Consumption Tax Filing and Payment Obligations for Small Companies in Their First Year After Incorporation

 After a company is incorporated, all corporations are required to file and pay corporate income tax, regardless of their size. However, with respect to consumption tax (*), small companies may be exempt from the obligation to file and pay under certain conditions.

This article explains when a company is exempt from consumption tax filing and payment obligations, as well as when it may be advantageous for an otherwise exempt company to voluntarily elect to become a taxable business operator, even in its first or second year after incorporation.

(*) Consumption tax is a tax imposed when goods or services are purchased (or sold by a business). In principle, it is levied at a rate of 10% of the price.

When Is the Obligation to File and Pay Consumption Tax Exempted?

First, we will explain in which cases a business is required to file and pay consumption tax, and in which cases it is exempt.

In principle, all business operators are subject to consumption tax filing and payment obligations. However, small-scale businesses may be exempt under certain conditions.

A business that is required to file and pay consumption tax is referred to as a taxable business operator, while a business that is exempt from this obligation is called a tax-exempt business operator.

Whether a business is classified as taxable or tax-exempt is generally determined as follows:

1) Determination Based on the Base Period

If the taxable sales during the base period do not exceed JPY 10 million, the business qualifies as a tax-exempt business operator.

The base period generally refers to the fiscal year two years prior to the current fiscal year.

For example, if the current fiscal year is the year ending December 2025, and taxable sales for the base period (the fiscal year ending December 2023) exceed JPY 10 million, the company will be a taxable business operator for the fiscal year ending December 2025 and will be required to file and pay consumption tax.

For the following fiscal year ending December 2026, the determination will be based on whether taxable sales for the base period ending December 2024 exceed JPY 10 million.

2) Determination Based on the Specified Period

Even if taxable sales during the base period are JPY 10 million or less, a business will still become a taxable business operator if both of the following amounts exceed JPY 10 million during the specified period (the first six months following the start of the previous fiscal year):

• Taxable sales during the specified period
• Total amount of salaries and wages paid during the specified period

For example, if the current fiscal year is the year ending December 2025, even when taxable sales for the base period ending December 2023 are JPY 10 million or less, the company will be a taxable business operator for the fiscal year ending December 2025 if both taxable sales and total salaries from January to June 2024 exceed JPY 10 million.

3) Determination Based on Capital Amount

Since the base period is defined as the fiscal year two years prior to the current fiscal year, Companies in their first and second fiscal years do not have a base period.

In such cases, if the company’s capital amount is JPY 10 million or more as of the first day of the fiscal year, the company will be classified as a taxable business operator.

4) Filing a Notification to Elect Taxable Status

Even if a small business qualifies as a tax-exempt business operator under the JPY 10 million threshold, it may voluntarily elect to become a taxable business operator.

By submitting a Notification of Election to Become a Taxable Business Operator to the tax office, the exemption from consumption tax will, in principle, no longer apply from the taxable period(FY2026) following the period in which the notification is filed(FY2025).

For the first fiscal year after incorporation(FY2025), the company may become a taxable business operator from the taxable period (FY2025) in which the notification is filed(FY2025).

5) Registration as a Qualified Invoice Issuing Business Operator

Even if a business is deemed tax-exempt under the JPY 10 million threshold, the exemption does not apply if the business is registered as a Qualified Invoice Issuing Business Operator.

By either submitting a notification to elect taxable status or registering as a qualified invoice issuing business operator, a small business becomes a taxable business operator.

 

When Should a Company in Its First or Second Year Voluntarily Become a Taxable Business Operator?

Based on the above rules, we now explain when it may be advantageous for a small, tax-exempt business to voluntarily become a taxable business operator during its first or second fiscal year.

1) How Consumption Tax Is Calculated

When a business purchases goods or services, it pays prices inclusive of consumption tax, and when it sells goods or services, it receives prices inclusive of consumption tax.

In principle, consumption tax is calculated and reported once per year using the following formula:

Consumption tax on sales − Consumption tax on purchases

If the consumption tax received from customers exceeds the consumption tax paid on purchases, the result is positive and the business must pay consumption tax.

If the consumption tax paid on purchases exceeds the consumption tax received, the result is negative and the business is entitled to a refund of consumption tax.

For taxable business operators, consumption tax collected and paid does not result in either profit or loss, as the tax is settled through filing a tax return.

However, tax-exempt business operators do not file consumption tax returns. Therefore, if the consumption tax received exceeds the consumption tax paid, the difference effectively becomes the business’s profit. This is sometimes referred to as “tax profit” (ekizei).

2) When Significant Capital Investment Is Planned at an Early Stage

Capital investment typically involves a large amount of consumption tax on purchases.

If a small tax-exempt business wishes to receive a refund of this consumption tax, it must complete the procedures to become a taxable business operator and file a consumption tax return.

3) When Registration as a Qualified Invoice Issuing Business Operator Is Desired

Consumption tax payable is calculated by deducting consumption tax on purchases from consumption tax on sales. This deduction is known as the input tax credit.

To minimize consumption tax payable, it is essential to properly claim input tax credits.

A key rule for claiming input tax credits is that only invoices issued by qualified invoice issuing business operators are eligible.

If a business is not registered as a qualified invoice issuing business operator, its customers may be unable to claim input tax credits, resulting in a disadvantage to them.

The advantage of registering as a qualified invoice issuing business operator is that customers can claim input tax credits and do not suffer a tax disadvantage.

On the other hand, a disadvantage is that a tax-exempt business becomes subject to consumption tax filing and payment obligations and can no longer benefit from tax profit.

Small businesses must carefully weigh their relationships with customers and the amount of potential tax profit when deciding whether to register as a qualified invoice issuing business operator.

If sales are made only to consumers, there is generally no need to register as a qualified invoice issuing business operator, since consumers do not file tax returns or claim input tax credits.

Special 20% Rule for Newly Registered Businesses

When a tax-exempt business registers as a qualified invoice issuing business operator, it may apply the 20% special rule to mitigate the disadvantage of losing tax profit.

Each year, the business may choose whichever method is more favorable:

• General taxation method:
  Consumption tax = (Consumption tax on sales − Consumption tax on purchases)
• 20% special rule:
  Consumption tax = Consumption tax on sales × 20%

Final Remarks

The above discussion applies to cases where a newly incorporated company qualifies as a small tax-exempt business operator.

If a company is not small in scale and is classified as a taxable business operator from its first fiscal year, it is necessary to consider whether to apply the general taxation method or the simplified taxation method. This topic will be explained in a separate article.