a. Factors that Determine Who is an Employee and Who is an Independent Contractor
An independent contractor under Japanese law is a person/ entity that works as an independent service provider, and not subject to instruction or supervision by the particular business entity which is the client. In determining whether the individual working for a client is an independent contractor, the administrative authorities and courts typically consider whether the independent contractor:
i. possesses the discretion to accept or refuse a job offer (i.e. cannot be “ordered” to work, and can choose to accept an assignment or not) – even clearer if the individual can and does take work from other client(s);
ii. has the discretion to decide how to perform their own service and management of their work, who to allocate for the work (when the independent contractor is not an individual), and not evaluated, supervised or directly managed by the client (the client may evaluate the contractor as it would any outside contractor, but cannot discipline, demote, or otherwise evaluate in a way that is unique to employees). When detailed instructions are necessary to outsource service, this can still be done if the requirements are set out in writing, and made as part of a pre-arranged agreements, rather than instructions by the client, but direct contact for detailed/ daily instruction is one of the strongest indicator of “contractor-in-disguise”;
iii. possesses the discretion to decide own working hours, work days as well as management of attendance;
iv. assumes responsibility for damage regarding their own performance and otherwise all responsibilities as a business entity regarding the performance of the service;
v. procures their own funds and makes payments necessary for the tasks assigned;
vi. tax treatment is in line with independent contractor, such as paying consumption tax (for domestic matters and the client is a taxable entity in Japan – this may not be added for service to a foreign entity), and the individual reports the remuneration as business income (not salary from client) for tax purposes;
vii. owns the instruments or materials to perform the work, or pays compensation for any instruments leased by the client, and does not simply provide physical labour subject to the client’s supervision and order;
viii. whether or not contributions to employment insurance, workers accident compensation insurance, employment pension and employee health insurance are not deducted from the remuneration to the individual;
ix. if the individual is substitutable with others in performing the work (i.e. if the individual has the discretion to use a substitute or an assistant), it will enhance the independence status;
x. any clear difference with how employees are treated would also help clarify the status of an independent contractor.
Not fulfilling one or more of the above criteria will not necessarily mean that the relationship will automatically be viewed as an employment relationship, as long as there is a reasonable business necessity for the exception (such as having to provide services at the client’s premise if the nature of the service requires it, but in such instance, the client needs to be careful not to directly give “instructions” and should be avoided as much as possible). In order to clarify that the contract fulfils the requirements for an independent contractor, there should be a written agreement to confirm the arrangement with the independent contractor.
b. General Differences in Tax Treatment
Independent contractors normally need to be paid consumption tax (for domestic matters and the client is a taxable entity in Japan – this may not be added for service to a foreign entity), to be borne by the client. Whether withholding for income tax is made for remuneration to an independent contractor depends on whether the independent contractor is incorporated or not. Remuneration to an independent contractor would be categorized differently from “salary income”. Employees’ remuneration, taxed as salary income, is subject to withholding of income and resident’s tax.
c. Differences in Benefit Entitlement
There is no statutory obligation to provide any benefit to an independent contractor – the independent contractor is responsible for their own (or if they employee employees, their employees’) benefits.
Provided, however for dispatched workers to receive access to benefits/ training opportunities that direct employees are provided as much as possible.
d. Differences in Protection from Termination
Contracts with an independent contractor is subject to the Civil Code and Commercial Code, so termination would need to meet requirements thereunder, or fall under a contractual cause for termination. There is no minimum or maximum period. While frequent renewals and/or a very extended period may lead to a client requiring a “justifiable cause” for termination, parties can exclude such a risk by having a clear agreement on what the criteria for extensions are and that the independent contractor is not given expectation of automatic renewals.
In contrast, employees, who are protected by the Labor Standards Act and Labor Contract Act, among other employee-related law, cannot be terminated without “reasonable cause” for open end employees (the term “reasonable” may be misleading, as it is not the same as “reasonableness” from what may be deduced from common sense, it requires a demonstration of a high-level difficulty to maintain employment by the employer), and “inevitable cause” for terminating a fixed term employee during their fixed term, and such strict rules cannot be changed even if the employee agrees to less stringent causes for termination in an employment contract if Japanese law applies as the most relevant law in relation to employment. Further, an amendment to the Labor Contract Act implemented in 2013 now stipulates that an employee has a right to change a fixed term employment contract to open end if a fixed term contract starting on or after April 1, 2013, reaches a period over 5 years due to renewals (please note that a fixed term employment contract as a general principle cannot be longer than 3 years – otherwise the court will assume that it turned into open end after exceeding the statutory upper limit).
e. Local Limitations on Use of Independent Contractors
Independent contractors must maintain their independence – otherwise, usage of a third party workforce is regulated, and unless the structure falls under such regulated exception, illegal.
Independence is determined by the factors listed under II.a. above. The few exceptions allowed (in other words, using labor of third parties as if the workers are employees of the Client) is to use worker dispatch from a registered worker dispatch agent, and such relationships are permitted under heavy regulation, or secondment, which is also subject to certain restrictions.
Use of third parties as part of the Client’s workforce, without distinction of the independence contractor status nor fulfilling the criteria for worker dispatch or secondment, is viewed either as (i) violation of the Employment Security Act (Shokugyo Antei Ho) called “worker provision” under which both sender and recipient are subject to criminal fine of JPY1million or less, or (ii) violation of the Worker Dispatch Act (Rodosha Hakenjigyo no Tekisei na Unei no Kakuho oyobi Hakenroudousha no Hogo ni kansuru Houritsu) under which the sender may be subject to criminal penalty, and the recipient (client) would be subject to administrative guidance. Which law will apply will depend on whether the sender and recipient each have an employment relationship with the worker. If the sender employs the worker, but the recipient does not, the Worker Dispatch Act will apply; if the sender does not employ the worker, or if the sender employs the worker but the client also employs the worker, the Employment Security Act will apply.
In case of violation of the Worker Dispatch Act, the following situations will lead to “deemed offer of direct employment” by the recipient, unless the recipient can prove that they were unaware of such violation and was not negligent in not noticing the violation:
i. Having the worker engage in prohibited areas of business (e.g. port work, construction, security, medical work, certain licensed work such as lawyer, judicial scrivener, certified public accountant);
ii. Accepting dispatched worker from an agent that is not a licensed agency;
iii. Accepted a dispatched worker beyond the period allowed under law.
Periods allowed under law:
• dispatch less than 30 days is prohibited except for certain types of work (e.g. translator, secretary)
• unless the worker is employed as an open end employee at the temp staff agency, is age 60 or older, or works under certain special circumstances (such as replacement during child care/ family care leave), there is a 3 year limitation on worker dispatch that applies in two different ways.
One is that the aggregate period of accepting a dispatched worker in the same workplace will need to be within 3 years – even if the individual changes, or the position a dispatched worker is accepted for is different, as long as there is a dispatched worker in that workplace, such period will be aggregated. The 3 year period can be renewed if the employer obtains the opinion of the employee representative of the workplace on what they think of continuing accepting dispatched workers (if an employer fails to do this, and continues the use of a dispatched worker, the employer will be deemed to have offered direct employment basically with the same terms and conditions of employment which applied between the worker and the temp staff agency).
The second restriction applies if the same worker works in the same position/ team for over 3 years, again, the employer is deemed to have offered direct employment. This means unless the worker is an open end employee at the temp staff agency (or falls under other exceptions explained above), any business accepting dispatched workers must rotate them at least every 3 years to avoid starting direct employment.
The 3 year period in both cases (where the workplace continuously receives a dispatched worker for 3 years, or if the same individual works continuously as a dispatched worker for 3 years) can be interrupted by a gap longer than 3 months – however this needs to be a genuine gap and if it is obviously placed to circumvent the 3 year gap, the parties involved in worker dispatch may be viewed to be in violation of the Worker Dispatch Act, and the recipient may be obligated to offer direct employment of the worker.
f. Leased or Seconded Employees
As explained above, the use of temp staff (worker dispatch) is allowed under certain restrictions although they are not referred to as “leased” employees in Japan.
Secondment, which is defined as a relationship where the seconding entity sends its employee to a different entity, and the recipient entity either employs, or enters into a similar relationship (not necessarily full employment, but a relationship includes aspects of employment) is commonly performed in Japan, especially among group companies, but according to administrative guidance issued by the Ministry of Health, Labor and Welfare, secondment must fall under one of the following categories to avoid falling under illegal worker provision. The administrative authorities’ view is more narrow than what is done in practice, so there is a significant discrepancy between what is done as common practice and what the administrative officials view as acceptable):
• the secondment is done to avoid termination of employment, by procuring a position as an employee at a group company;
• performance of guidance in management skills or technical skills;
• part of training work related abilities;
• exchange of personnel within corporate groups.