Consumption tax is a tax on the sale of goods and services and is the most common tax in our daily lives. Japan’s consumption tax rate was raised to 10% in October 2019.

Most transactions by a businessperson in Japan, whether a corporation or a sole proprietorship, are subject to consumption tax.

This article provides basic information on consumption taxes by explaining the background, the increase, and how to pay them.

What’s in this article?

• Background of the consumption tax and the increase to 10%
  
• Process prior to the payment of consumption tax
  
• How to understand and respond to consumption tax
  

Background of the consumption tax and the increase to 10%

Consumption tax rates have increased over time. The consumption tax was introduced to provide a stable source of revenue for social security, such as medical care and welfare, as Japan’s birth rate declines and the population ages at an accelerating pace. Since the consumption tax was introduced, the cost of social security has gone up over the years, which has also affected the consumption tax, increasing the tax rate.

The Ministry of Finance states that the consumption tax is “suitable as a stable source of revenue for social security because the burden is not concentrated on certain generations, such as the working-age population, the tax revenues are less subject to changes in the economy and other factors, and it is neutral to corporate economic activity.”

When did the consumption tax rate increase to 10% take effect?

The consumption tax was first introduced in Japan in April 1989, initially at a rate of 3%. It was subsequently increased to 5% in April 1997, 8% in April 2014, and 10% in October 2019.

When the 10% consumption tax rate was introduced, Japan’s first reduced tax rate system was established to decrease the burden on low-income consumers: the rate is still set at 8% for some eligible items.

The items subject to the reduced tax rate system are as follows, and mainly include daily necessities such as food, but not commodities. Therefore, please note that not all items are subject to the reduced tax rate.

Eligible items

• General foods and beverages (excluding pharmaceuticals, quasi-drugs, alcohol, food service and catering, etc.)
  
• Newspapers published more than twice a week based on a subscription agreement (excluding those purchased at railway stations, convenience stores, etc.)
  

No specific date has been set for the end of the reduced rate system, and there are currently no plans to fully revise the consumption tax rate to 10% for all goods and services. Therefore, at least until the tax law is revised, the two rates of 8% and 10% will continue to apply.

Cases in which the impact on the consumption tax rate varies by contract

The hike in consumption tax rates will have a significant impact on the average consumer and on many businesses. Before and after the implementation of the 10% rate increase in 2019, there have also been various scenarios involving it, either between businesses and customers or in contracts between businesses. Below is a summary of the cases that vary by contract after the introduction of the 10% increase. They are examples of tax reform that you should be aware of in the event of future tax reform.

• Case 1
  In the case of a construction contract, such as the remodelling or renovation of a house, if the contract was entered into before the 10% consumption tax hike, the 8% tax rate applied – even if the actual delivery of the house was after the tax increase was implemented. Thus, in construction contracts, it is important to note that the amount of sales tax to be paid depends on the contract’s start date.

• Case 2
  Unlike a construction contract, the consumption tax rate for a car purchase contract is determined by the registration date, not the contract start date. In other words, if the contract was signed before the 10% consumption tax was implemented, but the registration and delivery of the vehicle occurred after the tax rate was implemented, the 10% would apply.

Process prior to the payment of consumption tax

Products go through various processes – including production and manufacturing of raw materials, distribution, and delivery – before finally being placed in the hands of consumers when they are purchased.

The consumption tax on goods is levied on each transaction between businesses in each step of the process leading up to the final form of the goods sold. However, the system is designed to prevent double or triple payment of consumption tax in such cases (see our article on the purchase tax credit).

Specifically, the difference between the amount of sales tax the customer pays at the time of purchase and the amount of sales tax collected at each previous stage of the transaction is an indirect tax, and each business deducts and pays it to the tax authority.

Example of calculation

We will assume a 10% consumption tax rate for simplicity.

To sell a product for ¥10,000 (consumption tax: ¥1,000), a business purchases ¥6,000 (consumption tax: ¥600) of materials from a supplier:

¥1,000 Consumption Tax on Goods Received from the Customer - ¥600 Consumption Tax Paid on the Purchase of Materials = ¥400 Consumption Tax the Business Pays to the Tax Office

The materials supplier pays ¥600 consumption tax to the tax office for the materials purchased from the business. Meanwhile, the business pays ¥400 to the tax office based on the difference between the consumption tax it paid for the materials and the consumption tax it received from the customer.

A customer purchases the product with the price of ¥10,000 (consumption tax: ¥1,000), which is processed from the previously purchased materials.

Thus, the ¥1,000 consumption tax ultimately paid by the customer on the purchase of the goods is received by the business that sold it. It is then left to all businesses involved with the goods, including the materials supplier, to pay their respective tax amounts.

How to understand and respond to consumption tax

We’ve explained the consumption tax in the context of the tax increase to 10%, which began in October 2019.

Consumption tax has a significant impact on our daily lives. Tax hikes resulting from government reforms and systemic changes are also important to many people, as they affect companies’ accounting practices and individual households’ livelihoods. Therefore, it is wise to regularly review your understanding of excise taxes and prepare to respond flexibly to changes over time.

Consider also introducing automatic sales tax calculation functions and accounting software that can be customised to meet various needs. For example, Stripe Tax can automatically identify and reflect the 8% or 10% tax rate on different products, automating the tax processing of all electronic transactions and thus improving and streamlining sales tax-related back-office operations.