Overview of consumption tax

Entity engaged in domestic transactions and import transactions must file and pay consumption tax in Japan unless they are exempt from consumption tax. These entities include foreign corporations, branch office of international companies, KK/GK and sole proprietor.

Consumption tax is similar to VAT (value-added tax), GST (goods and services tax) or sales tax in some other countries, but there are many of unique aspects in calculating the tax amount.

This uniqueness often hinders the implementation of global accounting system like SAP and Oracle as they need to be tailored to effectively deal with the consumption tax under Japan’s tax law.

Current consumption tax rate is flat rate of 8%, but the rate will be raised to 10% in October 2019 with the introduction of the reduced tax rate for food and beverages.

Type of transaction subject to consumption tax (“C-tax)

Below is a summary of C-Tax categories for typical transactions:

Transaction C-tax categories
Domestic revenue Taxable sales
Export revenue Taxable sales (Exempt)
Interest income Tax-exempt sales
Sales of land Tax-exempt sales
Dividend received Non-taxable sales
Salary Non-taxable purchase
Medical care and welfare Non-taxable purchase
Import of product Taxable purchase
Domestic purchase of product Taxable purchase
3rd party fee(e.g. consulting fees) Taxable purchase
Rent Taxable purchase
Purchase of fixed asset Taxable purchase

Case 1 (Standard case)

# Income statement C-tax (8%)
Domestic revenue 10,000 800
Export revenue 2,000
Salary (5,000)
Rent (2,000) (160)
Consulting fee (1,000) (80)
Profit 4,000
C-Tax (receivable)/payable 560

(Calculation for C-tax)
Revenue 800 – Purchase 240*100% (*1)=560

(*1) The amount of this deduction is limited depending on the percentage of taxable sales calculated by the following formula:
Taxable sales
Tax-exempt sales+ Taxable sales

Case 2 (Tax refund)

# Income statement C-tax (8%)
Domestic revenue 5,000 400
Export revenue 5,000
Salary (2,000)
Rent (2,000) (160)
Depreciation (1,000)
Consulting fee (4,000) (320)
Profit 4,000
Purchase of Fixed asset (4,000) (320)
C-Tax (receivable)/payable (400)

Calculation for C-tax
Revenue 400 – Purchase 800*100%=-400

Journal entry for C-tax

Accounting system needs to capture the information on whether each transaction is taxable or non-taxable in terms of consumption taxes. According to tax laws, there are two ways to account for C-tax: 1) Tax exclusion method and 2) Tax inclusion method.

1) Tax exclusion method:
Under the method, the accounting system needs to separate transaction amount and C-tax amount for each transactions. Journal entry in the system is like this:

Dr) Account receivable—————$1,080
Cr) Revenue——————————$1,000
Cr) C-tax suspense received—————–$80
————————————————————–

Dr) Consulting fee —————$500
Dr) C-tax suspense paid ———-$40
Cr) Account Payable —————$540
————————————————————–

Dr) C-tax suspense received ———- $80
Cr) C-tax suspense paid ———- $40
Cr) C-tax payable  ———-$40

2) Tax inclusion method:

Under the method, the gross amount for each transaction should be recorded in the accounting system, and the C-tax amount can be expensed as a whole. Journal entry in the system is like this:

Dr) Account receivable  ———-$1,080
Cr) Revenue  ———-$1,080
————————————————————–
Dr) Consulting fee  ———-$540
Cr) Account Payable  ———-$540
————————————————————–
Dr) C-tax expense  ———-$40
Cr) C-tax payable  ———-$40

Tax exempt enterprises

New entity with the capital amount of less 10 million yen can choose the consumption tax position as either taxable payer entity or exemption entity. The exemption period is limited to the first two years. From the third year, whether or not the company is required to file and pay consumption tax is determined based on the sales amount of two years ago. In other word, if the sales amount in the first year (e.g. FY2016) is less than 10 million, the company can choose the tax exemption position in the 3rd fiscal year(e.g. FY 2018).

Regardless the tax benefits above for small business, if the company meets a) and b) below during the exemption period, the company is required to file and pay the consumption tax from the following fiscal year.

a) Sales amount for the first 6 month is over 10 million yen

b) Total salary amount for the first 6 month is over 10 million yen