The Invoice System in Japan came into effect on 1 October 2023.

In order to apply purchase tax credits under the Invoice System, a qualified invoice issued by a seller already registered with the system is required. As a result, transactions in which the buyer requests that the seller issue a qualified invoice are becoming increasingly common.

Although, in principle, compliance with the Invoice System is voluntary and sole traders – including freelancers – can register for the system in the same way as companies, the requirements are stricter and more information must be recorded than for a traditional itemised invoice. As a result, there is both support for and opposition to the Invoice System. In this regard, there are many tax-exempt businesses and sole proprietors who have questions about the consequences of not registering under the Invoice System.

For sole proprietors with sales of ¥10 million or less, the decision is an important one. The question of whether to register under the Invoice System in order to meet the needs of customers should be carefully considered. Meanwhile, it is also important to understand the risks of not registering under the Invoice System.

In this article, we will examine the various risks and effects that can occur for sole proprietors (tax-exempt businesses with less than ¥10 million in sales) by not registering under the Invoice System, as well as steps that sole proprietors can take to deal with Invoice System.

What’s in this article?

• Consequences for sole proprietors who do not register under the Invoice System
  
• What happens after a sole proprietor registers under the Invoice System?
  
• How sole proprietors can decide whether to register and comply with the Invoice System
  
• Understanding the Invoice System and choosing an optimal strategy
  

Consequences for sole proprietors who do not register under the Invoice System

Under the current Invoice System, only businesses that are subject to consumption tax can register as qualified invoice issuing businesses. As a result, for tax-exempt sole proprietors with less than ¥10 million in sales, the effects of the Invoice System are greater than for taxed businesses.

Tax-exempt businesses can submit a qualified invoice issuing business registration application to become a taxed business. This allows them to issue qualified invoices, which they cannot do without first registering.

That is, if the seller providing and selling an item is a tax-exempt sole proprietor and the buyer purchasing the item is a taxable business, the buyer will not be able to obtain a qualifying invoice and therefore will not be able to claim sales tax purchase credits. Therefore, if a sole proprietor does not enrol in the Invoice System, they should be aware of the potential negative impact on the businesses that purchase from them.

Cancelling existing transactions and new customers

As noted above, from a buyer’s perspective, the availability of input tax credits is a significant factor in whether they end up paying more or less tax. It is therefore an important factor in deciding where to source goods.

Accordingly, following the introduction of the Invoice System, there have been many buyers who have realised that it is likely to be more profitable to do business with taxed companies rather than tax-exempt ones. As a result, for sole proprietorships, failure to register under the Invoice System may result in cancelled transactions, requests to revise transaction costs, and negative impacts on existing transactions. When vendors are trying to reach new customers, they may find it difficult to do so, which can hinder the expansion of their business.

Benefits of not registering under the Invoice System

If a sole trader does not register under the Invoice System, they may face a reduction in transactions with taxable businesses, as mentioned above. However, there are benefits to not registering.

The most significant benefit of not registering under the Invoice System and maintaining tax-exempt status is that the business is not required to pay sales tax and does not have to worry about the increased time and effort required to pay these taxes. In addition, because the accounting software and other tools used to generate invoices do not need to comply with the Invoice System, the business can continue to use the same systems it has in place.

Businesses not registering under the Invoice System

Although the Invoice System imposes detailed restrictions on many businesses, there are some businesses that are comparatively unaffected by it. For example, compared to some other businesses, the Invoice System is unlikely to have a major impact on barber shops, nail salons, etc. that provide services to buyers who are regular customers rather than other businesses.

Also, businesses whose most common transaction partners are other exempt businesses and do not require qualified invoices can continue to operate as exempt businesses without registering under the Invoice System. However, as a business grows and its customer base begins to include more taxable businesses, it is important to note that future transactions may need to comply with the Invoice System.

As noted at the beginning of this article, registration under the Invoice System is voluntary, not mandatory. The decision to register under the Invoice System is left to the discretion of each business, regardless of its type (i.e. whether it is a sole proprietorship or a corporation).

Having gained a sufficient understanding of the risks associated with not registering under the Invoice System, let us examine the details of registration for those who do find it necessary.

What happens after a sole proprietor registers under the Invoice System?

For sole proprietors, even if total sales are less than ¥10 million, registering under the Invoice System may make it so that buyers find it easier to transact with the business. This is because transaction partners buying from the business can obtain the application of purchase tax credits.

Accordingly, if most of the existing customers are taxable businesses, registration under the Invoice System provides a benefit for transactions with buyers. Similarly, when developing new customers, it is possible that registering under the system will allow the business to gain ground and obtain more transactions than it otherwise would, so registration is likely to be beneficial to businesses seeking to expand.

However, in addition to creating an obligation to pay consumption tax from which the business was previously exempt, registration under the Invoice System also creates complex accounting requirements when filing tax returns. To make the post-registration process as smooth as possible, it’s a good idea to consider methods that avoid unnecessary waste and frustration, such as introducing systems capable of handling qualified invoices.

Furthermore, businesses that are currently examining how to deal with the Invoice System or planning to do so may wish to consider that introducing new tools and features can also lead to more efficient business.

With Stripe, for example, using Stripe Invoicing makes it possible to accommodate various invoicing needs as well as to create invoices that conform to the Invoice System. These changes then provide support for the optimisation of back-office operations. Additionally, by using Stripe Tax, which is able to automatically calculate customised consumption tax in compliance with business requirements, all tax processing is automated for electronic transactions – making it possible to achieve smoother and more efficient operations.

Measures available to tax-exempt businesses

The Invoice System takes into account the impact of conducting business-to-business (B2B) activities for tax-exempt businesses and provides transitional measures and special provisions for taxable purchases from tax-exempt businesses.

• Transitional measures
  Under the transitional measures – valid for six years from 1 October 2023, when the Invoice System first came into effect – a certain portion of the consumption tax charged on the purchase is considered to be a purchase tax and can be covered by tax credits, even for taxable purchases from tax-exempt enterprises. (For more information, refer to the following reference material from Japan’s National Tax Agency: Transitional measures for purchases from tax-exempt businesses)

• 20% special provision
  This special provision is applicable to companies that have transitioned from tax-exempt to taxable status and provides for payment of sales tax at a rate of 20% for a specified period after the transition.

How sole proprietors can decide whether to register and comply with the Invoice System

The opinions of companies may be divided on the issue of registering under the Invoice System. But regardless of whether a company registers, sole proprietors with sales of less than ¥10 million should first discuss the transaction costs with their buyers in order to avoid problems that may arise due to the Invoice System. The best way to proceed with the Invoice System might become clear as a result of these discussions.

Additionally, for sole proprietors who are offering a product or service that uses exceptional technology and who have a good business relationship with existing customers, it may be possible to simply continue to operate as a tax-exempt business with no change in transaction costs. Accordingly, it is important for businesses to acquire useful skills and knowledge, and to make an effort to study what products or services their customers need in order to differentiate themselves from other businesses.

Understanding the Invoice System and choosing an optimal strategy

In this article, we have explained the various effects that can occur when not registering under the current Invoice System, as well as important points to understand and consider.

Because the information recorded and registration requirements are stricter for the Invoice System (which began less than one year ago) than they are for traditional invoices and receipts, the reactions of businesses have been a mix of support and opposition. With respect to whether sole proprietors choose to conform to the Invoice System, the decision will depend on the target customer segment, the nature of customer transactions and relationships, and business plans. The decision may be particularly difficult for tax-exempt entities, but as noted above, the National Tax Agency has also provided transitional relief and special rules for tax-exempt entities. Therefore, it is important for tax-exempt entities to understand these provisions and consider the future course of the business to determine a path forward.

Going forward, we recommend that you analyse the risks posed by the Invoice System from many angles and determine the best course of action for your own business to ensure that not registering under the Invoice System does not impede business progress.

For those businesses that choose to register under the Invoice System, it is also important to examine registration with a full understanding of the short- and long-term effects on the business, and the benefits and drawbacks of doing so.