It is important to note that even if you have prepared an outsourcing contract and treat it formally as subcontracting, based on the actual situation, it may be treated by tax authorities as your company employing employees. Following is an example of a case in which a subcontracting fee paid to a subcontractor was recognized as salary in a tax audit, with the result being a consumption tax deduction was disallowed.
Company A (the plaintiff), which operates a painting business, explained to its employees that it would enroll them from April 2015 in health insurance and welfare pension insurance plans, which it had not previously enrolled in, and that it would deduct those social insurance premiums from their salaries.
However, the problematic situation seems to have begun when two workers asked the company, “Please treat us as subcontractors who don’t have the social insurance premiums deducted, so that our take-home pay will be the same as before. We it don’t want our take-home pay decreased because of the deduction of social insurance premiums.” The company agreed to their requests.
In accordance with the workers’ requests, Company A switched the remuneration that had been paid them as salaries to subcontracting expenses, and filed a consumption tax return for the subcontracting expenses paid to each worker as taxable purchases. However, the National Tax Agency (NTA) contended that these subcontracting expenses were "salaries, etc." which did not fall under the category of taxable purchases, and that no income tax had been withheld.
A Japanese Supreme Court decision in 1981 has become a judgment criteria for determining whether remuneration paid falls under the category of "salary, etc." In this case, in addition to the Supreme Court's decision, the Tokyo district court ruled that the Basic Interpretive Regulation 1-1-1 of the Consumption Tax Act is also a standard for determining whether remuneration constitutes "salary, etc.".
Under the Consumption Tax Act’s Basic Interpretive Regulation 1-1-1, the distinction between a sole proprietor and a salaried employee should be made based on whether or not there is an employment contract, etc. However, if the existence of a contract is unclear, for example, the following criteria 1. - 4. should be used for overall judgment:
As a result of applying the above criteria 1. - 4., the Tokyo district court pointed out that the money paid to each worker did constitute “salary, etc.” because it "was paid as compensation for the provision of labor or services to Company A under spatial and temporal restraint, either continuously or intermittently, and should be considered to be remuneration for labor provided under the employer's direction and orders based on an employment contract or a similar reason.”
The tax office's decision was judged legitimate because in addition to the fact that the payments were not for taxable purchases and not eligible for credits against purchase taxes, Company A should have withheld tax.
Whether "salary, etc." or a "subcontracting fee” is not only a matter of consumption tax. This issue also relates to the question of whether or not withholding tax obligations are being fulfilled. For those who receive remuneration, there is also the issue of whether it is business income or employment income.
With all the talk of reforming the way we work, switching from employment contracts to outsourcing contracts has become a hot topic among large companies, but it is important to note that there are tax risks associated with this type of change.
Under the revised electronic transaction system which will start from January 1 next year, the paper output storage option for electronic transactions will be abolished. If you are using paper output storage, please be aware that your blue tax returns may be cancelled.
The electronic transaction system mandates that those who are required to keep receipts, invoices, etc. for corporate taxes, etc. for "electronic transactions”, keep electronic data regarding the electronic transactions which they conduct.
Electronic transactions are defined as "transactions in which transaction information is exchanged by electromagnetic means," including transactions in which PDF files of invoices, etc. are attached to e-mails. Until now, PDF files could be printed out and saved on paper, but after January 1, 2022, paper output/storage will no longer be accepted.
Moreover, regarding the storage of electronic data, certain measures must be taken, such as the establishment of administrative rules regarding the prevention of corrections and deletions, and in addition, a search function must be secured. As for search conditions, the electronic data must be stored in such a way that it can be searched by "date of transaction, etc.”, "amount of transaction”, and "customer”. So it may be necessary to introduce a document management system with search functions.
On the other hand, there are some who state that "a company-wide response is necessary" in order to meet the preservation requirements of the system; however, since there will be no drastic easing measures, it can be assumed that there will be cases where preparations will not be completed in time. Even for small and medium-sized companies, it is not easy to review the operating methods that they have been accustomed to - including making sure that employees are aware of the new requirements. Therefore, it will be important to take action as soon as possible.
In this regard, much attention has been paid to the revocation of the approval for blue tax returns and the treatment of necessary expenses, etc. If a company does not comply with the requirements for storing electronic data related to transaction information for electronic transactions, or if it continues to use paper output instead of storing electronic data, it will be treated as if it had not stored the electronic data that should have been stored, and may be subject to revocation of its approval for blue return filing.
Although it may be unlikely that a blue tax return will be cancelled simply because a taxpayer did not save electronic data, there is no basis for complaint if it is indeed cancelled. The specifics of the circumstances under which a blue tax return will be canceled cannot be determined until the system is actually implemented.
In addition, if the electronic data is not stored in accordance with the requirements, or if written output of such electronic data is stored, it is not likely to be treated as direct evidence to confirm the content of the tax declaration, because the identity of the electronic data received from others is not guaranteed.
Just for that reason, it is necessary to confirm the fact of payment of the necessary expenses by other means, so additional explanation or submission of documents is required. As long as there is no concealment or disguised acts(*) and the transactions actually occurred, the necessary expenses will probably not be disallowed, but it will be a focus of attention as to how the tax offices will implement this.
※ concealment or disguised acts: actions taken to hide something and/or to make something up
Even after the transition to the revised electronic transaction system in January next year, the requirements for the purchase tax credit for consumption tax will not change until the invoice system starts in October 2023.
Under the current system for the preservation of consumption rate-separated invoices, the principle requirements for the deduction of purchase taxes are the recording and preservation of the fact of taxable purchases in account books, as well as the preservation of invoices, etc. that prove the facts behind taxable purchases, etc. On the other hand, there are no provisions for the receipt of invoices, etc. via electronic means.
Therefore, even after January 2022, when the revised electronic transaction system starts, in principle, paper invoices, etc. will have to be preserved in order to meet the requirements for the purchase tax credit for consumption tax.
However, if data such as invoices which is received via "electronic transactions" is stored electronically in accordance with the electronic transaction system, it is not necessary to store additional paper invoices, etc. in order to meet the requirements for the purchase tax credit. The reason is that if there is a "unavoidable reason" for not receiving a written invoice, etc., the company can apply for the purchase tax credit by preserving certain account books. In such a case, in addition to the items to be entered in the books, the unavoidable reason and the address or location of the counter-party of the taxable purchase can be entered and preserved to meet the purchase tax credit requirements.
|Prior to revision||After revision
information storage system
|Principle: Electronic data
Exception: Document output
purchase tax credit
Exception: Certain account books storage, etc.
|Same as left|
This "unavoidable reason(s)“ method requires that, in addition to the legally-required entries, the unavoidable reason(s) and the address or location of the counter-party to the taxable purchase be entered and preserved in the books.
The procedure of picking up the transactions saved in electronic data and writing "unavoidable reasons" for each and every one of them may be burdensome, especially for small and medium-sized companies with limited staff in charge of accounting.
The treatment is unclear in cases where invoices and other data are printed out and stored in writing. If this method, which is not allowed under the corporate tax law, is allowed under the consumption tax law, the taxpayer will be allowed to deduct the amount of purchase tax without having to provide a time-consuming statement of "unavoidable reasons”.
However, for transactions that are currently required to be stored electronically, it cannot be said that the purchase tax credit will be allowed with the alternative measure of storing the data in written form. This is because there is no provision that allows it. Therefore, when electronic data such as invoices are received, in principle, the only way to deduct the purchase tax amounts is to preserve the account books with entering "unavoidable reasons". Nevertheless, this does not necessarily mean that the purchase tax credit will be denied if the written output is preserved, and it is very difficult to determine.