The consumption tax hike to 10% this October could increase the risk of additional taxes being levied based upon tax investigations. For reference sake, the first examination of corporate results after the prior consumption tax hike (from 5% to 8%) showed that the amount of additional tax levies rose by 25%. Let’s review basic consumption tax-related matters which are easy to make mistakes on.

Consumption tax is a tax levied on the consumption of goods and services, as opposed to one levied on income, such as the corporation tax and income tax; many specific provisions exist regarding the consumption tax. Misunderstandings of such provisions are often pointed out in tax investigations.

Here we will introduce cases of land transfers where the amounts of transfer consideration have been incorrectly included in the ‘taxable sales’ category, even though the amounts should have been included in ‘non-taxable sales’ for the calculation of the taxable sales proportions.

“Building transfers are taxable, while land transfers are not” is basic knowledge for tax experts; however, this is one point which corporate accountants sometimes forget to note.

This misunderstanding notably seems to happen in cases where land is incidentally transferred – such as when business operators not in real estate professions buy or sell a headquarters site or a factory site for managerial reasons. Unless they are in the real estate business, corporate accountants tend to overlook this because they may deal with land transfers only every few years, or even every few decades.

The same is true for the simultaneous transfer of land and buildings. Though in reference to tax assessments of fixed assets, etc., the land portion essentially needs to be distinguished from the building portion, we hear that there are a number of cases flagged in tax investigations as the result of filing the entire transaction amounts as ‘taxable sales’.

Generally, land transfer consideration tends to total large sums, ranging from several tens of millions of yen to several hundreds of millions of yen.

If a business generating an annual turnover of 50 million yen transfers land worth 100 million yen, the taxable sales ratio will drop to 33% (50 million/150 million yen).

In this case, the method of calculating the tax deduction for taxable purchases would differ significantly from that of a normal fiscal year where the taxable sales ratio was quite close to 100%. That is, a mistake in calculating the taxable sales ratio would directly affect the amount of tax paid.

In the case of calculating the taxable sales ratio, it would be calculated higher than it normally would be if the amount of consideration for the land were incorrectly included in taxable sales (in the example above, the taxable sales ratio would remain 100%). As a result, the deduction for taxable purchases would be too large, with the filer then likely becoming a target for additional taxes, due to underpayment of tax.

For the accounting system, if the entry clerk is to select the consumption tax category as ‘taxable’, ‘non-taxable’ or ‘other’, the sharing of this kind of knowledge, and the use of flag marks, etc., to ensure such irregular transactions stand out is important.

It is indispensable to understand residence status, residence cards, visas, etc. when employing foreign workers.

There are various types of residence status, such as the status allowing specific kinds of work, the status allowing employment without restriction, etc.
In April 2019, ‘Designated Skilled Labor’ was added, so currently there exist 29 types of residence status. Of those, the ‘Engineer/Specialist in Humanities/International Services’ and ‘Technical Intern Training’ types are by far the most common among companies hiring foreigners.

• Residence statuses permitted to work in Japan:
  • ‘Diplomat’, ‘Official’,‘Professor’,‘Artist’,‘Religious Activities’,‘Journalist’,‘Highly-Skilled Professional(1), (2)’,‘Business Manager’, ‘Care Worker’,‘Legal/Accounting Services’,‘Medical Services’,‘Researcher’,‘Instructor’,‘Entertainer’,‘Engineer/Specialist in Humanities/International Services’,‘Intra-company Transferee’,‘Skilled Labor’,‘Technical Intern Training’,‘Designated Skilled Labor’
• Personal relationship or status for which residence is authorized (unlimited):
  • ‘Permanent resident’,‘Spouse or Child of Japanese National’,‘Spouse or Child of Permanent Resident’,‘Long-term Resident’
• Other:
  • ‘Designated Activities’

Residence cards will not be issued for foreigners with ‘Temporary Visitor’ status or those in Japan less than 3 months, as residence status and residences card are only issued for foreigners staying a medium-to-long period (over 3 months).
Instead of that, a seal for verification of stay is put in the person’s passport.

A foreign resident would be categorized as: a mid-to-long-term stay resident with a residence card; a short stay resident with a permit seal in their passport; or an illegal resident without either of those qualifications.

So what is the difference between ‘visa’ and ‘status of residence’?　A ‘visa” is essentially a recommendation by an overseas Japanese embassy or consulate, which is necessary for a foreigner to enter Japan; it shows that it won’t be a problem if the person is allowed into Japan.

On the other hand, ‘status of residence’ is a certificate of permission needed to stay, work, etc. in Japan. In short, ‘visa’ and ‘status of residence’ are totally different. We often hear the term “work visa”, but actually the expression “residence status allowed to work” is accurate. So please understand that a ‘visa’ is not directly related to ‘status of residence’.

It is obvious that Japanese consumption tax would not be imposed on products sold in the US. Currently, the Japanese government claims sovereignty over the Northern Territories (now controlled by Russia) as inherently territories of Japan. So let’s think about sales of products in those territories.

Consumption tax is levied on transactions which meet the following four conditions:

• Effectuated in Japan;
• Effectuated by a business for business purposes;
• Effectuated for compensation;
• Effectuated by the transfer or lease of assets, or by the provision of services.

As stated above, ‘Effectuated in Japan’ is one of the taxable conditions. Sales of products in the United States do not fulfill this condition, so Japanese consumption tax is not levied. So where does Japan begin and end? ‘Domestic” (= in Japan) is stipulated as the ‘jurisdiction of this act` (Article 2, Paragraph 1, Item(1) of the Consumption Tax Act). The jurisdiction of the act refers to the area wherein the Japanese government reserves the right to enforce the three powers of the legislative, judicial and administrative branches – that is, running the local administration.

Unfortunately, the Northern Territories are currently under the control of Russia; therefore, it is impossible for Japan to run the administration, though the central government has not clarified the issue.

Nevertheless, the current situation is that Japan cannot run the local administration, so Japanese consumption tax is not levied in the Northern Territories, as the area is not “domestic”.

Under the Enforcement Order Supplementary Provision Article 2 of the Inheritance Tax Act, for example, the Northern Territories are excluded from the jurisdiction of the Inheritance Tax Act.

【Inheritance Tax Law Enforcement Order Supplementary Provision Article 2】
Under Supplementary Provision Article 2, the areas where, for the time being, enforcement will not be carried out shall be the four islands Habomai, Shikotan, Kunashiri and Etorofu.

Unlike the inheritance tax law, the consumption tax law does not stipulate the names of the four islands as being excluded from the application of the law; however, according to legal interpretation like that above, the islands are not “domestic”.

Though your company may never be selling products in the Northern Territories, it may be helpful to know whether a transaction meets all four requisite conditions for the levying of consumption tax.