On 1 October 2023, the Qualified Invoice System was introduced in Japan. Under this system, businesses are required to deliver and retain qualified invoices (commonly known as invoices) to receive tax credits for purchases.

Only taxable businesses are allowed to issue qualified invoices; tax-exempt businesses are not. If a business on the customer’s side purchases from a tax-exempt business, it will not be able to obtain a qualified invoice from that business and will not be able to get a credit for taxable purchases.

This article explains what taxable businesses need to know when doing business with tax-exempt businesses under the Invoice System and how to journalize consumption tax on taxable purchases from tax-exempt businesses.

What’s in this article?

• What will happen with transactions with tax-exempt businesses under the Invoice System?
  
• How to journalise consumption tax on purchases from tax-exempt businesses
  
• What happens to the seller if the customer is a tax-exempt business?
  
• Find out the best that tax-exempt and taxable businesses can do
  

What will happen with transactions with tax-exempt businesses under the Invoice System?

As mentioned, under the Invoice System, in principle, purchases from tax-exempt businesses are not subject to tax credits for purchases. The Invoice System applies only to taxable businesses, regardless of whether they are corporations, sole proprietors, freelancers, or other types of businesses, and to receive credit for taxable purchases, they are required to deliver and store qualified invoices as stipulated in the Invoice System.

Only taxable businesses that have registered as a qualified invoicing business with the tax office having jurisdiction over the place of tax payment are eligible to issue qualified invoices. (If you are a tax-exempt business, you will become a taxable business after completing the application procedures for the Invoice System.)

In other words, the sales tax on purchases from tax-exempt enterprises that cannot issue qualified invoices is borne entirely by the customer’s enterprise because the purchase tax credit is not applied.

Therefore, it is important for a customer-side business that makes purchases to confirm whether the seller-side business is a qualified invoicing business that is registered under the Invoice System.

As for a seller, it is not possible to issue a qualified invoice without registering for the Invoice System. It is especially important for businesses mainly engaged in business-to-business (B2B) activities to register because they are often required to issue qualified invoices.

Businesses that are registered with the Invoice System but have difficulty issuing qualified invoices

Even in cases in which a business is registered under the Invoice System and allowed to issue qualified invoices, there are cases in which it is difficult to issue qualified invoices depending on the type of business.

Therefore, the issuance of simplified invoices is permitted for certain qualified invoicing businesses for certain industries. This simplified invoice requires less information compared with a qualified invoice and is often issued as a receipt in industries that serve an unspecified number of customers (e.g., supermarkets, restaurants).

See the article titled “What is a simplified invoice in Japan?” for more information.

What you need to take care of to receive a credit for taxes on purchases

• Before the transaction: Is the seller business a qualified invoicing business?
  As mentioned, qualified invoices and simplified invoices are documents that can be issued by only taxable businesses that have registered under the Invoice System as a qualified invoicing business. As proof of registration with the Invoice System, the qualified invoicing business must include on the qualified invoice a unique registration number that will be assigned after registration.
  
  Therefore, it is advisable to check with the seller’s business whether it is a taxable or tax-exempt business registered under the Invoice System, including whether it has a registration number and whether the number is correct.

• After the transaction: Do the invoices and other documents received meet the Invoice System’s requirements?
  Similar to before the transaction, regardless of whether they are qualified invoices or simplified invoices, it is important to check the existence and accuracy of the registration number and whether the correct consumption tax amount is calculated. It is also important to check again whether the requirements of the Invoice System are met.
  
  For more information on whether you are registered in the Invoice System and how to check your registration number, see the article titled “What is the registration number in Japan’s Invoice System?”.

Dealing with tax-exempt businesses and transitional measures

In principle, purchases from tax-exempt businesses are not eligible for tax credits. However, to avoid a sudden increase in the burden on taxable businesses and troubles and confusion among businesses caused by the Invoice System, phased-in transitional measures have been established for a specified period (6 years from the start date of the Invoice System).

Under transitional measures, as described in “Transitional measures for taxable purchases from tax-exempt businesses” (Page 15) in “Outline of Qualified Invoice Retention Method” by the National Tax Agency (NTA), a certain percentage of the consumption tax amount on taxable purchases from tax-exempt businesses is eligible for the credit against purchase tax.

Transitional period and deductible taxes
1 October 2023–30 September 2026: 80% of the amount equivalent to purchase tax
1 October 2026–30 September 2029: 50% of the amount equivalent to purchase tax

Tax-exempt businesses include sole proprietors with sales of ¥10 million or less. For these businesses, the decision on whether to comply with the Invoice System is important because it will determine the direction of their business. Therefore, tax-exempt businesses need to analyze all aspects of risks of not registering for the Invoice System and carefully assess them while using transitional measures.

For more information on the advantages and disadvantages of enrolling sole proprietorships in the Invoice System, see the article titled “How small sole proprietors can use the Invoice System in Japan.”

How to journalise consumption tax on purchases from tax-exempt businesses

A business makes a journal entry in its books for each transaction that occurs daily. This journalising process is an important part of the accounting work required to prepare tax return documents and financial statements.

The following is an example of a journal entry for a purchase of 1 unit with a unit price of ¥10,000, a 10% consumption tax rate of goods from a tax-exempt business, paid in cash. Applying the transitional measures for the Invoice System, the purchase tax credit is 80% of the consumption tax amount. The journal entries can be made using one of the following two methods:

Journalizing method

• Additional journal entry to the main price
  This method is used when the journal entry is to be completed at the time the payment is made, and the amount is added to the main price. The consumption tax on taxable purchases of ¥10,000 is originally ¥1,000. However, because of the application of transitional measures, 80% of the consumption tax amount can be credited against the purchase tax, and this is treated as “consumption tax paid provisionally,” and the remainder is recorded as a business expense.
  

• Journal entries to be treated as miscellaneous losses
  If a journal entry is made again at the time of closing, it can be treated as a miscellaneous loss. Unlike the journal entry to be added to the main price, the sales tax amount is recorded as it is at the time of the transaction (at the time of payment), and the 20% amount that is not deductible as a sales tax credit is again journalised as a “miscellaneous loss” at the time of closing.
  

At the time of transaction (payment)

At the time of closing

For amounts paid to tax-exempt entities, such as purchases and expenses, journal entries are extracted for “tax-exempt entities” at the time of closing, so it is necessary to enter “tax-exempt entities” in the Summary column to indicate this. As with transactions with taxable businesses, tax-exempt journal entries are created for transactions with tax-exempt businesses, and for journal entries extracted for tax-exempt businesses,” the total amount paid is multiplied by the tax amount (20%) to which the credit is not applied to create the closing journal entry.

What happens to the seller if the customer is a tax-exempt business?

Even if the seller is a taxable business (a qualified billing entity) and the customer is a tax-exempt business, sales tax is charged as it is for transactions with other taxable businesses. In other words, even if you are a tax-exempt business, you will pay sales tax to the taxable business from which you make purchases.

However, as stated in the NTA’s “Tax-exempt businesses and refund of purchase taxes,” tax-exempt businesses are not required to pay consumption tax and therefore cannot receive a refund of consumption tax on purchases.

At the same time, tax-exempt enterprises do not deduct tax on purchases, so even if they receive a qualified invoice from a taxable enterprise, they do not have to keep it.

On the other hand, if the seller is a tax-exempt business, it can collect sales tax from its suppliers and is not required to pay the sales tax received, which can be recorded as sales.

Find out the best that tax-exempt and taxable businesses can do

In this article, we have explained how customers handle purchases from tax-exempt businesses under the Invoice System and points to note.

For tax-exempt and taxable enterprises to comfortably conduct transactions with each other, all enterprises need to deepen their understanding of the Invoice System and find the best measures after considering the possible effects and risks caused by the Invoice System. Therefore, it is advisable to make good use of the effective period of transitional measures and comply with the Invoice System while preparing your business posture.

If you plan to register for the Invoice System, you might want to consider introducing new tools and functions. For example, Stripe can create invoices compliant with the invoicing system and handle various invoicing needs. Stripe Invoicing can boost back-office optimisation.