Takashi Yamaguchi, English Speaking Japanese Tax Accountant
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The tax invoice system and a hard bargain

In the past blog of mine, I touched on “Introduction of Invoice System for Japanese Consumption Tax“.
As for the invoice system, some people worry that it may be used for hard price negotiation against small-medium sized enterprises (exempt business operator).
What does it mean?

Mechanism of current system

Before that, let me recap how current consumption tax system works.
The consumption tax is a kind of VAT (value-added tax).
VAT is a tax on added value created by business activities.
Since the added value created by business activities is ultimately consumed by consumers, it is the consumer who will bear burden of VAT.
However, there are many distributors / manufacturers (business operators) involved in supply-chain of the goods and services delivered to the consumers.
These operators add value to the goods and services procured from others and resell them to the next supplier, so in a sense, they are also consumers as well.

Therefore, in a general value-added tax system, it has operators recognize value-added to be created and consumed in the course of the distribution of goods and services, then report and pay the tax amount for such value-added.
By doing so, consumers will bear taxes, and operators will bear the burden of reporting and paying taxes collected from consumers.
The consumption tax of Japan is also taxed, reported and paid under such a mechanism.

“Ledger system”, the mother of “exempt operators”
Theoretically speaking, all business operators should file tax return and pay the tax, however under the consumption tax law of Japan, business operators whose annual turn over (precisely speaking, sales amount of goods or services, which are subject to the consumption tax) is JPY10M or less are exempt from obligation of the tax return filing and tax payment (Consumption tax law (hereinafter referred to as “the law”) Article 9 para 1).
This is an exemption system legislated from the consideration that it is burdensome for small businesses to fulfill such obligation.
Why is it thought that it is difficult for small businesses to recognize the value-added?
That is because of the current “ledger system” where recognition of the value-added is done on a book basis.

The ledger system is a method of reporting a consumption tax based on the “book” recorded by the business operator.
The term “book” as used herein refers to journal entry books, general ledgers, trial balances etc., which are created according to the principle of double entry bookkeeping.
Considering the fact that quite a few small business owners manage to keep just a simple book, it would be impossible for such businesses to prepare full-fledged books for the consumption tax purpose.
Therefore, under the assumption that businesses with annual sales of 10 million yen or less can not prepare “books”, such small businesses are uniformly exempt from the tax return filing and tax payment obligations as uniform “tax exempt business”.
Of course, a small business that properly creates full-fledged “books” can opt to be a “taxable business operator” (Article 9, paragraph 4 of the law) so that it can avoid disadvantage of being treated as an exempt business operator (such as unable to file tax return for refund of the consumption tax).

Transactions with exempt businesses operators are also taxable?

Even if the supplier is an exempt business operator, as long as the nature of the goods or services supplied is taxable, it is reasonable to treat them a taxable purchase from buyer’s point of view.
Because the consumption tax is imposed on goods or services not the businesses operator.
Since the business operator only bears the burden of tax reporting and payment, even if the tax exemption business operator is exempted from the tax obligation, tax implication on the transaction per se does not change.

On the other hand, there is opinion that it is wrong to call it “taxable purchase” because the consumption tax is not included in the purchase price paid to an exempt business operator who never file the tax return nor pay the tax to the government.
It is also reasonably arguable.

In the current consumption tax system presupposing the book system, even purchases of goods or services from tax exempt business operators are to be treated as “taxable purchase”.
This clear-cut rule creates tax benefits to both exempt suppliers and taxable buyers.
However, from the point of the buyers paying price of goods or services, they may doubt that they are charged for “consumption tax” never reported nor paid to the government as the tax.
If the buyer is a an exempt business operator, the consumption tax included in the purchase price will be the cost of the buyer. So the lesser price is advantageous for the buyer.
Even the buyer is a taxable business operator, it may still not be sure for the buyer whether the tax on the purchase can be fully creditable. So the lesser the purchase price is, the better for the buyer in any event.

A Pandora’s box being opened by the invoice system

Introduction of “invoice system” in October 2023 will entail drastic changes of tax practice for consumption tax return filing.
The tax due amount is directly computed based on “invoice” not by a roundabout way to recognize value-added based on the books then calculate the tax amount.
This “invoice” is called “qualified invoice” and can be issued by only taxable business operator “registered” with the tax offices.
After October 2023 only purchase of goods or services evidenced with the qualified invoice will be regarded as “taxable purchase”.
Therefore, purchase from exempt business operators and taxable but not registered business operators are not regarded as “taxable purchase”.

Then, it is anticipated that exempt business operators will be under a price-cut pressure something like “you do not have to pay the tax to the government. So you can make it cheaper by that tax amount can’t you?”.
We cannot rule out such possibility.
However, even an exempt business operator should bear the consumption tax imposed on its own purchase of materials and other goods or services from other business operator.
If the exempt business operator cannot pass on cost of the tax through sales price to others, it will not be able to sustain its business operation.

Even if you explain it to your business partners, they may force you to accept price-cut exercising their predominant business relationship with you.
It is avoidable that there will be a move to review conditions of transaction with exempt businesses operators triggered by introduction of the invoice system.
However, if we succumbed to unjustifiable price-cut pressure there is no future.
In such a case, do not worry alone. It is a good idea to consult with the authority, 内閣府消費税価格転嫁等相談センター The Cabinet Office, the consultation center for passing the consumption tax in pricing.

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