Introduction

This article aims to provide an overview of trends and developments in the areas of employment outsourcing, including the Employment Security Act (Act No 141 of 1947), the Act on Securing the Proper Operation of Worker Dispatching Businesses and Protecting Dispatched Workers (Act No 88 of 1985) (the “Worker Dispatch Act”). It will then look at service outsourcing agreements, which are usually categorised as non-employment arrangements, and the recent developments in regulation.

The Employment Security Act and Its Amendments

In Japan, the Employment Security Act provides that the government monopolises job placement services while exceptionally permitting private businesses. The government operates Public Employment Security Offices based on the Employment Security Act, where it conducts activities such as job placement, vocational guidance, employment insurance, and other related services. These offices are commonly referred to as “Hello Work (ハローワーク)” or “Shoku-An (職安)”.

Private enterprises, whether engaged in fee-charging employment placement business or free employment placement business, are required to obtain licences from the Ministry of Health, Labour and Welfare (MHLW).

Additionally, the Employment Security Act prohibits labour supply businesses by prescribing that “no person shall carry out labour supply business or have workers supplied by a person who carries out labour supply business work under [their] own directions or orders” (Article 44). The only exception is when a labour union engages in free labour supply business by obtaining a licence from the MHLW.

However, it is important to note that worker dispatch – as defined by the Worker Dispatch Act – is excluded from the prohibition of labour supply business. It is permitted as an exception where licensed worker dispatch agencies carry out the worker dispatch business.

Recently, the Employment Security Act was amended in 2022 owing to the proliferation of online job media and other job services that do not fit the traditional definitions. The act expanded the definition of “providing recruitment information, etc” subject to regulation, obligating businesses to make notifications, take measures to ensure that job-related information remains accurate and up-to-date, and avoid making false or misleading representations. Furthermore, it introduced provisions concerning the handling of personal information collected from job seekers, thereby requiring a clear declaration of the purpose when collecting such information.

Worker Dispatch Act

As mentioned earlier, while labour supply businesses are generally prohibited under the Employment Security Act, worker dispatch based on the Worker Dispatch Act has been permitted and widely utilised as a form of employment outsourcing. 

Since the enactment of the Worker Dispatch Act in 1985, there have been fluctuations in the market due to factors such as:

• the amendment in 2004 that allowed dispatch in manufacturing business and prohibited worker dispatch by the day; and
• the amendment in 2012 that introduced an 80% cap on intra-group worker dispatch.

Nonetheless, the market size has generally continued to grow, with total sales revenue reaching JPY8.62 trillion in fiscal year 2020 and the total number of licensed worker dispatch offices as of June 2021 amounting to 42,448 (according to the Japan Staffing Services Association’s website).

Article 2, item 1 of the Worker Dispatch Act defines “worker dispatch” as “having a worker employed by one person so as to be engaged in work for another person under the instructions of the latter, while maintaining the worker’s employment relationship with the former, excluding cases where the former agrees with the latter that such worker is to be employed by the latter”.

Based on this definition, worker dispatch comprises three key relationships:

• the employment contract relationship between the dispatching business operator and the dispatched worker;
• the contractual relationship between the dispatching business operator and the client; and
• the relationship of orders and instructions between the client and the dispatched worker (Tokyo Metropolitan Government’s Bureau of Industrial and Labour Affairs’ “Worker Dispatch Handbook” at page 28).

In terms of worker dispatch, it is important to note the following aspects that require special attention:

• the existence of prohibited tasks for worker dispatch;
• the prohibition of receiving dispatched workers from unlicensed operators;
• limitations on the period for receiving worker dispatch at the client’s place of business;
• limitations on the period for which the same individual worker can be dispatched; and
• the regulation of disguised subcontracting, as elaborated on later in this article.

Additionally, as a result of the amendment to the Worker Dispatch Act in 2015, there is a system known as the “constructive offer of an employment contract” should illegal worker dispatch occur contrary to these provisions (Article 40-6). Under this system, when in violation of the above-mentioned provisions, the client shall be deemed to offer an employment contract to the dispatched worker on the same terms and conditions as the existing employment contract with their original employer. Subsequently, if the dispatched worker agrees to this offer, an employment contract is considered established between the dispatched worker and the client.

There have been a number of landmark cases involving the constructive offer of an employment contract now that a certain period has passed since the amendment in 2015. A recent landmark judgment by the Osaka High Court on 4 November 2021, Dispatched Worker v TOLI Corporation, acknowledged a violation of the regulation on disguised subcontracting in the Worker Dispatch Act. As such, an employment contract between a dispatched worker and the client was deemed to be established in accordance with Article 40-6.

Besides the above-mentioned matters, the wage gap between dispatched workers and regular workers employed by the client has been a concern. Consequently, this has led to introduction of the principle of “equal pay for equal work” for dispatched workers via amendment of the Worker Dispatch Act in 2018.

The government issued an explanatory note that must be referred to when considering the employment conditions of the dispatched worker and regular workers – namely, the MHLW’s Gist of “Equal Pay for Equal Work” for Dispatched Workers.

Service Outsourcing Contracts

In recent years, the number of cases where companies considering employment outsourcing use a service outsourcing contract (ie, a non-employment contract) with external vendors or freelancers has increased.

Since the COVID-19 pandemic, there has been a growing trend towards allowing side jobs outside working hours and introducing remote working. Accordingly, some individual workers choose freelancing as a side job. Some scholars have critically observed that companies are doing everything they can to escape the responsibilities of employment, labour and social security laws associated with regular employment. However, the trend for utilising freelancers or service outsourcing contracts is expected to continue. It is anticipated that these arrangements will be regulated in the future by, for example, the New Freelance Act mentioned later in this article.

In any case, several issues commonly arise when entering into service outsourcing contracts with external vendors or freelancers. These issues mainly concern disguised subcontracting, the Subcontract Act, worker classification matters, and the New Freelance Act.

Disguised subcontracting

When a company enters into subcontracting contracts with external vendors and allows the vendor’s employees to work on its premises, there is a risk that – depending on the arrangement – it could be regarded as circumventing the aforementioned regulations under the Worker Dispatch Act.

In other words, where the contract is formally a subcontracting agreement but actually functions as a worker dispatch, it is referred to as “disguised subcontracting”. Prefectural labour bureaus regulate and penalise this as violating the Employment Security Act and the Worker Dispatch Act, and sometimes publish the violation with the company’s name on the bureau’s website. As mentioned earlier, when the arrangement violates the Worker Dispatch Act, it may also be subject to the constructive offer of an employment contract.

To avoid being categorised as “disguised subcontracting” and thereby violating the Employment Security Act or the Worker Dispatch Act, when entering into subcontracting agreements, it is essential to ensure that – at the very least – the commissioning entity does not provide direct instructions or commands to the subcontractor’s employees. Moreover, if possible, the employees should not frequently work on the premises of the commissioning entity. 

It is worth noting that, with the increase in agile-type information system development, closer communication between the commissioning entity and the commissioned workers is necessary. This leads to the former’s direct instruction or commands to the latter requiring even greater attention so as to avoid being regarded as “disguised subcontracting”. The government regularly publishes rules for worker dispatch and disguised subcontracting, which should be referred to when considering the subcontracting arrangement – namely, the MHLW’s Guide for Proper Worker Dispatch and Subcontracting.

Subcontract Act

Furthermore, when a company directly enters into contracts other than employment contracts with external freelancers or smaller companies, there is a possibility that the Act Against Delay in Payment of Subcontract Proceeds, etc to Subcontractors (Act No 120 of 1956) (the “Subcontract Act”) may apply, depending on the contract type and the amount of capital. The Subcontract Act establishes obligations and prohibitions for the client entity, making it necessary to exercise caution.

When it comes to the manufacture or repair of goods, or the creation of information products or the provision of services specified by cabinet order, the Subcontract Act may be applicable:

• where a client company with capital of between JPY10 million and JPY300 million subcontracts to a freelancer or a subcontractor with capital of JPY10 million or less; and
• where a client company with capital of more than JPY300 million subcontracts to a freelancer or a subcontractor with capital of JPY300 million or less.

In terms of the creation of information products or the provision of services that are not specified by cabinet order, the Subcontract Act may be applicable:

• where a client company with capital of between JPY10 million and JPY50 million subcontracts to a freelancer or a subcontractor with capital of JPY10 million or less; and
• where a client company with capital of more than 50 million JPY subcontracts to a freelancer or a subcontractor with capital of JPY50 million or less.

When the Subcontract Act applies, the client company incurs various obligations, including obligations to:

• provide an orders document;
• create and maintain documents;
• specify payment due dates within 60 days of receiving products or services; and
• pay late interest.

Furthermore, the Subcontract Act prohibits the following actions by the client in its relationship with the subcontractor:

• refusing to receive work from the subcontractor;
• delaying payment of subcontracting fees;
• reducing subcontracting fees;
• returning the goods relating to the received work;
• undue pressure on a significantly low price;
• compelling purchase of goods or utilising services of the client;
• retaliatory measures;
• early settlement of compensation for raw materials, etc;
• issuance or delivery of hard-to-discount promissory note, etc;
• request for the provision of undue economic benefits; and
• change or redoing of work.

For violations caused by these actions, investigations and inspections may be conducted. In addition to recommendations by the Japan Fair Trade Commission for prohibited actions, there is also the possibility of criminal penalties, including fines of JPY500,000 or less for representatives and employees.

Please note that, owing to changes in the Consumption Tax Act (Act No 108 of 1988), the Japan Fair Trade Commission anticipates typical cases of Subcontract Act violation and it has issued guidance on such cases. Specifically, after 1 October 2023, the retention of “qualified invoices” (commonly known as “invoices”) issued by “qualified invoice issuers” who have applied to and been registered with the district director of the tax office will be a requirement for input tax deduction. If the subcontractor to whom work has been outsourced is not a qualified invoice issuer, there may be an increase in the burden – specifically, for the portion of input tax deduction. At this time, demanding a reduction in the consumption tax amount from the transaction price may be considered a prohibited action, as outlined in Article 4, paragraph 1, item 3 of the Subcontract Act (Japan Fair Trade Commission, Caution Cases Related to Implementation of the Invoice System).

Worker classification matters

When a company directly enters into service outsourcing contracts (other than employment contracts) with freelancers, there is a risk of it being classified as an employment contract based on the specific circumstances between the contracting parties – even if the form of the contract is service outsourcing, delegation, subcontract or commissioning. In such cases, there is a possibility of employment laws, labour laws and related regulations being applied – these are commonly known as worker classification matters.

In Japan, the debate often revolves around whether an individual falls under the category of “employee” when determining if employment laws, labour laws and related regulations apply. However, the criteria for determining whether an individual falls under the category of “employee” can vary depending on the specific laws. There are slight differences between the criteria for determining employees under the Labour Standards Act (Act No 49 of 1947) and the Labour Union Act (Act No 174 of 1949).

Firstly, regarding the definition of “employee” under the Labour Standards Act, the following factors are considered:

• the freedom to accept or decline work;
• the presence or absence of specific instructions and supervision on how to carry out work;
• the degree of time and location restrictions;
• the substitutability of labour;
• the remuneration in relation to the work performed;
• the existence of the nature of business ownerships;
• exclusivity; and
• treatment under tax and social insurance laws. 

These factors are taken into account when determining employee status (Ministry of Labour, Labour Standards Act Study Report: the Criteria for Determining “Employee” Under the Labour Standards Act, dated 19 December 1985).

As regards the definition of “employee” under the Labour Union Act, the following factors are considered:

• incorporation into the organisational structure of the business;
• unilateral and standardised determination of contract terms;
• remuneration as consideration for labour;
• a relationship where the work is performed in response to requests from the employer;
• labour provided under the broad meaning of supervision and control with certain time and location restrictions; and
• the significant nature of business ownerships. 

These factors are taken into account when determining employee status under the Labour Union Act (Ministry of Labour, Labour Management Relations Law Studying Group Report: the Criteria for Determining “Employee” Status Under the Labour Union Act, dated 25 July 2011).

In a recent case (Employee v Uber Japan Co, Ltd (2022)), Uber Japan Co Ltd refused to engage in collective bargaining based on the argument that Uber Eats delivery drivers do not fall under the definition of “employee” under the Labour Union Act. The Tokyo Metropolitan Government Labour Relations Commission ruled that delivery drivers should be considered “employees” under the Labour Union Act (Tokyo Metropolitan Government Labour Relations Commission, Order of 4 October 2022, Roudou Hanrei No 1280, p 19).

In any case, when a company formally enters into contracts (other than employment contracts) with external principals or freelancers and categorises them as non-employees, it is crucial to be aware that – depending on the actual circumstances – these individuals might still be considered employees. If so, this makes them subject to protections stipulated in employment laws, labour laws and related regulations.

New Freelance Act

As mentioned earlier, the protection of individuals who undertake work through contract types other than employment is considered crucial. On 28 April 2023, the Act on the Improvement of Transactions with Specified Contractors (Act No 25 of 2023) (the “New Freelance Act”) was enacted. At the time of issuance of this article, it has not yet been implemented – although it is scheduled to come into effect no later than autumn 2024.

Originally, the contract conditions on freelancers related to the Subcontract Act (administered by the Japan Fair Trade Commission) and employment laws, labour laws and related regulations (administered by the MHLW). However, there are regulatory gaps where none of the Subcontract Act, employment laws, labour laws or related regulations apply. Within these regulatory gaps, a freelancer has had no proper way to consult with the government office, as the Japan Fair Trade Commissions and the MHLW have not had any clear authority to govern the regulatory gap field until recently.

The New Freelance Act aims to fill the gap in protection not covered by the Subcontract Act, employment laws, labour laws and related regulations. Although its application is broad and it may potentially apply when freelancers are contracted to perform work, careful attention is required.

First, the New Freelance Act defines certain categories such as specified service providers and specified service engagement participants as the subjects of the protections. It also specifies service outsourcing businesses and specified service outsourcing businesses as the main entities responsible for obligations. Thus, the scope its application is made clear.

When the New Freelance Act is applied, the following are among the regulations for contracts:

• disclosure of payment details (content of payment, amount of compensation, payment deadlines, etc);
• payment deadlines;
• prohibitions on specific actions (similar to the Subcontract Act regulations);
• accurate display of recruitment information;
• consideration for pregnancy, childbirth, childcare, and caregiving;
• measures against harassment; and
• advance notice of termination and disclosure of reasons.

In case of violations of this law, there are plans for reporting and inspections (Articles 11 and 20), advice and guidance (Article 22), recommendations (Articles 8 and 18), orders and public disclosure (Articles 9 and 19), and criminal penalties (including fines) for violations of orders and refusal of inspection, etc.

Furthermore, it is expected that the government will take measures to establish the necessary systems for responding appropriately to enquiries and consultation from freelancers. Currently, this is being managed by the “Freelancer Trouble 110” helpline administered mainly by the Second Tokyo Bar Association. Regardless of whether it is published before the enactment of the New Freelance Act, the Second Tokyo Bar Association Labour Issues Study Committee’s Freelance Handbook (2021) is useful material for considering the regulation of freelancers.