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In brief

The Japanese value added tax is referred to as JCT. As all taxes around the world have connections with the history of the tax mechanism of each country, the explanation below also covers the history of the discussions regarding introducing value added tax in Japan.


Overview of the history of introducing value added tax in Japan

As a historical background to understand the JCT mechanism, it may be worthwhile mentioning the history of value added tax in Japan. In the early 70s, to tackle the budget deficit at that time, the ruling party (the Liberal and Democratic Party (LDP)) and the government were contemplating introducing value added tax in Japan.

However, the LDP and the government twice failed to introduce valued added taxes in the late 70s (1979) and late 80s (1987), respectively. In these proposals, it appears that the introduction of the EU-type value added tax was contemplated, including the invoice method. In the 70s and 80s, tax revenue was mainly corrected by means of income taxes, such as individual income tax and corporate income tax. The marginal progressive rate of individual income tax was 88% (including local tax), and the standard effective tax rate of corporate income tax was approximately 55%. In other words, the majority of the tax revenue was collected from wealthy people and large corporations at that time. However, tax revenue that mainly relies on income taxes is destined to fluctuate with economic conditions, and any tax revenue mainly sourced by income taxes is not necessarily stable. Indeed, in the 70s, Japan was suffering from a shortage of tax revenue due to the economic downturn, including the oil crisis, and an increase in expenditures, especially medical expenditures corresponding to the aging population. Under the circumstances, the LDP and the government were contemplating introducing value added tax as a stable source of tax revenue. However, in 1979 and 1987, the introduction of value added tax was not supported in the election and failed. There was strong opposition from the majority of middle-class voters potentially targeted by the value added tax. As a result of the defeats in election, the ruling party withdrew the proposal.

History of the JCT

In 1989, after around 20 years of discussions regarding the introduction of value added tax, the JCT was introduced. It replaced the commodity tax, which was only imposed on listed luxury goods whose purchasers were mainly wealthy people.

Traditionally, no invoice method has been applied for the input JCT credit for the purpose of simplifying the JCT-related procedures. This was practically possible as the JCT rate was a single rate until 30 September 2019.

In addition, under the JCT system, in relation to small/medium-sized enterprises, exemption measures are also provided. It can be said that having no invoice system is a part of such measures. Namely, to protect small/medium-sized enterprises as parties in transactions with JCT taxpayers (i.e., so as not to be excluded from transactions with the JCT taxpayer solely because they are not JCT taxpayers), no invoice system has been introduced under which only JCT taxpayers can claim the input credit. Instead, as all business enterprises retain and maintain the invoices and other records, and the books of account recognizing commercial transactions, a so-called books and record method has been adopted in recognizing the JCT-taxable transactions. Namely, the input JCT creditability is determined based on the nature of the transaction supported by the books and record requirements (i.e., it is required to maintain accurate records in the books of account, retaining traceable records of the transactions).

The items to be stated in the books of account and the records (invoices, etc.) are summarized in Table 1 below. Due to the introduction of multiple JCT rates, this has been changed slightly, as shown in the columns on the right.

Table 1 – Requirements for the books and records

Requirements until 30 September 2019 Requirements from 1 October 2019 to 30 September 2023 (bold parts)
Books (1) identification of the transaction party
(2) transaction date
(3) nature of the transaction
(4) amount of the consideration
(1) identification of the transaction party
(2) transaction date
(3) nature of the transaction (with separate statements for the transactions to which the lower rate is applicable)
(4) amount of the consideration
Records (1) identification of the person who prepares the document
(2) transaction date
(3) nature of the transaction
(4) amount of the consideration
(5) identification of the person who receive the document
(1) identification of the person who prepares the document
(2) transaction date
(3) nature of the transaction (with separate statements for the transactions to which the lower rate is applicable)
(4) amount of the consideration
(5) identification of the person who receive the document

 

These are mostly overlapping and there have been some critical comments from practitioners that both the books and records requirements are redundant and too burdensome.

On the other hand, such measures considering the small/medium-sized enterprises also create a problem ⁠— non-JCT taxpayers can also receive the output JCTs even if they are not needed to pay the JCT liability to the government. This is called “Ekizei” meaning the part of the JCT legally retained by business enterprises. In theory, at the non-JCT taxpayer level, Ekizei constitutes a part of the consideration for the transaction and is subject to corporate income taxes as a taxable revenue; it is not completely tax-free. However, focusing on the JCT mechanism, it is a loophole and the legislative history of the JCT summarized in Table 2 below shows that the legislations are mainly aimed at closing this loophole.

Table 2 – Summary of the JCT’s legislative history

Year Major legislation for the scope of JCT taxpayers JCT rate
I 1989 If the taxable sales in the “base period” (the second preceding year) are JPY 30 million or less, a JCT exemption is available for the current year (the “two-year exemption” treatment). Thus, a newly established company is not a mandatory JCT taxpayer for the initial two years of operations at least. 3%
II 1997 A newly established company with JPY 10 million or more in capital became ineligible for the two-year exemption treatment. 5%
III 2004 The taxable sales threshold in the base period for the exemption was lowered from JPY 30 million to JPY 10 million.
IV 2013 A shorter exemption period (one-year exemption) was introduced, subject to certain conditions.
If the taxable sales in the “specified period” (the first six months of the preceding year, e.g., 2018 for 2019) are JPY 10 million or less, a JCT exemption is available for the current year.
For the JPY 10 million threshold for the specified period, a company may use the payroll amount paid to Japanese residents instead of taxable sales for the threshold (the payroll amount paid to Japanese non-residents does not need to be counted, at least under the existing JCT law).
V 1 April 2014 Newly established companies in which a large corporate group (i.e., a corporate group with over JPY 500 million in annual JCT taxable sales) owns more than 50% of the shares became ineligible for the two-year exemption treatment. 8%
Total JCT rate National JCT rate Local JCT rate
8% 6.3% 1.7%
8% or 10% from October 2019 (lower 8% rate applies for foods and newspapers)
VI 1 October 2023 (predetermined future change) The input JCT credit will only be available for statutory invoices issued by the JCT taxpayer who is a registered invoice issuer.
Total JCT rate National JCT rate Local JCT rate
8% 6.24% 1.76%
10% 7.8% 2.2%

Introduction of the qualified invoice system on or after 1 October 2023

As shown in Table 2 above, on or after 1 October 2023, a JCT taxpayer is required to maintain qualified invoices issued by registered invoice issuers to be eligible for the input JCT credit. The necessity of the qualified invoice method is generally supported by the multiple JCT rates such as 8% or 10%, introduced on or after 1 October 2019. In other words, after the introduction, a JCT taxpayer cannot recognize the input tax credit for transactions with non-registered invoice issuers who are mainly non-JCT taxpayers (please see the special measures for the transit period mentioned in (4) below).

Procedures and time schedule

The application for the registration will be made to the appropriate national tax office from 1 October 2021. When the registration is made, the name of the registered invoice issuers and their registration numbers can be confirmed through the website of the National Tax Agency of Japan. To be a registered invoice issuer on or after 1 October 2023, the application must be submitted on or before 31 March 2023. The registration number would be either “T + the My Corporate Number” or “T + the newly allocated 13-digit number” (for non-corporate enterprises or other persons/entities that have no My Corporate Number, per se).

The time schedule can be visualized as follows.

Requirements for registered invoice issuers

A registered invoice issuer is required to (a) provide the qualified invoices to the transaction parties and (b) retain copies of the registered invoices (subject to the separate books retention rule, under which the retention period is generally seven years). Once the registration for the registered invoice issuer is made, it cannot become a non-JCT taxpayer even if the JCT taxable sales amount in the base period becomes JPY 10 million or less. Non-registered persons cannot issue qualified invoices, and making false statements in qualified invoices is prohibited. These actions are subject to a penalty.

The items that must be stated in the qualified invoice are described in Table 3.

Table 3 – Items to be stated in the qualified invoice (with bold for the new requirements)

1 Identification of the qualified invoice issuer (e.g., name) and the registered number
2 Transaction date
3 Nature of the transaction (with separate statements for the transactions to which the lower rate is applicable)
4 Amount of the consideration (exclusive or inclusive basis) per applicable JCT rates (and applicable JCT rates)
5 Amount of the applied JCT
6 Identification of the person who receive the document (e.g., name)

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Author

Shinichi Kobayashi has more than 20 years of experience advising on a broad range of tax and transfer pricing issues. He has authored and co-written several highly-regarded publications on Japanese tax and other related matters, including Business Tax in Practice and Theory and M&A Handbook on Conducting Business Practically.

Author

Edwin Whatley leads the Firm's Tax Practice Group in Tokyo and is highly experienced in both US and Japanese tax law. He is recognized as a leader in his field by the Asia Pacific Legal 500, ITR World Tax and Chambers Asia. Edwin has authored numerous articles on US and Japanese tax and regularly speaks on tax matters at international conferences and seminars. He is actively involved in pro bono work, including assistance on various matters to the California, Georgia and Tokyo Bar Association. Prior to joining the Tokyo office, he worked in the Firm's San Francisco practice.