Table of Contents

1. Summary
2. Payment Frequency
3. Overtime Compensation
– a) Issues
– b) Standard Rules on Working Hours and Overtime
– c) Method 1 – Exemption for Managerial or Supervisory Roles
– d) Method 2 – Deemed Working Hours System
– e) Method 3: High-Level Professional Exemption
– f) Method 4: Fixed-Amount Overtime Charge
– g) Accurate Tracking of Working Hours
4. Reduction of Annual Salary from the Previous Year’s Level

1. Summary

The “annual salary system” is a pay structure commonly used by international companies, and it typically has the following features:
– The employee’s compensation is determined on an annual basis, rather than a monthly basis as is typical in Japan.
– The annual salary is set each year based on performance evaluations and discussions between the employer and the employee. This contrasts with Japan’s traditional seniority-based wage system, where salary levels are generally determined by age and length of service.
– The amount of compensation is based on performance rather than the actual number of working hours.

Although popular among foreign-affiliated businesses in Japan, introducing a true annual salary system is not straightforward due to the constraints of Japanese labor laws.

In this column, we first explain the legal requirement regarding payment frequency in Section 2. Section 3 outlines Japan’s overtime compensation rules and discusses how companies can structure salaries so that compensation is not directly tied to actual working hours—a crucial consideration, especially given the increased enforcement of overtime laws in recent years. In Section 4, we explore how employers may reduce an employee’s annual salary based on performance. Although performance-based reductions are inherent in the annual salary model, Japanese regulations place certain limitations on such practices.

2. Payment Frequency

Under Article 24, Paragraph 2 of the Labor Standards Act, wages must be paid at least once a month on a fixed date. Therefore, even if an annual salary system is adopted, employers may not pay the entire salary as a lump sum once a year.

However, employers are not required to pay an equal amount each month. For example, they may divide the annual salary evenly and pay 1/12 each month, or pay 1/16 monthly and reserve 4/16 to be paid as a form of bonus at some points in the year.

3. Overtime Compensation

a) Issues

Japanese labor law requires employers to pay overtime compensation when employees work more than 8 hours a day, or when they work on statutory holidays or during nighttime hours. Although there are limited exemptions—such as for managerial/supervisory employees or under the deemed working hours system or high-level professional exemption—and some employers pre-include a fixed overtime allowance in salaries, each method has specific legal requirements and limitations.

We begin with an overview of working hours and overtime compensation under Japanese law.

b) Standard Rules on Working Hours and Overtime

In Japan, statutory working hours are limited to 8 hours per day and 40 hours per week. Employers must also provide rest breaks (45 or 60 minutes depending on the hours worked) and at least one day off per week or four days off over a four-week period.

To require employees to work overtime or on days off, employers must enter into a labor-management agreement under Article 36 of the Labor Standards Act—commonly referred to as a “saburoku kyotei”—with a certain labor union or employee representative. Even with such an agreement, overtime work is generally limited to 45 hours per month and 360 hours per year. These limits may be extended to a maximum of 100 hours per month and 720 hours per year under exceptional circumstances.

Overtime compensation must be paid at the following premium rates:
– Overtime Work: 25% premium for hours exceeding statutory limits, increasing to 50% for hours exceeding 60 in a single month.
– Holiday Work: 35% premium for work on statutory holidays.
– Night Work: 25% premium for work performed between 10:00 p.m. and 5:00 a.m.
If an employee works overtime during night hours or on a statutory holiday, both applicable premiums must be paid cumulatively.

c) Method 1 – Exemption for Managerial or Supervisory Roles

Under Article 41, Item 2 of the Labor Standards Act, employees who serve in managerial or supervisory positions (kanri kantoku sha) are exempt from regulations concerning working hours, rest periods, and days off. However, this exemption does not apply to nighttime work compensation, which must still be paid.

According to the notice issued by a competent Japanese authority, “employees who serve in managerial or supervisory positions” mean employees whose positions are in a part of management team in regard to determination of working conditions and other labor management matters. Typically department head or factory head would fall into this category but it shall be determined based on the reality rather than name of the position.

On the other hand, based on the past court cases, all of the following conditions must generally be met to qualify as a managerial or supervisory employee:

1. Significant Decision-Making Authority: The employee is functionally equivalent to management from a labor management standpoint. They are involved in important business decisions, have authority over divisions or teams, and exercise discretion over personnel matters.

2. Autonomy over Working Hours: The employee has control over their own working schedule and is not subject to directives regarding arrival or departure times.

3. Appropriate Compensation: The employee receives sufficient remuneration reflecting their managerial, which justifies non-payment of overtime.

Courts assess this exemption on a case-by-case basis. For instance, factory heads, store managers, and department heads have often been denied the exemption due to lack of managerial authority, autonomy over working hours, or adequate compensation.

In contrast, courts have upheld the exemption in cases where employees:
– Oversee the entire company or multiple branches;
– Hold executive titles and are involved in core decision-making;
– Head of department or section having personnel authority, discretion over work schedules, and receive compensation aligned with their responsibilities.

Also, it is not clear whether senior staffs who do not have subordinates but are engaging in important corporate decision-making and have senior title may also fall into the “employees who serve in managerial or supervisory positions”. According to the competent Japanese authority’s view, such senior staffs can fall into the category, but Japanese courts have judged as explained above.

d) Method 2 – Deemed Working Hours System

Another way to fix compensation regardless of actual working hours is through the use of deemed working hours systems. These systems are designed for roles where tracking actual working hours is difficult or where the nature of the job requires significant discretion on the part of the employee. Under these systems, employees are deemed to have worked a pre-set number of hours. However, if the pre-set hours exceed statutory working hours, overtime compensation must be paid. Additionally, statutory requirements concerning break time, days off, and late-night work premiums still apply.

(1) Deemed Working Hours for Work Outside the Office

This system applies to employees whose actual working hours are difficult to measure due to their work being performed outside the office—for example, field sales representatives who are not micromanaged in their daily schedules. In such cases, the employee is deemed to have worked a set number of hours.

However, the deemed hours must correspond to the employee’s actual workload. If the employee generally works beyond the statutory hours to fulfill their duties, they are deemed to have worked the number of hours “generally required” to perform the job. If the employer and the majority labor union (or a representative of the majority of employees, if no such union exists) enter into a written agreement specifying the deemed working hours and submit it to the competent Labor Standards Office, the agreed-upon hours will be treated as the hours “generally required” for the work.

(2) Discretionary Working Hours System for Professional Services

This system may be used for certain professional roles that require considerable discretion in how tasks are performed and are not suited to detailed employer instruction including the instruction as to time allocation.

Eligible job types are listed under Article 24-2-2, Paragraph 2 of the Enforcement Ordinance of the Labor Standards Act, and include product development, R&D, system engineers, certain mediapersons such as press persons, editors, producers and directors, designers, copywriters, system consultants, interior coordinators, game software producers, securities analysts, development of financial product using financial engineering, investment bankers advising M&A, and certain other professional jobs. Even if the employee falls within an eligible job category, the system cannot be used if the employer gives specific instructions on how and when tasks should be completed (including when to arrive and leave office). For example, if R&D is conducted by team and chief of the team gives team members specific instruction how and when tasks should be completed, this exemption can be used for the team members.

To adopt this system, the employer must enter into a written agreement with the majority labor union or an employee representative and submit it to the competent Labor Standards Office. The agreement must specify the hours that the employee is deemed to have worked. Additionally, individual employee consent must be obtained (which can be later withdrawn), and the employer should take measures to keep employees’ health and address employees’ complaints.

(3) Discretionary Working Hours System for Business Planning Roles

This system applies to roles involving planning, research, and analysis of business management (typically, development of business strategy) that require significant discretion in the execution of duties.

To use this system, the employer must establish a labor-management committee (an “Labor-Management Committee”) comprising representatives of both management and employees. At least half of the Labor-Management Committee must consist of employee representatives. A supermajority (four-fifths) of the Labor-Management Committee must approve the use of the system, and the resolution must be submitted to the competent Labor Standards Office. As with the discretional working hour system for professional services, individual employee consent is also required and may be freely withdrawn, and the employer should take measures to keep employees’ health and address employees’ complaints. Employer using this system cannot give the targeted employees specific instructions on how and when tasks should be completed (including when to arrive and leave office).

The working hours deemed for applicable employees must be specified in the Labor-Management Committee’s resolution.

e) Method 3: High-Level Professional Exemption

A third method of decoupling compensation from actual working hours is the high-level professional exemption. Under this system, all statutory regulations concerning working hours—including those on overtime, breaks, holidays, and late-night premiums—are waived. Notably, this exemption also waives the night work premium, which remains mandatory even for managerial/supervisory employees.

Given the extensive flexibility afforded by this exemption, it is subject to stringent eligibility and procedural requirements, along with mandatory health safeguards.

Eligibility:
– The employee must earn a fixed annual compensation of at least JPY 10.75 million.
– The exemption applies to highly specialized roles where there is little correlation between working hours and output. These include financial product development using financial engineering, fund management, proprietary securities trading, investment advisory, management consulting, and R&D.
– An employer using this system cannot give the targeted employees specific instructions on how and when tasks should be completed (including when to arrive and leave office).

Procedural Requirements:
– Employers must form a Labor-Management Committee.
– The Labor-Management Committee must pass a resolution approving the exemption by a four-fifths supermajority.
– The resolution must be submitted to the Labor Standards Office.
– The individual employee’s written consent is also required and can be freely withdrawn at any time.

Health and Welfare Measures:
– Employers must ensure that employees take at least 104 days off per year.
– Additional health and welfare measures, as prescribed by regulation, must be implemented.

f) Method 4: Fixed-Amount Overtime Charge

The final method used to fix salary levels irrespective of actual working hours is the use of a “fixed-amount overtime charge.” Unlike the exemptions above, this approach does not relieve the employer of its obligation to pay overtime. Instead, it involves the employer pre-paying a fixed amount of overtime compensation (e.g., the equivalent of 30 hours of overtime per month), regardless of whether the employee actually works those hours.

This method is lawful, as employers may legally pay overtime premiums even if employees do not work full time corresponding to the overtime charge. However, several conditions must be met:
– The employment contract and other relevant documents such as offer letter must clearly distinguish between base salary and the overtime component.
– If the employee’s actual overtime exceeds the fixed amount, the employer must pay additional compensation for the excess hours.

g) Accurate Tracking of Working Hours

Even though employers adopt exemption for managerial or supervisory roles, deemed working hour system or fixed-amount overtime charge, employer is required to track employee’s working hour accurately, by way of objective method such as time card or record of PC or other electronic devise usage or other appropriate methods (Article 66-8-2 of Industrial Safety and Health Act, and Article 52-7-3, Paragraph 1 of Industrial Safety and Health Regulation).

4. Reduction of Annual Salary from the Previous Year’s Level

Finally, we address whether an employer may reduce an employee’s annual salary compared to the prior year.

In the typical annual salary system, the amount is determined each year through agreement between the employer and the employee, based on past performance and expectations for the coming year. If the employee consents to a lower salary, the employer may validly reduce the amount. In regard to the employee’s consent, even if an employee continues working and receives a reduced salary without protest, such conduct alone typically does not constitute implied consent to the reduction.

If the employee does not agree to the reduction, the legal situation becomes less clear. According to a judicial precedent (Tokyo High Court decision dated April 9, 2008), if the employer’s Rules of Employment expressly grant the employer discretion to set the annual salary and specify:
– Performance evaluation criteria,
– Process for salary determination,
– Any applicable limits on reductions, and
– An internal mechanism for employees to raise objections,
then the employer may unilaterally set a lower salary, provided these standards and procedures are fair and reasonable.

In contrast, where such provisions are absent or insufficient, the employer may lack the authority to unilaterally reduce the employee’s salary, and the previous year’s salary level may continue to apply by default.

It is important to note that the discussion above concerns the setting of salary for the following year. Once an annual salary has been agreed and finalized, the employer generally may not reduce it during the course of the year without the employee’s consent.

Disclaimer: This column intends to provide a high-level summary of the subject matter, and it does not aim to provide exhaustive information. Also, this column is for informational purposes only and does not constitute legal advice. For specific issues, we recommend consulting an expert. If you have any query, please contact us via inquiry form in this homepage.