On May 20, 2015, in accordance with the Business Entity Accounting Act and the International Financial Reporting Standards (IFRSs), Article 235-1 of the Company Act was amended to reflect a change in the characterization of employees’ compensation. Employees’ compensation was previously characterized as a distribution of surplus earnings, but it is now to be characterized as an expense item, so as to comply with international standards and to protect employees’ right to a share in profits.
Major provisions of the amended Article 235-1 include the following: (1) a company is required to amend its articles of incorporation to provide that employees’ compensation is to be determined based on the current year’s profits, either as a fixed amount or as a ratio of the profits, with such profits being the pre-tax profit prior to deducting employees’ compensation (as opposed to after-tax profit); (2) for the soundness of the company’s continuing operation, the company's accumulated losses shall first be covered before distributing employees’ compensation; (3) the form of employees’ compensation may be in cash or shares, as determined by the board of directors; and (4) the amended Article 235-1 applies mutatis mutandis to a limited company (which does not issue shares, thus those parts of Article 235-1 relating to shares are not applicable), so that rules relating to employees’ compensation are no longer only for employees in companies limited by shares.
The competent authority regulating employees’ compensation, the Ministry of Economic Affairs, issued a ruling regarding employees’ compensation in June, 2015, stating that (1) companies shall distribute employees’ compensation for the current year (2015) in accordance with properly-amended articles of incorporation; failure to do so may subject companies to claims by employees, to the extent such failure causes damage to employees; (2) where the articles of incorporation specify employees’ compensation as a ratio of profits, such ratio must be set in one of three ways: (i) a fixed ratio (e.g. 2%), (ii) a range of ratios (e.g. 2-10%); or (iii) a minimum threshold (e.g. at least 2% or no lower than 2%); and (3) the board of directors may distribute employees’ compensation by issuing new shares or with outstanding shares by adopting a special resolution and reporting to the shareholders’ meeting.
The Ministry of Economic Affairs also issued another ruling in October, 2015, stating that (1) where employees’ compensation is specified in the articles of incorporation as to be between a set range or to be above a certain minimum threshold, the yearly distributing ratio for employees’ compensation must be decided by a special resolution adopted by a meeting of the board of directors; the power to decide the distributing ratio is a statuory power granted to the board of directors, and cannot be determined by the articles; and (2) after modification of the articles of incorporation in accordance with Article 235-1, employees' compensation may be distributed by a special resolution adopted by a meeting of the board of directors; however, if the distribution requires a modification of the articles to increase the company’s capital, the board of directors may adopt a conditional resolution stating that “employees’ compensation shall be distributed in new shares only if the shareholders’ meeting adopts a resolution to modify the articles to increase the capital, otherwise the compensation will be in cash”.
Based on the rulings discussed above, a company must amend its articles of incorporation in accordance with the amended Article 235-1 no later than the upcoming general shareholders’ meeting in 2016. Furthermore, where employees’ compensation is specified in the articles as to be between a set range or to be above a certain minimum threshold, the yearly distributing ratio shall be decided by a special resolution adopted by the board of directors and be reported in the shareholders’ meeting. However, no penalties have been set forth in the Company Act for failure to comply with the amended Article 235-1, therefore, it remains to be seen whether the amended Article 235-1 will be fully complied with by companies.