Asking a Tax Accountant: Mid-term Increases in Executive Compensation — Even if Business is Booming, Can You Overcome the Tax Barrier!?
Mid-term Increases in Executive Compensation — Even if Business is Booming, Can You Overcome the Tax Barrier!?
Characters:
President: A passionate startup CEO. Grinning at the increase in sales.
Tax Accountant: A steady professional. Calm analysis behind a smile.
President: Doctor, our new product is a smash hit! This year, we have a 20% increase in profit compared to last year! Well, our company's time has finally come!
Tax Accountant: That is wonderful, congratulations. It is truly the fruit of your hard work.
President: Right? So, as a reward for our strong performance, I was thinking of increasing executive compensation by 10% mid-term. Hehe.
Tax Accountant: ...That "hehe" is what concerns me.
President: Hmm? Is there a problem? The company is making money, so I should be able to reward myself a little...
Tax Accountant: President, in terms of tax, that won't just be a "little" issue.
1. Basic Rules of Corporate Tax Law
With the 2006 revision, only the following three patterns are permitted for tax-deductible executive compensation.
Regular fixed compensation (Article 34, Paragraph 1, Item 1 of the Corporate Tax Law)
Pre-notified compensation (Item 2 of the same paragraph)
Profit-linked compensation (Item 3 of the same paragraph)
The issue here is whether an "increase due to strong performance" like this qualifies for these.
2. What is Regular Fixed Compensation?
Under Article 69 of the Corporate Tax Law Enforcement Order, "regular fixed compensation" is defined as:
at a fixed time
the same amount
Providing it on a continuous basis
is a requirement, and unless it is revised within "three months from the start" of the fiscal year, it will not be recognized as a deductible expense.
President: Whoa, so if I increase it after the mid-term closing this period, is that... out?
Tax Accountant: Yes, unfortunately, that increase will not be recognized as regular fixed compensation and will not be tax-deductible.
President: What!? Is the National Tax Agency really that strict!?
Tax Accountant: They say love is found within strictness.
3. Is it okay if it's a temporary revision or a revision due to poor performance?
Under Article 69 of the Enforcement Order, the following cases may also be permitted:
Temporary revision reasons (e.g., change in officers, etc.)
Reasons for revision due to poor performance (reduction due to poor performance)
But since this is an "increase due to good performance," it doesn't fall under either category.
President: ...So if performance is bad, lowering it is tax-deductible, but if it's good and I raise it, it's not... that's unreasonable!
Tax Accountant: That is a common sentiment, but the purpose of tax law is to curb profit manipulation. If you could raise and lower it freely, it could be used to defer taxes.
4. So what should I have done?
Tax Accountant: Actually, the standard approach is to make the increase as a regular revision within three months of the start of the next fiscal year.
President: I see! So, keep it as is for this term, and raise it confidently next term.
Tax Accountant: That is correct.
President: By the way, is the entire increased amount disallowed?
Tax Accountant: No, the original amount will be tax-deductible. Only the increased portion will be disallowed.
President: Alright, I'll have the accounting department be careful about that.
5. Summary: Points to Note for Mid-term Increases
Regarding mid-term increases in executive compensation:
Regular revisions are limited to "within 3 months from the start of the fiscal year"
Mid-term increases due to strong performance are, in principle, non-deductible expenses
Only the increased portion is non-deductible; the original amount is acceptable
Plan for increases in the next fiscal year
Reference Laws and Regulations
Corporation Tax Act Article 34
Corporation Tax Act Enforcement Order Article 69
National Tax Agency "Q&A on Executive Compensation" (December 2008) Q3
Active Recall: 7-Question Check!
What are the requirements for fixed-amount periodic compensation?
According to Article 69 of the Corporation Tax Act Enforcement Order, by when must regular revisions be made?
Why are mid-term increases in executive compensation not tax-deductible?
What constitutes grounds for a revision due to deteriorating business performance?
Which part of the executive compensation becomes non-deductible in a mid-term increase?
What are the conditions for an increase in executive compensation to be tax-deductible in the next fiscal year?
How should the increased portion that became non-deductible be handled?
Answers
To pay the same amount continuously at fixed intervals.
Within three months from the start of the fiscal year.
Because arbitrary increases are not permitted in order to prevent profit manipulation.
When it is necessary to reduce compensation because business performance has deteriorated and management has become difficult.
Only the increased portion will be treated as non-deductible expenses.
As a regular revision, it should be done within three months from the start of the fiscal year.
The increased portion is treated as a non-deductible expense for corporate tax calculation purposes and processed separately.
President: The world of taxes is truly profound. I'm glad I have a tax accountant.
Tax Accountant: I'm glad to hear that. But please consult with me earlier next time, okay?
President: Understood! (Looking remorseful)