such as welfare benefits can lead to costs exceeding expectations.

Impact on Talent Development Curriculum

If you employ local staff, they will require different training from Japanese employees. Overseas education systems differ from Japan’s, which may hinder the implementation of appropriate training. There could be cases where local employees resist Japanese management methods or communication misunderstandings lead to conflicts. In such cases, you may need to develop a unique curriculum tailored to the country, which can be time-consuming and costly.

Furthermore, in many countries, there is little resistance to changing jobs, so there is a possibility that employees may leave after acquiring skills.

Key Points to Consider When Establishing a Corporation (Company) Overseas

When establishing an overseas corporation, there are four key points to consider:

• Whether the business aligns with the country in which it will operate
• Whether the country has potential for future growth
• How receptive the country is to foreign corporate entry
• Not to focus solely on tax savings

Please refer to the following detailed explanations when considering establishing a corporation overseas.

Compatibility of Business Operations with the Target Country

When establishing a subsidiary overseas, it is crucial to conduct thorough market research to determine whether the planned business operations are compatible with the target country. While there are many unknowns that can only be uncovered after setting up the foreign entity, insufficient market research can significantly increase the risk of failure.

It is also necessary to assess whether your company’s products or services will be accepted in the target country.

Assessing the Growth Potential of a Country

Due to the difficulty of achieving corporate growth solely within the Japanese market, some companies may consider establishing overseas subsidiaries. However, if the country they plan to enter does not show promising growth, the rationale for international expansion may be undermined. It is crucial to conduct thorough local research and assess whether the country has the potential for economic growth.

Attitude Towards Foreign Corporate Entry

Some countries actively welcome the entry of foreign companies. In the United States, the level of enthusiasm can vary by state. Since some countries offer preferential treatment systems, choosing such a country may facilitate a smoother establishment of a foreign corporation.

Do Not Solely Focus on Tax Savings

When establishing an overseas corporation solely for tax savings, caution is necessary as it may conflict with the ‘Japanese Controlled Foreign Company (CFC) rules’. While it is not illegal to establish a corporation in a tax haven, increased scrutiny has been applied due to numerous past incidents of improperly hiding assets.

Even if you establish a corporation in a tax haven, it is possible to be exempt from the Japanese CFC rules if certain conditions are met. The requirements for exemption are as follows:

Summary: Consult with Experts When Establishing a Foreign Corporation (Company)

Establishing a corporation overseas can provide various benefits, such as market expansion and tax-saving strategies. However, it is also true that there are disadvantages, such as the need to comply with tax and administrative procedures specific to the country you are entering, and the existence of various risks that differ from country to country. When expanding overseas, it is essential to conduct preliminary local research and information gathering.

If you are establishing a foreign corporation for the first time, it is advisable to consult with experts. Seek support from experienced professionals with a proven track record and aim to establish your foreign corporation.

Guidance on Measures by Our Firm

Monolith Law Office is a legal practice with extensive experience in both IT, particularly the internet, and law. In recent years, global business has been expanding increasingly, and the need for legal checks by specialists is growing more than ever. Our firm provides solutions related to international legal affairs.

Areas of practice at Monolith Law Office: International Legal Affairs & Overseas Business[ja]