6 Essential Points Startups Should Know About Japan's Tax Regulations
For many sole proprietors and entrepreneurs in Japan, the New Year brings, among other things, the “joyful” moments of paperwork and tax declarations—congratulations on the arrival of the new tax season!
Of course, the easiest solution would be to seek professional help and take the services of a tax accounting office. We are usually very religious about receiving, categorizing, and storing clients' receipts, invoices, and other important business documents—this way, we ensure their tax season or audit (if they're up to it) is a breeze.
But what if you're just starting out and are not sure if you can afford to hire a professional on a regular basis?
Sad news: You'll have to maintain every drop of paperwork that enters your startup on your own. Every receipt and invoice, payroll paperwork—all these records matter and should be taken record of.
Good news: This document organizing turns out to be very helpful when calculating how much to claim for business expenses, including meeting or travel expenses, equipment bought and used for business purposes, office products—and even a part of your rent or utilities if you work from home.
In this article, we'll offer several tax-related considerations that perhaps can either help you save on tax or get a better grasp of the Japanese tax system.
Alright, let's get the ball rolling.
Disclaimer: Under no circumstances should the tax points covered in this article substitute professional consultation. Whether certain regulations are applicable to your situation or not can only be decided by a professional tax accountant after careful examination of your documents. For this reason, we are not held responsible for any damages caused by this article.
1. Notification of Business Opening (個人事業の開業・廃業等届出書)
If you establish yourself as a sole proprietorship, we highly recommend submitting the Notification of Business Opening (個人事業の開業・廃業等届出書) to national, local and municipal offices within one month of the business commencement date.
Plant this idea firmly in your mind before taking on some projects as a freelancer because filing this notification does have some well-grounded reasons:
Blue Form Return tax benefits: it will give you the chance to receive up to ¥650,000 in tax deductions.
Not doing business registration might prevent you from being eligible for the available subsidies in the future (which happened to many sole proprietors in 2020 when the COVID-19 subsidy was introduced).
You can create a business bank account under your business name/trading name.
Indeed, it is common practice for sole proprietors not to submit the Notification of Business Opening just yet because it's not punished by the law, and most of them are not even aware of its existence.
So, you can surely wait and see how your business develops and backdate the Notification of Business Opening later when the situation gets more or less stable, but in that case, you'll lose the chance to enjoy the Blue Form Return tax benefit because its application time is limited (more on Blue Return will be featured below).
2. Blue-Form Return (青色申告)
There are two types of tax returns: White Return (shiro-iro shinkoku, 白色申告) and Blue Return (ao-iro shinkoku, 青色申告). So getting the colors right before filing a return can help you enjoy considerable tax benefits.
What is Blue Form Return?
As you may guess, the Blue Return is preferable as it offers greater benefits, including special deductions. Sole proprietors or corporations that adhere to a double-entry booking system and file their balance sheets and income statements within the statutory tax return due date can claim a generous deduction of up to ¥650,000.
Moreover, the blue filers that have family employees who are exclusively engaged in their business can include salary payments to those family employees as necessary expenses.
There are other perks like the possibility for revenue losses to be carried forward for three years or carried back to the previous year; or allowance of uncollectible receivables. So it's definitely worth challenging double-entry bookkeeping considering all the tax benefits offered, especially if you're just starting out.
How do I take advantage of the Blue Form Return?
If you want to get Blue Return tax benefits, you'll be required to submit an application form where you'll indicate how you do accounting, such as types of accounting books kept and timing of entries (monthly, quarterly, or yearly).
The application time is quite limited, though.
For sole proprietors: You should submit the Blue-Form Return Application within two months of the business opening date (in case the business opening date is after January 16th) or until March 15th.
For corporations: The due date for submitting is either within three months of the incorporation date or the last day of the first business year (whichever is earlier).
3. Operating in Japan: G.K., K.K., or sole proprietorship?
Those who are new to Japan and are just testing the waters here usually start by registering as sole proprietors. Later on, upon increasing their sales amount, they either establish Godo-Kaisha (G.K., Japanese version of LLC) or Kabushiki-Kaisha (K.K., Japanese version of Ltd.).
So, when should you consider getting incorporated?
When our clients' sales amount increases to ¥8 million, we would normally start advising them to consider opening a company. If their sales amount is ¥10 million and more, then this should definitely be an option to go with, tax-wise.
This is because the Individual Tax rate in Japan is progressive: the more you earn, the more taxes you pay. Corporate Tax rates, on the contrary, are reasonable and easier to control (which is especially important for SME companies).
Based on our observations, G.K. has been gaining popularity recently, apparently, because the establishment process is much faster and easier than that of the K.K.'s. Besides, establishment cost, which is lower than K.K's one, plays quite an important role here.
So, if you hold a Table 2 Visa, you are good to go and have nothing to worry about when establishing a G.K. because you'll have as much authority as Japanese citizens.
If, however, you hold a Table 1 Visa, you'll need to acquire a Business Manager Visa, deposit 5 million yen capital and acquire the Japanese office address.
So what are some of the perks you can get with incorporation?
Besides reasonable tax rates, you can also enjoy some benefits related to National Health Insurance. If you establish a G.K., you can treat your family (wife and children, if any) as dependents of Social Health Insurance.
What is more, if you set up a company and become a company director, you can significantly reduce your National Health Insurance payment. This is because your company will burden half of the insurance payment (and deduct it as an expense). You can also switch to Social Insurance which is more beneficial.
Tokyo is a special zone for company establishment, so there is a chance you may get a special visa. Please contact a professional to learn about the latest updates.
Despite the fact that we say G.K. is a «Japanese version of LLC» pass-through taxation doesn't exist in Japan.
4. Establishing a G.K. or K.K.: Japanese bank account
It's far from a secret that it's close to impossible to operate your business efficiently without having a Japanese bank account. Yet, the selection process is very strict—that is why many companies end up being rejected in opening a corporate bank account by major Japanese banks.
In fact, you can neither establish a G.K. nor K.K. without having your Japanese bank account open.
If you're just planning to start a company and have little to no business history, you could try going with Japan Post Bank or Shinsei Bank.
If you're already an established firm with headquarters overseas and plan to start operations in Japan (G.K. or K.K.), you have two options:
Try opening an overseas Japanese bank account (in the country where your company is registered). During the bank account set-up procedure, make sure to tell bank clerks you're planning to establish a company in Japan and that once the company registration procedure has been completed, you'll open a bank account in Japan as well.
Try opening a Japanese bank account with CitiBank.
You'll need it anyway because you're required to deposit initial capital for the Japanese G.K./K.K (whichever you choose) before proceeding to company registration procedures.
Also, it is better if the G.K.'s or K.K.'s investor is a company rather than an individual—it will enhance the chances of having your Japanese bank account approved.
Below is the list of commonly used overseas Japanese banks:
5. Semi-Annual / Annual WHT Application (源泉所得税の納期の特例の承認に関する申請書).
Basically, if you are an owner of a company, you need to pay Withholding Tax every month. However, it may be quite cumbersome for startups considering they normally don't have financial departments that could take care of such payments. Besides, they have more important things to do.
Actually, it is possible to postpone the payments and make them just twice a year, providing that you pay salaries on a regular basis to fewer than ten employees and file an “Application for Approval Made in Relation to the Special Provision for Due Dates for Withholding Income Tax” (源泉所得税の納期の特例の承認に関する申請書).
This significantly eases the document organizing work in the office and benefits a company's finances.
Please note that you cannot file this notification without submitting "Notification on the Establishment of a Salary-Paying Office” (給与支払事務所等の開設・移転・廃止の届出).
How does it work?
Let's say you filed an application in August. The schedule would look like this:
August, X: Application Filing
End of September, X: Application comes into effect
So basically, you would still need to pay WHT for August (until September 10th). But WHT payments for September, October, November, and December should be paid until January 20th.
6. Japanese Consumption Tax: changing your status from "non-payer" to "payer"
Disclaimer: Please note in case your capital amount exceeds ¥10 million, you're always liable for JCT, and this information is not relevant to you.
Generally, businesses with taxable sales of ¥10 million or less in the base period are determined as "non-taxable person for Japanese Consumption Tax" by the NTA and are exempt from filing the Japanese Consumption Tax Return.
However, in certain cases, filing "Report on the Selection of Taxable Proprietor Status for Consumption Tax" (shouhizeikazeijigyoushasentakutodokesho, 消費税課税事業者選択届出書) and becoming a JCT taxpayer, even if your sales do not exceed ¥10 million in the base period, can be a wise strategy.
New businesses that would normally be exempt from paying the JCT may result in paying it in excess due to their expenses like office construction, acquisition of new equipment/machinery, etc., in the base period. You know, you always pay JCT with expenses and receive it with sales. And if your sales are limited but expenses are huge, especially during your first fiscal year, you could take advantage of the situation and submit "Report on the Selection of Taxable Proprietor Status for Consumption Tax" to receive the refund for the JCT paid.
Also, it is a possible scenario if most of your sales are non-taxable (based abroad) because, in such a situation, you would only pay the JCT (with your expenses) and would never receive it, so claiming a refund sounds like a plan.
But there are some tricky points as well:
Those who opt for becoming JCT payers should keep in mind that this notification is valid for two years, so there is a chance you may not return to "non-JCT payer" status, and if something changes in the business model, etc., you might end up paying the JCT instead of receiving a refund. Also, if you choose this option, you'll need to prepare a JCT return which would be unnecessary otherwise.
Besides, whether or not this option is advantageous for your business is judged based on the calculations of a company's financials that should be made in advance before submitting this notification. To prove a point, we'll describe two situations from our practice.
Client 1: sales come from abroad, expenses are paid in Japan. After working out a client's financials, we concluded that filing this notification is advantageous for him. As a result, he was able to get a JCT refund of more than one million yen last year.
Client 2: most of the expenses consist of salary/bonus payments (salary expenses are not liable for JCT). So, this option doesn't really work for him.
But even such business types (system engineers, design agencies, etc.) can take advantage of the situation. They should start by registering as sole proprietors. This way, they will be exempt from JCT for two years. Then they should get incorporated during their 3rd year of operation (either G.K. or K.K.) and get exempt from JCT payments for two more years. The reason is simple: the tax liability of a self-employed (before becoming a corporation) and a corporation (once that individual business owner switched to a corporation status) is determined separately. It means that even if your taxable sales as a sole proprietor exceeded ¥10 million last year, once you've become a corporation, there won't be any reference to your history of sales. You will get treated as a newly-established corporation and will be exempted from paying the Consumption Tax for two more years.
In any case, spending a little extra effort on determining whether or not you should file a certain notification did no harm to anyone because eventually, you may end up getting extra tax benefits.
Indeed, taxes sound like a lot of legwork. But the truth is they don't have to be your headache. All you have to do is to be a stickler for paperwork—make sure to maintain receipts, invoices, and bank statements. Then just wrap up everything in a bow and send it off to your tax accountant. The rest, as they say, is history.
If you're interested in learning more about the points covered in the article or how Otani Accounting Office's finance professionals can help you manage your company's finances, drop us a line and tell us your story.
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