• English
• 日本語

Income tax and corporation tax are taxes imposed on “income”.
“Income” is “earnings”.
On the other hand, an accounting term or general wording “profit” also means “earnings”.
Are these two “earnings” the same or different?
Even if you are not expert in accounting but do care of such difference, you have good sense for tax.

What is “income”?

“Income” is a concept in tax laws and economics, and often appears in formal documents as an “official term”.
I was enough ignorant to believe that “income” is just a formal expression of “profit”.
However, every law provides specific definition of the “income” and its contents will differ slightly if the law differs.
For example, in the Corporation Tax Law, there is a general rule that net income is “the excess of gross income over total costs”, but the Income Tax Law provides 10 types of incomes by income category such as “gross receipts minus deductible necessary expenses” or “gross receipts amount” respectively.
Therefore, how much income out of the same amount of “10,000 yen” earnings will be taxed may be different depending on taxpayer’s status either a corporation or natural person.
By the way, “income” in economics terms means the total amount of “added value” produced by the people and enterprises.

What is “profit”?

An accounting terminology “profit” means excess of revenues over expenses.
The formula “income – expense = profit” is a basic rule common to individuals and corporations, but more detailed and strict rules (Corporate Accounting Principles, Rules of Corporate Accounting, Financial Instruments and Exchange Act, International Financial Reporting Standards, etc.) are applied to recognition of the revenues and expenses by corporations.
For example, it is unnecessary for individuals to recognize “profit” on their securities (stocks, bonds, etc.) unless they sell off them, but corporations need to recognize “profit” or “loss” on certain types of securities as appreciated or depreciated as of every fiscal year ending date, i.e., even before they dispose such securities.

How is “income” different from “profit”?

So, what is the difference between “income” for tax and “profit” for financial accounting purposes? And why they need to be different?
The tax laws provide calculation of “taxable income” which is the tax base for income tax and corporation tax.
Financial accounting is to report the “result” of the business to the stakeholders of companies such as shareholders and creditors.
They aim fair calculation of “earnings” suitable for their objectives respectively.

Briefly speaking, the tax laws try having taxpayers recognize “earnings” as earlier and much as possible whereas financial accounting suggest matching recognition of expenses and revenue as long as the expenses are reasonably estimated (the matching principle).
As for revenue recognition, there is no big difference between tax and financial accounting but the tax laws do not allow expense recognition until amount and liability of expense become fixed and determinable.
As a result of expense recognition later than revenue, “income” for tax purpose will be recognized earlier than “profit” for financial accounting purpose.

Besides, expenses recognized for financial accounting are sometimes disallowed for tax purposes.
For example, directors’ bonus, entertainment expenses and donation should be recognized as expenses for financial accounting purpose but the corporation tax law limits deduction of those expenses for the taxable income calculation.
It is to restrain redundant expense payment for mere income reduction purpose.
Expenses used in such ideas are called “redundancy”.
If there is redundancy, “income” will be recognized more than “profit” for financial accounting purpose.

However, due to political and tax technical consideration, certain revenues are excluded from taxable income or deferred for income recognition.
In such a case, “income” will be recognized less or later than “profit”.
There is such a difference between “income” and “profit”.

For corporations, having discrepancy is “all right”!

The Corporation Tax Law stipulates that taxable income should be calculated in accordance with “accounting standard generally accepted as fair and reasonable rule” (CTL Article 22 Para 4).
This does not intend taxpayers to calculate “profit” and “income” in parallel but to calculate the taxable income based on the profit for financial accounting purpose making necessary adjustments if there is any discrepancy between CTL and the accounting standard.

As mentioned in an earlier blog “For whom financial statements be prepared?“, CTL has a number of provisions that require reconciliation from profit for financial accounting purpose to taxable income (so-called “specific provision”).
Therefore, it is rather rare that the profit amount on the financial statements simply agrees to the taxable income amount.
In most countries, it is common that there are some discrepancy between profit for financial accounting and taxable income.

Standalone Calculation for individuals

On the other hand, preparation of financial statement is not mandatory for natural persons’ tax return filing.
Therefore, the Income Tax Law provides that taxable income shall be computed as an excess amount of gross receipts over the deductible necessary expenses based on books and records not financial statements.

***
When I was new-grad in the financial controller of a Japanese company, the firm sponsored training course for basics of corporation tax but I did not fully understand difference between “income” and “profit”.
While I was doing general groundwork, I did not have much problems.
But later on, I was assigned to new function involved in tax calculation then made a big mistake because of such ignorance.
It was quite obvious that I did not study hard.
The general manager might have known it though he said nothing.