Japanese Court Rules Stock Option Gains Are Salary Income

February 20, 2004 (PLANSPONSOR.com) - The decision that stock options gains in Japan should be treated as salary income - not occasional income - could send plan sponsors scrambling to review compensation programs for their Japanese-based employees.

The ruling in question was handed down by the Tokyo High Court, which reversed a lower court ruling and sided with the Japanese tax office that originally said a higher tax rate should be imposed on a president of a foreign-capitalized company, regarding his stock gain as salary income. A “gain from stock options is a reward for dedicated work by an employee. Therefore, it should be considered salary income,” said presiding Judge Keiichi Murakami in the decision, according to a report in the Yomiuri Shimbun.

Implications of the Japanese’s court decision could have a ripple effect not only in Japan but also across the globe.   Currently in Japan there are about 100 ongoing lawsuits over similar cases of additional taxes levied against stock option related income across the nation. But on a macro scale, plan sponsors currently find themselves struggling with how to administer compensation programs when there are a myriad ways other countries tax equity-based compensation (See  Feature: Expatriate Gains ).  In fact, according to the PricewaterhouseCoopers Human Resource Services’ 2003 Global Equity Survey, in which 70 US-based multinational companies with operations in 20 countries answered 300 questions, 70% of respondents indicated that global regulatory compliance is one of the most challenging aspects of a global equity plan.

Japanese Case

The latest case centered around the stock options of Keisuke Yawata, the former president of Applied Materials Japan Inc., a subsidiary of the United States-based semiconductor maker.  Yawata earned approximately 360 million yen between 1996 and 1998 through the exercise of stock options he was awarded by the US-based Applied Materials.   This income was then reported as occasional income to the appropriate tax office.  

However, the Tokyo Regional Taxation Bureau later began instructing tax offices to tax stock-option gains as salary income.   The Income Tax Law now stipulates any reward for work is salary income further setting a tax rate for salary income that is nearly double the rate for occasional income.

Applying the directive ex post facto , Yawata was ordered to pay about 90 million yen in additional tax, including a penalty for underestimating income, in 2000. Yawata filed suit against the Japanese tax office’s original levy of the tax, contending it was illegal for the tax office to have imposed additional tax by regarding the income earned by exercising his stock options as salary.

Originally, the Tokyo District Court sided with Yawata, finding that stock option gains were occasional income, because the gain fluctuates depending on the option holder’s investment judgment over the timing of purchase and changes of the stock price.   This decision was overturned, with the high court turning to the fact a worker’s labor contributes to improvement of the company’s performance thus improving the company’s share price and boosting the worker’s gain from exercise of the stock option.  

As such, the high court found the income should be treated as salary income.   Yawata plans on appealing the latest verdict.