Businesses in Japan today need to introduce software and install new equipment to improve efficiency and productivity. This article discusses the eligible entities and software for the small and medium enterprise (SME) investment promotion tax system, the upper limit of the deduction amount, and the SME business enhancement tax system.

What's in this article?

• What is the SME investment promotion tax system?
  
• What is the SME business enhancement tax system?
  
• Before filing your tax return
  

What is the SME investment promotion tax system?

The SME investment promotion tax system allows SMEs that submit blue tax returns to choose either a special depreciation rate of 30% of acquisition costs, or a tax credit* of 7% when installing eligible machinery or software within the period up to 31 March 2025. Digital transformation (DX) is now seen as a way to improve and enhance operations, so SMEs are proactively installing various types of software. But equipment investments can become a significant burden for them. As one way to address this issue, the 2023 tax reforms made by the Japanese government extended deadlines in the SME investment promotion tax system (they were originally set for March 2023). This is expected to boost SME productivity and functionality and invigorate the economy.

The information presented in this article is based on the content of the 2023 tax reforms. The system has been amended several times, with changes to its content and deadlines. As further amendments are expected, please check the latest information on the updates provided on the websites of the National Tax Agency and the Small and Medium Enterprise Agency.

*Entities eligible for the tax credit differ from entities eligible for the special depreciation. For more details, refer to the sections on eligible entities and software for the SME investment promotion tax system immediately below.

Eligible entities for the SME investment promotion tax system

First, let's look at which entities are eligible under the SME investment promotion tax system. They are legal entities – SMEs and sole proprietorships – that file blue tax returns.

Requirements can be broadly divided as follows:

• Legal entities: Capitalisation or investment of ¥100 million or less
  
• Legal entities: Without capitalisation or investment, having 1,000 or fewer employees on a regular basis (including agricultural cooperatives and shopping district promotion associations)
  
• Sole proprietorships: 1,000 or fewer employees
  

Among these SMEs, the 7% tax credit is limited to those with capitalisation of ¥30 million or less, and to sole proprietorships. Furthermore, the 30% special depreciation can be claimed only by legal entities with capitalisation or investment of ¥100 million or less.

In other words, SMEs with capitalisation exceeding ¥30 million can claim only the special depreciation – they are not eligible for the tax credit. On the other hand, SMEs and sole proprietorships with capitalisation of ¥30 million or less have the option to claim either special depreciation or a tax credit.

There are many types of such eligible designated businesses. For further details, check designated businesses published by the National Tax Agency.

It should be noted that, according to applicable legal entities on the National Tax Agency website, even if the above criteria are met, SMEs with issued shares or investments that are owned above a certain extent by large legal entities – such as "legal entities with capitalisation or investment exceeding ¥100 million" or "legal entities without capital or investment but with more than 1,000 regular employees" – will be excluded from the scope of application. This includes SMEs where:

• A large legal entity owns half or more of the total number of issued shares (or investment).
  
• Two or more large legal entities own two-thirds or more of the total number of issued shares (or investment).
  

Eligible software for the SME investment promotion tax system

Eligible software includes software that is intended for business use such as treasury management systems, with an acquisition cost of ¥700,000 or more for a single item, or a combined total of ¥700,000 or more for multiple items with usage that began during the fiscal year in question. The main categories of eligible software are listed below. In order to take advantage of this programme, the eligible equipment or software must be acquired and used for the designated business before the deadline.

• Word processing software
  
• Spreadsheet software
  
• Accounting software
  
• Payroll software
  
• Illustration software
  
• Imaging software
  
• Computer-aided design (CAD) software (used for drawing design and drafting)
  

Note that software intended for research and development purposes is not eligible, and neither are originals to be copied for sale. Furthermore, server operating systems, server virtualisation software, database management software, integration software and unauthorised access prevention software that have not been evaluated and certified under standard 15408 of the International Organisation for Standardisation (ISO) and the International Electrotechnical Commission (IEC) are not eligible. For more details, refer to article 5-8 (income tax) and article 20-3 (corporate tax) of the enforcement regulations of the special taxation measures law. For queries regarding whether software meets the above standards, make sure that you contact the software manufacturer directly.

Examples of eligibility or non-eligibility depending on the situation

So far, we have detailed eligible entities and software.

The SME investment promotion tax system can be used for various designated businesses and eligible software, but there are cases where eligibility or non-eligibility depends on the situation.

For example, solar power generation businesses, classified under the "electric utility industry" category, are not included in the designated businesses and thus are ineligible. However, if, for example, a solar power generation system is installed on the roof of a plant and the electricity generated is used there for business operations such as manufacturing, it is "used for the business" and therefore eligible for the SME investment promotion tax system. On the other hand, if a business owner installs a solar power generation system at their home that is unrelated to their business operations and uses it for domestic purposes, it is "not used for the business" and is not eligible.

Upper limits stipulated under the SME investment promotion tax system

• Limit on depreciation amount
  The depreciation limit amount is the sum of (i) the special depreciation limit amount equivalent to 30% of the acquisition cost of machinery and software that were first installed and put into use in the fiscal year of acquisition, and (ii) the ordinary depreciation limit amount (recorded as a depreciation expense). Additionally, special depreciation can be accounted for separately from depreciation expenses.

• Limit on tax credit
  The limit on the tax credit is equivalent to 7% of the acquisition cost. The tax credit can be directly deducted from the corporation tax amount after calculating the corporation tax on taxable income for the fiscal year when the machinery and software are introduced and put into use.

What is the SME business enhancement tax system?

The SME business enhancement tax system, such as the SME investment promotion tax system, aims to encourage the efficiency and productivity of SMEs by providing tax incentives for the adoption of equipment and software.

The similarities between this system and the SME investment promotion tax system include:

• A designated period of until 31 March 2025 (effective as of March 2024)
  
• Definition of SMEs eligible under the system
  
• Designated eligible businesses
  
• Eligible software (however, the acquisition cost of the software must have been ¥700,000 or more per item, and it must have been launched on the market within the previous five years)
  
• Tax system requirements applicable to solar power generation which determine eligibility or non-eligibility
  

Eligible entities under the SME business enhancement tax system

Entities eligible under this system are SMEs (including agricultural cooperatives and shopping district promotion associations) that submit blue tax returns and are required to receive certification for a business capability improvement plan as stipulated in the Small and Medium Enterprise Management Strengthening Act.

For detailed guidance on business capability improvement plans, application forms relevant to such plans, and certificates showing that productivity improvement requirements have been met for business capability improvement equipment (certification by industrial associations, etc.), refer to the support for improving business capabilities page on the Small and Medium Enterprise Agency website. The Small and Medium Enterprise Agency website also provides information on how to submit an application relevant to business capability improvement plans, and it allows for the downloading of various forms.

Upper limits in the business enhancement tax system

Compared to the 30% special depreciation and the 7% tax credit available under the SME investment promotion tax system, the SME business enhancement tax system, which requires prior certification, allows for immediate depreciation (the entire acquisition cost can be depreciated) and offers a tax credit of 10% (7% for legal entities with capitalisation over ¥30 million and up to ¥100 million), thereby differing in tax-saving amounts and upper limits.

Note that the total amount of tax credits from both the SME investment promotion tax system and the SME business enhancement tax system cannot exceed 20% of the corporation tax (or income tax in the case of sole proprietorships) for that fiscal year. Amounts in excess of the tax credit limit can be carried over to the next fiscal year. Additionally, if special depreciation expenses are not recorded up to the limit, the balance can be carried over to the next fiscal year.

For more information on the SME business enhancement tax system, you can check the Small and Medium Enterprise Agency's Q&A page.

Before filing your tax return

To take advantage of the SME investment promotion tax system, the following documents are required when filing a tax return:

• For the tax credit, an annexed document (detailing special tax deductions related to the acquisition of machinery, etc. by an SME)
  
• For special depreciation, a schedule for special depreciation (a schedule for calculation of the maximum allowable amount for special depreciation of machinery, etc. acquired by an SME, or a small- or medium-size affiliated legal entity)
  
• A detailed list of the applicable amounts
  

Note that, for the SME investment promotion tax system, there are no procedures required other than the tax filing itself. On the other hand, if you wish to take advantage of the SME business enhancement tax system, obtaining certification for a business enhancement plan is mandatory. Therefore, if you plan to acquire business capability improvement equipment or software, you must obtain a certificate showing that productivity improvement requirements have been met – either a certificate by an industrial association or an attestation issued by a bureau of economy, trade and industry. In addition, as mentioned above, only businesses that have been certified for a business enhancement plan by the government are eligible for tax benefits, so it is important to submit a plan application as soon as the certificate is issued. For more details, refer to the "guide to utilising support measures" provided by the Small and Medium Enterprise Agency.

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