Consumption Tax
In our last article, we introduced consumption tax and explained that small businesses can be treated as tax-exempt if their sales two years earlier were 10 million yen or less. But if you're setting up a brand-new company in Japan, that rule creates an obvious problem: a new company has no sales from two years ago, because it didn't exist yet. So how does the exemption work when there's no history to look at?
Normally, whether your business is tax-exempt depends on your taxable sales in what's called the base period, which is your fiscal year from two years earlier. If those sales were 10 million yen or less, you're generally exempt from consumption tax this year.
A newly incorporated company simply doesn't have a base period yet. For its first fiscal year, and often its second, there's no historical sales figure to check. Because of this gap, the tax office uses a different set of rules for new companies during this window, rules that look at your company's capital and, in some cases, its shareholders, rather than its sales.
This matters because many founders assume "no sales history" automatically means "no consumption tax to worry about." That's not always true, and getting it wrong can mean an unexpected tax bill, or missing paperwork you should have filed from day one.
The first and most important rule is based on your company's capital amount at the start of each fiscal year.
If your capital is 10 million yen or more, your company is treated as a taxable enterprise from its very first fiscal year, with no exemption at all, regardless of how much (or how little) you actually sell.
If your capital is under 10 million yen, you can generally qualify as tax-exempt for your first two fiscal years, subject to the other rule below.
This is a common surprise for foreign-affiliated subsidiaries in particular. A Japanese subsidiary is often capitalized generously by its overseas parent company, sometimes specifically to meet visa requirements, banking relationships, or the parent's own governance standards. If that capital happens to land at 10 million yen or above, the new subsidiary is a taxable enterprise immediately, with consumption tax obligations starting from its very first invoice. This is worth discussing with your accountant before you decide on the capital amount, since it's set at incorporation and isn't easy to change afterward.
Even if your capital is under 10 million yen and you qualify as exempt for your first fiscal year, there's a separate rule that can end your exemption a year earlier than you might expect.
Japan's tax rules look at what's called the specified period, which is generally the first six months of your first fiscal year. If either of the following exceeds 10 million yen during that six-month window, your company becomes a taxable enterprise from your second fiscal year, even though it would otherwise still qualify as exempt based on capital alone:
Your taxable sales during the specified period, or
The total salary and other compensation you paid to employees during the specified period
Your company can choose whichever of these two figures works in its favor, so if your sales were high but you paid little in salaries (or vice versa), you may still qualify as exempt using the more favorable measure.
This is easy to miss because it isn't about your capital or your sales in general, it's specifically about the first half of your first fiscal year. It's a particularly common trap for foreign-affiliated subsidiaries, which often start hiring staff quickly after incorporation. Even with modest sales, salary payments alone can push a young company over the 10 million yen line and trigger consumption tax obligations a year sooner than planned.
Even if your capital is under 10 million yen, there's a second rule to be aware of, aimed at what the tax office calls a "specified new company."
In simple terms, if your new company is majority-owned (directly or indirectly) by another company or group of companies whose own taxable sales exceed 500 million yen, your new company can lose the exemption and become a taxable enterprise, even in its first fiscal year and even with capital under 10 million yen.
This rule exists to prevent large corporate groups from using small, low-capital subsidiaries to sidestep consumption tax obligations. For a foreign multinational setting up a small Japanese subsidiary, this is easy to overlook: the subsidiary itself might look small and low-capital on paper, but if its overseas parent is a large company, the subsidiary can still be taxable from the start.
In practice, this means a few things are worth checking before you incorporate, or as soon as possible afterward:
What will the company's capital be at the start of each fiscal year?
What are your expected sales and salary payments in the first six months of operation?
Does any parent company or group in the ownership structure have taxable sales over 500 million yen?
If the answer to either question points toward "taxable," it's worth planning for consumption tax obligations, and the related bookkeeping and invoicing requirements, from day one rather than assuming you have a grace period.
As mentioned in our previous article, since 2023 there's also Japan's Qualified Invoice System to think about, which affects your customers even if you personally remain exempt. We'll go through that system, and how it interacts with these exemption rules, in the next article in this series.
This article is for general informational purposes only and does not constitute tax advice for any specific situation. If you're setting up a business in Japan, feel free to reach out to us about your particular circumstances.