Compliantly Engage Contractors in Japan

Any business hiring in Japan should understand the important legal distinction between who classifies as an independent contractor and who can be hired as an employee. Fines or penalties may be issued to businesses who are hiring contractors under the guise of employment, which can lead to criminal charges and reputational damage.

Understanding the differences between employees and independent contractors is therefore critical to compliantly engaging workers in Japan. It is important to work with a partner like Worksuite to ensure you put in place an engagement framework that accurately classifies independent contractors for you and lets you know when freelance talent must be engaged as an independent contractor or employed directly.

Employment remains the overwhelmingly predominant working model in Japan. Japanese law refers to three types of employee: permanent employees or seisha-in (正社員); contract employees or keiyakusha-in (契約社員); and temporary or ‘contracted employees’ hakensha-in (派遣社員). As such, there is no clear definition of independent contractors or those who work outside one of these employment types, although Japan has a growing number of individuals who do work as independent contractors. 

Depending on the individual’s classification, this can have significant implications for companies looking to hire independent contractors in Japan. For the hiring company, engaging with independent contractors may be legally and financially risky, especially given the possibility of an independent contractor becoming re-classified as an employee of the hiring company.

As in many countries, if the real substance of the company-contractor relationship proves to effectively be an employment relationship, the hiring company may suffer legal and financial penalties (including payroll taxes). It is therefore important to leverage an employment service partner like Worksuite when hiring in Japan in order to ensure that independent contractors fall under the correct working relationship with your business.

Who is an Independent Contractor?

As in many countries, there is no strict definition of employees and independent contractors in Japanese law. However, individuals are generally considered independent contractors if they:

• Can choose whether to accept or decline a job
• Perform work for more than one client
• Are not subject to the hiring company’s operational rules
• Can choose their own working hours, days, or schedule
• Can choose their own place to work from (unless the work is site-specific)
• Provide their own equipment to carry out assigned tasks 
• Do not work under direct supervision, directives, or instructions
• Are paid on the basis of time spent on work, not for deliverables
• Are not subject to disciplinary procedures
• Are responsible for any damages relating to work performed

The following category of independent contractor applies in Japan:

Sole Proprietor: Unlike many other countries, Japan has only one type of independent contractor category, the sole proprietor (kojin jigyo or 個人事業), who is also referred to informally as a freelancer. An individual who runs their own company, such as a Limited Liability Company, must draw a salary from the company and is considered an employee of that company. To set up a sole proprietorship, individuals need to submit a “Notification of Opening or Closing of a Sole Proprietorship” (kojinjigyou no kaigyou, haigyou nado todokede sho or「個人事業の開業・廃業等届出書」) to the National Tax Agency (NTA).

There are two primary engagement models for working with independent contractors in Japan:

A. Direct Engagement: Under this model, the hiring company engages directly with the independent contractor and establishes a direct contract for the provision of services (often called an ‘outsourcing contract’). The hiring company then pays the independent contractor directly, in accordance with the terms of the contract.

B. Third Party: These firms come in two forms and both are specially designed to vet and engage freelancers compliantly as either contract employees or independent contractors on your behalf.

1. Agency: Here, the hiring company engages with a staffing or temporary (‘temp’) agency, which in turn supplies one of its own contractors to deliver the contracted services. These are called haken contracts, and temporary employees are called hakensha-in. The hiring company pays the staffing agency directly, in accordance with the terms of the contract. The contract is therefore between the hiring company and the staffing agency, while the agency pays the independent contractor through a separate contractual arrangement.
2. Umbrella Company: Japanese independent contractors can also work through an umbrella company. This turns a ‘self-employed’ individual into a legal ‘employee’ of the umbrella company and therefore helps avoid complications around tax and other issues. The contractual relationship is between the umbrella company and the client, with the umbrella company running payroll and administration for the independent contractor. The umbrella company invoices the client directly, while paying the contractor as a standard employee. Umbrella companies levy a fee on the contractor to cover their costs.
3. Employer of Record (EOR): Like an umbrella company, an EOR can also act as the independent contractor’s legal employer, while the hiring company is effectively a customer of the EOR. However, unlike the limited scope of an umbrella company, an EOR’s responsibilities are wider-ranging and can include all aspects of payroll, taxes, and HR (including onboarding and offboarding).
4. Hiring Partner: The hiring company can also work with a hiring partner who helps them vet potential independent contractors, set up contracts, ensure the contractor is properly classified, onboard and manage contractors, and pay contractors.

Companies hiring independent contractors in Japan should avoid making payments directly through their payroll system. Beyond these guidelines, there are no specific lawful requirements related to paying independent contractors in Japan. The contract should stipulate the preferred payment method agreed upon by both parties.

Employees are subject to income tax or shotoku-zei (所得税) which is withheld at source. This means employees are typically not required to submit any tax forms in relation to their income earned via employment, unless they have additional sources of income that are not taxed at source. Japan has a progressive tax rate, starting at 5% for incomes up to JPY 1.95 million, and increasing to 45% for incomes over JPY 40 million. Independent contractors file and pay their own income taxes. The tax filing deadline is 15 March for the preceding tax year, and taxes can be filed online at the National Tax Agency’s (NTA) e-tax portal. 

Japan has a strong social security framework backed by the National Universal Health system. This includes five types of insurance: health insurance; welfare pension insurance; unemployment insurance; nursing care insurance; and, for some occupations, workers’ compensation. Employers and employees typically contribute a 50:50 share to health insurance, welfare pension insurance, and nursing care insurance; employers typically pay a greater share of the employment insurance premiums.

In Japan, permanent resident taxpayers are taxed on their worldwide income. Non-resident taxpayers are taxed only on their Japan-sourced income. Non-permanent resident taxpayers are taxed on their income other than foreign-source income (in particular, potentially, on certain capital gains) that are not remitted into Japan plus potentially part of their foreign-sourced income that is paid in or remitted to Japan.

A non-resident taxpayer’s Japan-source compensation (employment income) is subject to a flat 20.42% national income tax on gross compensation with no deductions available. This rate includes 2.1% of the surtax described above (20% x 102.1% = 20.42%). A non-resident taxpayer may be subject to the local inhabitant’s tax at a rate of 10% if they are registered as a resident as of 1 January of the following year.