Japan’s Startups to Benefit from Easier Stock-Option Tax Rules

Japan’s government and ruling Liberal Democratic Party have announced plans to ease the tax rules for stock options granted by startups to their employees and outside specialists. This move is aimed at fostering a more vibrant startup ecosystem and attracting talent to the sector.

What are Stock Options and Why are They Important for Startups?

Stock options are contracts that give the holder the right to buy or sell a certain number of shares of a company at a predetermined price within a specified period of time. They are often used by startups as a form of compensation or incentive for their employees, directors, and outside collaborators, such as freelance programmers, designers, and consultants.

Japan’s Startups to Benefit from Easier Stock-Option Tax Rules
Japan’s Startups to Benefit from Easier Stock-Option Tax Rules

Stock options can help startups to reduce their cash outflow, motivate their workers to perform better, and align their interests with the company’s long-term goals. They can also help startups to attract and retain talent, especially in fields where there is a shortage of skilled workers or high competition from established companies.

How are Stock Options Taxed in Japan?

In Japan, stock options are generally taxed as employment income at the time of exercise, regardless of whether the shares obtained from the exercise are sold or not. The tax rate can range from 10% to 45%, depending on the income bracket of the individual. In addition, a local inhabitant tax of 10% is also levied on the income.

However, there is an exception for “qualified stock options” that meet certain criteria, such as being granted by a listed company, having an exercise price that is not lower than the fair market value of the shares at the time of grant, and having an exercise period that is between two and 10 years from the date of grant. Qualified stock options are taxed as capital gains at the time of sale of the shares, rather than at the time of exercise. The tax rate for capital gains is 20%, which is lower than the employment income tax rate.

What are the Proposed Changes for Startups?

Under the proposed changes, the exercise period requirement for qualified stock options will be relaxed for stock options issued by certain unlisted Japanese startups to their employees and outside specialists. The new requirement will be that the option must be exercised within 15 years from the date of grant, rather than within 10 years.

This means that individuals who receive stock options from startups will have more time to defer their tax liability and benefit from the lower capital gains tax rate. This will also give startups more flexibility to design their stock option plans and reward their workers based on their performance and contribution.

The proposed changes will apply to startups that are unlisted Japanese companies (“Kabushiki-Kaisha”) that have been in existence for less than five years and meet certain other requirements, such as having a certain ratio of research and development expenses to sales or having received funding from venture capital firms or angel investors.

What are the Expected Impacts of the Changes?

The proposed changes are expected to have positive impacts on Japan’s startup sector, which has been lagging behind other countries in terms of innovation and growth. According to a report by Startup Genome

, Japan ranked 15th in the global startup ecosystem ranking in 2020, behind countries such as China, India, Germany, and France.

By easing the tax burden on stock options, Japan hopes to encourage more people to join or start new ventures, especially in fields such as artificial intelligence, biotechnology, fintech, and green energy. The changes are also expected to help startups compete with larger companies for talent and foster a culture of entrepreneurship and risk-taking.

The proposed changes are part of Prime Minister Fumio Kishida’s vision of “new capitalism”, which aims to promote social justice and economic growth through innovation and investment in human capital. The changes are also in line with Japan’s efforts to attract more foreign talent and diversify its workforce amid an aging population and a shrinking labor market.

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