The objective of this page is to provide certain useful information for a foreign company or entrepreneur who is going to commence or has commenced business with a Japanese enterprise to understand the general background of the Japanese accounting and tax systems. Since the contents of this page consist of basic information and do not cover every details and exceptions, etc.,  it should be noted that your understandings on the information or decisions made based on the information in this page should be reviewed and checked by a Japanese accounting and taxation specialist before you have executed any business arrangements.  We will not take any responsibilities for the use of information of this page by anyone who read this page, unless we are requested by the person to provide professional advice. 　

1. Statutory Tax Rates:

The Japanese corporate income tax rates prevailing for the fiscal years commencing on or after April 1, 2004 are summarized as follows.

Notes

(1): Enterprise Tax is assessed by prefectural governments. Since prefectural governments are allowed to increase Enterprise Tax rates up to 105% of standard tax rates, several prefectural governments (Tokyo, Kanagawa, Shizuoka, Aich, Kyoto, Osaka and Hyogo) are imposing higher tax rates to companies whose whose taxable income exceeds certain amount ( From \ 25 Mill(Tokyo's case) to \ 50 Mill (Osaka and Hyogo's case)).

(2): Inhabitants tax consists of prefectural inhabitants tax(standard rate of 5.0%)and municipal inhabitants tax(standard rate of 12.3%).

Since prefectural governments and municipal governments are allowed to increase tax rates up to the maximum rates (6.0% for prefectural and 14.7% for municipal), many local governments are imposing higher tax rates to companies whose whose taxable basis (the amount of Corporation Tax) exceed certain amount (mainly \4 Mill to \10 Mill).

(3):In addition to tax on income, companies are subject to inhabitants tax per capita charges which are assessed by the local government who governs the place where the  business premises of the company is located. Current per capita charges are summarized as follows.

Notes

(1): Enterprise Tax is assessed by prefectural governments. From April 2004, in addition to historic assessment of enterprise tax on income, the concept of assessment on the size of business is introduced by the government for the companies whose paid in capital is more than \100 Million. Since prefectural governments are allowed to increase Enterprise Tax rates up to 105% of standard tax rates, several prefectural governments (Tokyo, Kanagawa, Shizuoka, Aich, Kyoto, Osaka and Hyogo) are imposing higher tax rates to companies whose whose taxable income exceeds certain amount ( From \ 25 Mill(Tokyo's case) to \ 50 Mill (Osaka and Hyogo's case)).

(2): Inhabitants tax consists of prefectural inhabitants tax(standard rate of 5.0%)and municipal inhabitants tax(standard rate of 12.3%).

Since prefectural governments and municipal governments are allowed to increase tax rates up to the maximum rates (6.0% for prefectural and 14.7% for municipal), many local governments are imposing higher tax rates to companies whose whose taxable basis (the amount of Corporation Tax) exceed certain amount (mainly \4 Mill to \10 Mill).

(3):In addition to tax on income, companies are subject to inhabitants tax per capita charges which are assessed by the local government who governs the place where the  business premises of the company is located. Current per capita charges are summarized as follows.

2. Effective Tax Rates:

Since the Enterprise Tax is deductible for computation of taxable income for the fiscal period when the tax become due (i.e., usually three month later than the closing date of the company when the Enterprise Tax Return has to be filed), the Japanese effective tax rates should be calculated by taking into account of the effect of deductibility of the Enterprise Tax and ordinarily calculated as follows.

Accordingly, the statutory tax rates and effective tax rates for a company whose paid in capital is more than \100 Million may be summarized as follows.

Note: The above effective tax rate does not include effect of enterprise tax assessed on the value added and on the capital explained above.

Foreign corporations may choose a branch or subsidiary for doing business in Japan.

In principle, there is no material difference between branch and subsidiary in connection with taxation and other legal requirements in Japan. However, the foreign investors should notice the following facts.

 1.      Difference in Taxation: 

2.      Advantages and disadvantages:

 As shown above, there is no material difference in the Japanese taxation between branch operation and subsidiary operation.  Accordingly, advantages (or disadvantages) of a branch against a subsidiary, vice versa, should be reviewed based on other factors than the Japanese taxation. It is ordinarily said that a branch is recommendable for a small or medium sized operation in Japan or for a start-up period since the tax loss incurred by the branch may be utilized both in the home country (losses incurred by a Japan branch may be deducted from taxable income of the head office for the home country's tax purposes) and in Japan (tax loss may be carried forward for 7 years to offset against future taxable income). However, it should also be noted that, for the Japanese tax purposes, the tax loss of a branch may not be simply carried forward by a subsidiary who may take over the branch's business and there must be a tax planning opportunity for transforming a branch operation to a subsidiary operation.

Perhaps, the most important disadvantage of a branch against a subsidiary is that the foreign company may be directly subject to all of the Japanese laws and regulations, while the foreign company is only subject to the shareholder's responsibility in case of a subsidiary operation.

1.      Self assessment system:

Companies are liable for the Japanese corporate income taxes on a self-assessment basis. Due date of the payment of the final corporate income taxes is the same as the deadline of filing final tax returns which is in principle within two months after the end of the accounting period of the company. One-month extension of the deadline is almost automatically accepted for a Kabushiki Kaisha (a limited liability company who may issue a share certificate) by the tax authorities provided that the company has filed an application for the extension before the end of the accounting period from which the company would like to apply the extension.

2.      Taxable income:

Corporate taxable income is calculated by the aggregate of gross income from all sources, less the aggregate of all costs, expenses, tax-purposes reserves and provisions.

In general, gross income, costs and expenses for tax purposes are calculated based on all accounting transactions, other than capital transactions, made in the accounting period, which have to be recorded based on generally accepted accounting principles.

Capital gains or capital losses are included in taxable income or tax loss and there is ,in principle, no requirements to differentiate how to calculate income or loss  between classes of income or losses.

Selling, general and administrative expenses (except for depreciation) and other expenses including financial expenses which are not included in cost of sales are in principle tax-deductible when the following conditions are all satisfied.

(1)   Legally liable for payment of such expenses

(2)   Transaction has been made or event has happened, which gives rise to the liability for payment

(3)   The amount of liability may be reasonably calculated

3.      When to recognize income or loss:

(1) Income or loss on sales of goods:

Income or loss on sales of goods has to be recognized in the year when the goods are delivered. The delivery date may be the day when the goods are shipped by the seller, the day when the goods are inspected by the purchaser, the day when the goods are made available for the purchaser's use, the day when the quantity of goods are counted by the purchaser, etc., which may be elected and should be continuously applied by the taxpayers.

If costs are not yet determined at the delivery date, taxpayers have to estimate the amount of cost based on the information and reasonable assumptions available at the year-end.

(2) Income or loss on contract:

For tax purposes, income or loss on contract shall in principle be recognized on a so-called "completion of contract basis" as follows.

(a)   Contract to complete something to be delivered to a customer:

Income or loss shall be recognized when the entire contracted article is completed and delivered to the customer.

(b)   Contract to complete something which does not have to be delivered to a customer:

Income or loss shall be recognized when all of the contracted services are completed

However, for certain contracts, exceptional basis to recognize income or loss shall be applied as follows.

(a)   For a long-term and significant construction or manufacturing contract:

For a contract which is classified as a long-term and significant construction or manufacturing (a contact which satisfy the following three conditions;(1) contracted construction period is 2 years or more, (2) amount of the consideration is Yen5,000 million or more and (3) contract does not prescribe that at least half of the consideration shall be paid after the date when one year has passed since the transfer of the ownership of the object), income or loss of a contact is prorated based on the accumulated actual cost of the contract against total estimated cost of the contract. 

(b) For a contract for which payment of consideration is regularly divided to several parts and made based on the completion of certain part of the contract:   

For certain contracts which consist of a bulk of similar construction etc., or payment of consideration is divided to several parts and made based on the completion of certain part of the contract, etc., application of the "completion of contract basis" (principle method) is not acceptable to the tax authorities, but a corporation is required to adopt the "partial completion basis" and recognize a part of income or loss of the whole contract attributable to the completed portion when the part of the contract is completed.

(3) Income or loss on providing services:

Service fee shall in principle be recognized when all of the contracted services have been rendered (similar to " completion of contract basis").

However, if service fee is calculated and paid on a "partially completed basis" which is the case explained below, application of the principle method is not acceptable, but a corporation is required to adopt the "partially completion basis" and recognize fee income attributable to a portion of the contracted services which have been completed.

The sample cases where the "partially completed basis" has to be adopted are as follows.

(a)   Service fee is calculated by the number of engineers and the number of days worked for the project and the service fee is computed and paid by certain period during the whole contract period.

(b)   Service fee is determined by each step of the project (e.g. fee for basic design and fee for detailed design are separately determined) and the fee for each step is paid after completion of each step.

Even if this is the case where "partially completed basis" has to be adopted, if the service fee will not be paid until all of the services have been completed or a certain period more than one year has passed, recognition of service fee may be postponed to such dates.

4.      Accounting method to be elected by a taxpayer:

(1) Depreciation of fixed assets:

Depreciation is allowed for tangible fixed assets, excluding land and any rights related to the ownership or use of land and other assets of which value may not decrease in the futures, such as jewelry, art objects, antiques, etc., and intangible fixed assets, such as acquired patent rights, trade marks, copy rights, goodwill, etc.

Depreciation has to be booked in the statutory books of accounts of the company in order to be tax deductible.

The amount of tax-deductible depreciation of tangible fixed assets may be computed by either the straight-line or the declining balance method which, in principle, has to be elected by the taxpayer.  If a report on election of depreciation method has not been filed before the deadline of filing the tax return, the declining balance method shall be applied. Change in the depreciation method is ordinarily approved by the tax authorities subject to a filing of an application before the beginning of the fiscal year.

Useful lives and depreciation rates which are under the assumption that 10 % of acquisition cost shall be residual after completion of depreciation to be applied for calculation of depreciation are prescribed by the ministerial ordinance issued by the government. Almost all Japanese companies apply these useful lives and depreciation rates for accounting purposes.

The amount of tax-deductible depreciation of intangible fixed assets is calculated by the straight-line method. Useful lives and depreciation rates which are under the assumption of no residual value after completion of the depreciation to be applied for tax depreciation purposes are also prescribed by the ministerial ordinance.

Goodwill may be equally depreciated for 5 fiscal years, irrespective of whether it is acquired at sometime during the fiscal year.

Fixed asset of which useful period is less tan 1 year or acquisition cost is less than Yen100,000 per unit (may be called as "minor fixed assets") may be charged to taxable income if the cost is charged to income in the statutory books of account for the year when acquired.

Depreciation of a fixed asset of which acquisition cost is Yen100, 000 or more and less than Yen200,000 may be calculated by a basket depreciation method where the elected assets in the basket are combined in one group and depreciated under the basket useful period of 3 fiscal years and no residual value at the end of third fiscal year, if it is elected by a taxpayer.

(2) Amortization of deferred charges:

Deferred charges may be amortized by the straight-line method over the period when the effect of charges shall last.

Acceptable amortization period is instructed by the tax authorities.

(3) Inventory valuation:

A company may elect one of the designated valuation methods by each category of inventories and by each location of business premises and each lone of business.

Available valuation methods are as follows. 

The report on election of inventory valuation method has to be filed by the deadline of filing the tax return. If the report is not filed, the last purchase price method is in principle applied. In order to change the valuation method, the company has to file the application for approval on the change before the commencement of the fiscal year.

(3) Securities valuation:

A company may elect one of the designated valuation methods by category of securities.

Available valuation methods are as follows.

The report on election of securities valuation method has to be filed by the deadline of filing the tax return. If the report is not filed, the weighted average method is in principle applied. In order to change the valuation method, the company has to file the application for approval on the change before the commencement of the fiscal year.

(4) Translation of foreign currency receivables and payables:

Foreign currency receivables or payables have to be translated into Japanese yen at end of the fiscal year by one of the designated methods.

Available translation methods are as follows.

For short-term foreign currency receivables or payables, a company may elect to translate by the historical rate method by filing the report on election of the translation method by the deadline of filing the tax return. This election may be made by each foreign currency. If the report is not filed, year-end rate method shall be applied.

In order to change the translation method, the company has to file the application for approval before commencement of the fiscal year.

5.      Non-taxable income:

(1) Dividends from Japanese corporations

Dividends received from Japanese corporations may be fully excluded from taxable income if a receiving company owns at least 25% of the shares in the paying company.

If a company owns less than 25% of the shares, only 80% of dividends received from the paying company may be excluded from taxable income.

(2) Asset revaluation gain

Revaluation gains, with certain exceptions such as revaluation of certain financial products which may be revaluated by the market value and revaluation made in the process of rehabilitation under the Corporation Reorganization and Rehabilitation Law, etc., are excluded from taxable income.

6.      Non-tax deductible expenses:

In general, all costs, expenses and losses incurred by a company are tax deductible.

However, there are certain non-tax deductible items as follows.

(1)   Entertainment expenses:

Entertainment expenses are in principle non-tax deductible.

However, for a small and medium size company, certain amounts of entertainment expenses are still deductible from taxable income as follows.

In case of a branch of a foreign company, the amount of paid-in capital for calculation of tax-deductible entertainment expenses shall be prorated by the ratio of the assets located in Japan against total assets of the company.

(2)   Donations and charitable contributions (Donations):

Donations are tax deductible to certain tax limit.

For an ordinary company, limit of tax-deductible donations is the amount of 1.25 % of annual taxable income (before deduction of donations) plus 0.125 % of paid-in capital and capital surplus of the company.

Like the case of entertainment expenses, for a branch of a foreign company, the amount of paid-in capital and capital surplus is prorated by the ratio of the assets located in Japan against total assets of the company.

(3)   Corporation tax, inhabitants tax and penalty taxes:

Except for Enterprise Tax, taxes assessed on income (i.e. Corporation Tax and Inhabitants Tax) are non-tax deductible. The Japanese penalty taxes and other penalties and fines (including those assessed by foreign governments) are also non-tax deductible.

Enterprise Tax is deductible for Corporation Tax, Inhabitants Tax and Enterprise Tax purposes when paid, which give rise to a reduction of the Japanese effective tax rates from nominal rates.

(4)   Directors bonus, excessive directors' remuneration and retirement allowances:

In order to avoid unfair tax savings which might be arranged by a family owned corporation, certain restrictions on tax deductibility of payments to directors are prescribed by the tax laws.

Regular remuneration to a director is tax deductible unless it is regarded as excessive amount. Whether the amount is excessive or not may be judged by comparing with the level of payments made by comparable companies. If the amount of directors' remuneration exceeds the amount approved by a resolution at the general shareholders' meeting, the excess amount shall not be tax deductible.

Directors' bonus is in principle not tax deductible, regardless of how paid and recorded by the company. Any non-regular payments other than payments of severance or retirement allowance to directors are in principle regarded as payments of bonus.  

Bonus to a director who is classified as a director who is also subject to duties as an employee is tax deductible to the extent that the amount is reasonable for the duties as an employee.

Retirement allowance to a retired director in excess of a reasonable amount for the past contribution made by the retired director is non-tax deductible. 

Payment of salaries, bonus or retirement allowances to employees who has certain special relationship with a director of the company are also subject to similar restriction and the amount in excess of a reasonable amount is non-tax deductible. 

(5)   Asset devaluation loss:

In principle, unrealized loss on devaluation of assets are non-tax deductible.

However, devaluation loss on certain assets under certain circumstances may be tax deductible, subject that such loss is recorded in statutory books of accounts.

Tax-deductible devaluation loss is summarized as follows.

7.      Blue form tax return:

In order to encourage taxpayers to keep appropriate accounting records, the blue form tax return system where certain tax privileges are granted to taxpayers who file a blue form tax return has been adopted by the government.  Taxpayers who are keeping proper accounting records may file application for approval on filing blue form tax return.  Applications will be almost automatically approved by the tax authorities.

The tax privileges granted to a taxpayer who files a blue form tax return are as follows.

(1) Tax authorities may only be able to correct the taxable income based on the result of examination on books of accounts (correction on an assumption basis is not possible) and has to disclose the reasons of correction of taxable income on the assessment notice

(2) Tax loss carry-forward for 5 years (7 or 10 years for certain cases)

(3) Tax loss carry-back for 1 year (provisions of tax loss carry-back is currently suspended and not available expect for the case of dissolution, etc.)

(4) Tax deductible reserves and special accelerated depreciation under the Special Taxation Measures Law

(5) Special allowance for income from technical services provided for certain emerging countries

(6) Tax credit for Research and Development Expenses and for certain designated investments

8.      Tax deductible provisions:

Presently, six kinds of provisions are allowed under the Corporation Tax Law and three of which exist as a transitional measure before permanent abolishment in the near future.

In order to claim deduction from taxable income, provisions have to be recorded in the statutory books of accounts of the company.  Outline of available tax-deductible provisions are as follows.

(1) Provision for doubtful debts:

Estimated loss on bad debts calculated on the balance of monetary receivables at year-end is allowed to deduct from taxable income. The maximum amount of provision is calculated as follows.

Estimated loss on identifiable bad debts (A)  +  Estimated loss on unidentifiable bad debts (B)  =  Maximum amount

(A) Estimated loss on identifiable bad debts = aggregated amount of estimated loss on receivables which seem to be difficult to collect under designated conditions

(B) Estimated loss on unidentifiable bad debts = Amount of monetary receivables other than receivables subjected to the above (A)  ×　Actual bad debts ratio for the preceding 3 year period

(Exception for small and medium sized companies)

For companies whose paid in capital is Yen100 million or less, the above amount (B) may be calculated by a convenient and beneficial method as follows.

Amount of monetary receivables other than receivable subjected to the above (A), net of the amount of payable to the same company  ×  Standard rate as shown below  × 116%  =  Estimated loss on unidentifiable bad debts

The amount of the provision deducted from taxable income should be reversed and added to taxable income in the following year.

(2) Provision for returned goods:

Provision for returned goods is allowed to a company who is doing certain designated business (publishing, wholesale of books, and manufacturing or wholesale of pharmaceuticals, agricultural chemicals, ready-made-clothes, cosmetics, audio/visual  disks/tapes)  under an unconditional repurchasing agreement with its customers.

The maximum amount of the provision is computed by the balance of account receivables at year-end or the last 2 months sales for the fiscal year multiplied by the returned goods ratio for the latest two years up to the year-end and gross profit ratio for the fiscal year.

The amount of the provision deducted from taxable income should be reversed and added to taxable income in the following year.

(3) Provision for employees' severance indemnities:

In Japan, a lump-sum severance payment plan has been more common compensation plan than a pension plan. Most of the Japanese companies have their-own rules or regulations for payment of severance indemnity. Tax-deductible provision for employees' severance indemnities are allowed to a company who has a rules or regulations of the severance indemnities and filed a copy of the regulations with the tax authorities so that the company may accrue some part of payments to be made in the future for tax purposes.

The amount of this provision is in principle calculated by the net increase in the liabilities of severance indemnities for the fiscal period, which is calculated based on the assumption that all employees shall voluntarily resign at year-end.

The maximum amount of the accumulated balance of this provision shall not exceed 20 % of the assumed liability (As a transitional measure for the tax revision made in 1998, which reduced the limit from 40% to 20%, reduction will be made gradually by the year commencing from April 1, 2003) 

(4) Provisions for employees' bonus:

Explanation is omitted since the provision only exists as a transitional measure and will be fully abolished in the near future.

(5)   Provision for significant repairs:

Explanation is omitted since the provision only exists as a transitional measure and will be fully abolished in the near future.

(6)   Provision for warranty:

Explanation is omitted since the provision only exists as a transitional measure and will be fully abolished in the near future.

9.      Tax deductible reserves:

Although the scope and items of tax-deductible reserves has been reduced by the government in recent years, certain tax deductible reserves are still available for a company who is filing a blue form tax return.

Reserves have to be recorded in the statutory books of account either as charges to income or as items of the appropriation of retained earnings.

Most of the reserves are allowed to a company doing certain business which is deemed to be encouraged or supported by the governments to develop Japan's industries and a company who may utilize the reserves is usually a large sized company.

Examples of tax-deductible reserves are as follows.

10. Sur-tax on retained income for a family owned company:

Since Japan has been adopted graduated tax rate system for individual income tax and the rates applied to higher income have been significantly higher than the tax rates of corporate income tax and also imputation tax system is not adopted in Japan, high income individuals have tend to establish a company and transfer his/her income to the company and to retain the income in the company for tax saving purposes.

In order to prevent inappropriate tax savings which might be attempted by a family owned company, the sur-tax on retained income for a family owned company (a branch of a foreign company is not subject to the tax) has been adopted by the governments.

If 50% or more shares of a company is directly or indirectly owned by any combination of three or less shareholders (relatives, persons dependent with the shareholder or corporations which is owned 50% or more by the shareholders are counted as one shareholder), the company is subject to the sur-tax on retained income.

The amount of the retained income subject to sur-tax is calculated as follow.

The sur-tax rates are as follows. 

 *Maximum rate (actual rate may vary depend on the location of the company)

11. Additional taxes on unaccounted expenditures:  

Expenditures of which name and address of payees and objectives for payments are not recorded in the statutory books of accounts are non-tax deductible and subject to 40% extra corporation tax in addition to ordinary corporation tax. Since the inhabitants tax shall be assessed on the corporation tax at 20.7% (maximum rate), the aggregated tax burden on such unaccounted expenditures will be approximately 90% (effective tax rate of 42% plus additional tax of 48%). 

12. Transfer pricing legislation:

Under the provisions of the Article 66 - 4 of the Special Taxation Measures Law, the tax authorities may correct the taxable income of a company if the company has cross-border transactions with its foreign affiliated companies and the prices agreed with the foreign affiliated companies for the transactions are less than the amount which shall be calculated on an arm's length basis.

The foreign affiliated company subject to transfer pricing legislation is as follows.

The arm's length price may be calculated by the following methods. 

13. Thin capitalization rules:

Interest is in principle fully tax deductible.

However, the tax deductibility of interests paid to "foreign controlling companies" is restricted by the "thin capitalization rules".

The foreign controlling company subject to the thin capitalization rules is as follows.

The amount of non-tax deductible interest paid to a foreign controlling company is calculated by the following formula.

Notes:     (1) If the amount of (Average balance of total interest bearing debts  − Average amount of total shareholders' equity  ×  3) , is less that the amount of the above numerator, the numerator should be replaced by the amount.

               (2) The company may use other multiplier than 3, if they can find a reasonable debt (interest bearing debt only) equity ratio based on the information of comparable Japanese companies.             

Borrowings from third parties based on guarantees made by foreign controlling companies are not subject to the Japanese thin capitalization rules.

14. Statute of limitation:

In principle, the tax authorities may correct the tax return filed by a company within 3 years after the due date for filing the tax return. If no return has been filed, the tax authorities may determine the amount of income tax within 5 years after the due date for filing the tax return. For negative correction (reducing the amount of tax liability), the statutory limitation is 5 years.

In connection with corrections of tax liability under the transfer pricing legislation, the statutory limitation is extended to 6 years from ordinary 3 years.

In case of tax evasion or false return, the statutory limitation for correction or determination of tax liability by the tax authorities is extended to 7 years.

15. Tax audit:

Since the self-assessment system is adopted for collection of income tax, tax audit by the tax authorities after filing of tax return and payment of tax liability is a common practice in Japan. Tax audit is ordinarily done by the National tax authorities and the result of the audit is informed to the local tax authorities.

In principle, a company whose paid in capital is Yen100 million or more will be audited by the Regional National Tax Administration Bureau and other small and medium sized companies will be audited by the local National Tax Office.

Under the provisions of Corporation Tax Law, the tax auditors have rights to make questions and examinations to the taxpayer and also anyone who may have transactions with the taxpayer.

 A company who earns considerable taxable income may have tax audit at least once in every 3 years.

16. Penalties:

10% penalty tax is in principle assessed on additional Corporation Tax reported by (1) the notice of correction of original tax return issued by the tax authorities, (2) amended tax return filed by the taxpayer after discussions with the tax auditors on the items found during the tax audit, or (3) even amended tax return voluntarily filed after the taxpayer is informed by the tax auditors the commencement of the tax audit.

10% rate will be increased to 15% on the portion exceeding the larger of Yen500,000 or the amount of tax payable per the original tax return.

Penalty for non-filing of tax return or late filing is in principle 15% on the tax liability.

If a tax return is filed after the due date and before commencement of tax audit, the penalty rate for late filing will be reduced to 5%.

In case of tax evasion, penalty tax rate will be increased to 35% (40 % in the case of non-filing of tax return).

(Under Construction)