Digital Tax in Japan: what it is and who is liable? Let’s figure it out together!
Tax rules related to digital businesses are constantly changing worldwide and can greatly affect e-services companies if they cannot catch up with the latest amendments. In the era of Covid, when digital saw its rise and e-commerce is booming, many countries around the globe are considering ways to charge tax based on the location of the product purchaser.
So, one thing that is for sure if you’re a digital-based company – digital tax rules do affect you. You may be kicking back in your own country thinking you’re perfectly fine paying taxes locally, but what you really need to do is consider the tax rules of other countries you sell your products/services in.
Doing digital business across borders is a bit complicated, so in this article, we’re going to introduce the taxes you may be liable to pay in Japan if you’re an online business.
Table of Contents
Digital Tax Rules in Japan: Corporate Taxes
Now let’s dive right into the details.
Corporate taxes in Japan are levied on corporate income and are divided into the following categories:
– Corporate Tax (national),
– Local Corporate Tax ( national),
– Corporate Inhabitant Tax (local),
– Enterprise Tax (local)
– Special Local Corporate Tax (national, but the payments are made to local governments along with Enterprise Tax).
Domestic companies in Japan have to pay Corporate Taxes not only on domestic income but also on their worldwide income (including branch income) while foreign companies are taxed only on the income earned in Japan.
Domestic Corporations: a company with a head office or main office located in Japan. The nationality of the shareholders or place of its central management is not relevant. This is usually the case for companies that were first established and registered in Japan.
Foreign Corporations: corporations other than domestic (including branch offices or manufacturing plants established in Japan by foreign corporations).
When it comes to foreign corporations, the liability for corporate taxes depends on the following factors:
- Whether a foreign company has a PE (“permanent establishment”) in Japan (aka taxable presence)
- The nature of PE, in case the foreign company has it ( we will discuss later the main types of PE)
- The nature of Japanese-source income
Permanent Establishment (PE)
The definition of PE has been amended several times. The articles of the Corporate Tax Law and CTL Enforcement were last revised in 2019 to comply with the updated Article 5 of the OECD MTC (Model Tax Convention).
The revised definition of PE divides taxable presence a foreign company may have in Japan into the following places:
- Direct PE
Branch, factory, other fixed places in which business is conducted in Japan, mine, quarry, building for rent, etc.
Important: the definition of the Direct PE above EXCLUDES places used only for the purpose of storage, display, or delivery of goods or merchandise belonging to the company and any other activity of a preparatory or auxiliary character.
- Construction PE
Construction/installation work, assembly project, or supervisory services related thereto that continue for a period of more than one year.
Important: the definition of the Construction PE above EXCLUDES places used only for the purpose of storage, display, or delivery of goods or merchandise belonging to the company and any other activity of a preparatory or auxiliary character.
- Agent PE
A person acting on behalf of a foreign company in Japan is treated as an Agent PE of that foreign company in case he/she:
- Habitually concludes contracts or plays a principal role that leads to the contract conclusion and these contracts are routinely concluded without any modifications from the side of a foreign company and,
- These contracts are concluded in the name of the foreign company (1), are for the transfer of ownership of /right to use the property owned by the foreign company/property the foreign company has the right to use (2) or for the provision of services by the foreign company (3).
Please note that Independent Agent doesn’t fall under the scope of the Agent PE definition.
Independent Agent doesn’t fall under the scope of PE. definition if he/she meets all of the following conditions:
- A person doesn’t receive comprehensive and detailed instructions from a foreign company when running his/her activities, runs business activities on its own discretion, and is legally independent of a foreign company;
- Through his/her own knowledge and skills related to the business of a foreign company, the person takes the risk and is economically independent of the foreign company;
- The person is himself carrying on his/her normal business activities or processes.
Important: the definition of the Agent PE above EXCLUDES places used only for the purpose of storage, display, or delivery of goods or merchandise belonging to the company and any other activity of a preparatory or auxiliary character.
If you feel like it’s a bunch of confusing information you don’t know what to do with, you may want to take a look at the graph below designed exclusively for the ease of your understanding:
Tax Treaties and the way they affected PE Definition
Japan has also concluded a number of Tax Treaties that have precedence over domestic tax law. Therefore, if the amendments in the definition of PE under Japanese domestic law are different from the definition of PE under a tax treaty, the articles of the relevant tax treaties should override the articles under the Japanese domestic tax law.
The bottom line? If you’re a, let’s say, U.S. company that doesn’t have a PE in Japan, then you should not be paying Corporate Taxes in Japan because under the Japan-US Tax Treaty; only the resident engaged in industrial and commercial activities through PE in Japan should be subject to tax (either Individual or Corporate)
Digital Tax Rules in Japan: Consumption Tax
Japanese Consumption Tax is similar to European-style VAT and is levied on the volume of business (aka “taxable sales”) and is paid based on a self-assessment method. Read our article on the Japanese Consumption Tax for more details.
On October 1st, 2015 Japanese Consumption Tax was made pertinent to digital services by foreign enterprises to Japanese consumers, and several amendments were made to the Digital Service Legislation in 2016.
So, what does NTA regard as “digital services’’?
According to the NTA, digital services are certain services provided via a telecommunication network. The following examples of transactions constitute the digital/electronic services:
- Provision of e-books, digital newspapers, music, videos, and software (including various applications such as games) via the internet
- Services that allow customers to use software and databases in the cloud
- Services that provide customers with storage space to save their electronic data in the cloud
- Distribution of advertisements via the internet
- Services that allow customers to access shopping and auction sites on the internet (e.g., charges on posting goods for sale, etc)
- Services that allow customers to access the place to sell game software and other products on the internet
- Provision via internet reservation website for accommodation and restaurants (those who charge on posting for the website from the businesses that operate accommodation and restaurants)
- English lessons provided via the internet
What Digital Businesses are Liable for JCT?
The liability for the Japanese Consumption Tax depends on whether a foreign company’s digital service is classified as B2B or B2C and whether the transaction is treated as domestic or foreign.
The NTA defines the B2B services as “services that are normally limited to businesses.”
Services other than those that are limited to businesses are classified as B2C and are subject to Japanese Consumption Tax.
Foreign companies that provide B2B digital services for a Japanese business are not liable for the Japanese Consumption Tax.
However, they are required to clearly indicate that the service recipient will be subject to and will have to pay Japanese Consumption Tax (that the transaction is subject to tax filing under “reverse charge mechanism”) when providing such digital services.
On the other hand, foreign companies providing B2C digital services are required to file and pay Japanese Consumption Tax.
Businesses with taxable sales under 10 million JPY in the base period during the taxable period are exempt from Consumption Tax.
Sole proprietors that do not have an address or domicile in Japan and foreign companies that have no head office/office located in Japan must appoint a Tax Agent to handle tax return filing and payment.
It is important to note, however, that the Japanese government focuses on the nature of the service or the terms of the service contract (the scope of B2B supply is very narrow) rather than the status of the consumer when deciding whether a service should be classified as B2B or B2C.
Therefore, foreign companies providing digital services to Japanese consumers should be really careful about this note since they may discover that their services are classified as B2C (and therefore subject to JCT) even though they mostly provide digital services to businesses.
This may happen when, for example, you’re a cloud service provider accepting applications for such services through a website on the internet.
You state and clearly notify that “this service is for business use only” but in reality fail to effectively restrict accepting applications from general consumers or others, those who are not in the business and who are not going to use your service for business only.
In that case, you will be classified as a B2C service provider and will get liable for the Japanese Consumption Tax.
Domestic vs. Foreign Transaction
The criterion for determining whether the transaction is treated as domestic or foreign is whether the address of the digital service consumer is in Japan.
The NTA states they determine whether the consumer is located in Japan based on “objective and reasonable criteria.” What does it mean?
Literally, it’s either by using the address provided by the consumer to the service provider or by using the address registered to the credit card the consumer used to pay for the digital/electronic services.
It is also worth noting that if you provide digital services to a Japanese branch of a foreign company, the transaction s treated as a foreign one and is not subject to Japanese Consumption Tax.
Voluntary registration for Consumption Tax in Japan
If you’re a B2C supplier providing digital services for a Japanese company, you may consider registering your foreign business in Japan if you want your Japanese service recipient to be able to claim a purchase tax credit.
Again, this is not mandatory, but just something you may want to consider if you want to maintain long-lasting relationships with your Japanese business customers.
To be able to register your foreign business in Japan, you must satisfy the following criteria:
(1) Your business is Japanese Consumption Taxpayer
(2) Your business provides or will provide B2C digital services
(3) Your business has an office in Japan to provide such B2C electronic services
(4) In case your business does not have an office, it has designated a Tax Accountant Proxy for consumption tax purposes
(5) If a corporation does not have an office in Japan or if a sole proprietor does not have an address or domicile in Japan, it has designated a Tax Agent and
(6) A business has no delinquent national tax liabilities (a business may not be able to register depending on the state of delinquent tax)
All in all, Japan tries its best to adjust the digital tax rules to the ever-growing and constantly evolving world of international trade. The ultimate goal is, apparently, to transform the country into the world’s leading financial centre attracting as many foreign investors and high-income executives as possible. Whether or not they will reap the benefits of their efforts we can’t say for sure now.
But you can definitely take advantage of the changing regulations to ensure you’re compliant with the digital tax rules in Japan and are not overpaying the Japanese taxes.
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