Employee vs. contractor: How to classify workers in Japan (quiz included)

If you’re looking to expand your team internationally, you might have thought about hiring workers in Japan. And as with any other country, it’s crucial to classify your workforce as either employees or independent contractors. Not only will this help you stay in compliance with Japanese employment laws, but you’ll avoid the hefty penalties of misclassifying workers.

The Japanese government uses multiple criteria to determine whether a worker is an employee or a contractor. Read on as we help you better understand worker classification in Japan—and stay compliant with the Japanese Labor Standards Act and the Labor Contracts Act.

Table of Contents

• Classifying workers in Japan
  • What is an employee in Japan?
    • Types of employment in Japan
  • What is a contractor in Japan?
    • Requirement for independent contractors to establish a sole proprietorship
  • Worker classification overview: Employees vs contractors in Japan
• How to classify your global workers in 90 seconds
• Penalties for misclassifying workers in Japan

Classifying workers in Japan

To avoid any issues related to employee misclassification, it's important to properly classify your workforce in Japan.

However, it's worth noting that there are specific categories for workers in Japan—and those working outside of these categories, such as freelancers or independent contractors, may not have a clear definition. Make sure to correctly classify your workers before running payroll to mitigate any risks.

What is an employee in Japan?

An employee in Japan is an individual who works for an employer under an employment contract in exchange for wages or other compensation. This can include full-time and part-time employees, as well as temporary and contract workers.

As an employer in Japan, you should be aware of your responsibilities towards your employees.

One of these responsibilities is providing benefits to your employees, which includes enrolling them in Japan's public health insurance and pension systems. In addition to these mandatory benefits, there are other types of insurance and benefits that employers can provide, such as long-term care insurance and labor insurance.

By fulfilling your obligations towards your employees, you can create a positive working environment and ensure compliance with Japanese employment laws.

Types of employment in Japan

Let’s discuss the main types of employment in Japan.

1. Permanent employment

Permanent employees or Seishain (正社員) are those who work full-time and have signed a contract with the company as regular employees.

Most employees push for permanent employee status, as it offers workers stable employment tenure, yearly raises, and employee benefits that are typically associated with working full-time in the Western working world. It's why you'll typically see a high volume of applicants for every permanent job posting.

However, one downside of having permanent employees is that it may be difficult to terminate those who perform poorly.

2. Contract employment

Contract employees or Keiyaku-shain (契約社員)​ are hired to work contract to contract for a short and specified term, usually between three to 12 months.

Hiring contractors has the advantage of easy termination since you can dismiss them by simply not renewing their contracts. Also, your obligations towards them are low, and they are not entitled to additional benefits such as bonuses or transportation allowance, unlike full-time employees.

In the past, many employers hired contract employees and kept renewing their contracts, sometimes for years, so they could terminate them whenever they pleased. However, this approach is no longer effective today.

Japanese courts have passed a ruling under which long-term contractors are entitled to the same protection as permanent employees. This gives them the right to social security benefits and paid leave and cannot be terminated without cause or compensation.

3. Part-time employment

Part-time employment is a popular option for students (or Arubaito) and housewives (or Baito), as it offers more flexibility in terms of scheduling.

Part-time employees are hired on a fixed-term contract and can be paid either on a daily or hourly basis. Although they are not entitled to the same benefits as full-time employees, such as bonuses and insurance, they do have the right to take paid leave and have their transportation costs covered.

In some cases, companies use part-time employment as a trial phase for potential permanent hires. If the employee performs well, they may be offered a regular full-time position.

4. Temporary employment

Temporary employees or Haken (派遣社員) differ from the employment categories discussed above, as they are not your employee and nor are they on your payroll.

Instead, they are typically recruited by agencies, who then invoice you for the hours worked by the temp. If you find the temporary employee unsuitable, you can ask the agency to send a replacement since you have no direct obligation to the employee.

One benefit of using temporary employees is that you don’t have to provide them with employee benefits or perks, and you have the flexibility to downsize in a bad economy without paying severance or making huge redundancy payments.

While temps are a great solution for hiring back-office staff, there are two downsides:

• Only a small section of people is willing to do temporary work in specialist areas; and 
• Costs are significantly higher compared to contract or permanent employees at first glance.

However, it’s important to note that the additional cost accounts for the agency providing the temp with employee benefits, such as social security, employee support, and paid leave, in addition to the agency fee.

Most of these are costs that you, as an employer, would otherwise have to bear, so the true cost works out similarly to that of hiring a permanent employee.

What is an independent contractor in Japan?

An independent contractor or Gyoumu-Itaku (業務委託) in Japan is any person or entity that provides services free of supervision from the client. Also known as a freelancer or outsourced worker, an independent contractor in Japan:

• Has the freedom to accept or reject projects
• Determine how and when a project gets completed
• Acquire funds necessary to complete the project
• Assume responsibility for their performance
• Report earnings as business income and not salary

Laws about hiring contractors are significantly simpler in Japan compared to hiring employees. You can onboard talent in a few days instead of weeks or months, plus both you and the talent have more flexibility.

Requirement for independent contractors to establish a sole proprietorship

When you hire an independent contractor, they are not your employee legally. This is because the Japanese labor law doesn’t recognize them as employees and considers them to be self-employed.

This makes it necessary for the individual to be set up as a sole proprietorship in Japan—and have to submit a Notification of Opening or Closing of a Sole Proprietorship to their National Tax Agency (NTA).

Here’s how this works: individuals who wish to run their own company (for example, as a Limited Liability Company) will be considered an employee of that company and can, therefore, draw a salary. This makes the risk of independent contractor misclassification considerably low in Japan compared to other countries.

How to classify your global workers in 90 seconds

Are you classifying your workers correctly? Find out now.

Accurately classifying your employees and contractors is crucial for complying with employment regulations in Japan and around the world. With our free classification quiz, you can mitigate the potential business risks and ensure you’re correctly classifying employees and contractors—in just 90 seconds.

Penalties for misclassifying workers in Japan

Misclassifying workers can land you in serious trouble in Japan, as it involves several labor law violations. For example, if the substance of your business-contractor relationship should really be an employment relationship, your company can suffer both legal and financial penalties, including payroll taxes.

In 2008, the Tokyo District Court ordered McDonald's to pay several million yen in overtime allowance and extra compensation to a manager at one of its outlets. The court ruled that employees in managerial positions must be able to exercise significant authority and receive privileged treatment, such as higher pay and status.

Here are some of the potential penalties you could face in different situations:

• In case of labor law violations, applicable criminal penalties are a fine of up to JPY 300,000 (around USD 2,200) and/or imprisonment for up to six months in most cases.
• In case of a shortfall in withholding taxes, you face possible penalties. This may include a penalty tax at a 10% rate (or 5% in case of voluntary late payment) and an interest rate of 2.4% per year (or 8.7% per year after two months from the due date). Note: The interest tax rate is for the year 2022, and changes each year based on the disclosed interest rate by the MOF (Ministry of Finance Japan) on November 30 each year.
• In case of social security issues, you can be fined up to JPY 500,000 or imprisoned for up to six months.

For these reasons, you must be extra cautious when creating offer letters in Japan and onboarding your workforce—and know whether you‘re engaging with talent as an independent contractor or an employee.