Japan’s 2017 Consumption Tax increase from 8% to 10% will most likely add a reduced rate. A reduced rate in most countries is a normal event but in Japan it will require a fundamental change to how the Consumption Tax is recorded and documented.
Reduced rates are common around the world, the European Union allows member states to have reduced rates provided they are no lower than 5%; however, special provisions allow the United Kingdom, France, Ireland and Luxembourg all to continue applying reduced rates below 5% to certain goods and services. Generally, the reduced rates apply to food, books, medicines, restaurants and hospitality. Canada and Australia apply a 0% rate which is referred to as exempt with credit, zero-rated or GST-free on basic foods stuffs. This same zero-rating occurs in the United Kingdom and Ireland for certain types of food.
How much the reduced rate will be and what items will be subject to a reduced rate are up for debate. A survey recently conducted in Japan found there is wide support for a reduced rate. However, depending on the item the fiscal impact could be significant, for example, a 2% reduction in the consumption tax rate on rice would lead to $330 million in reduced funding. A complex reduced rate list could increase the complexity of administering and charging the consumption tax because items would have to be scrutinized to determine the appropriate rate. Most likely the reduced rate will be applied to food products, which have had been problematic globally.
In 2009, Proctor & Gamble, lost a court case on the VAT treatment of Pringles in the United Kingdom. Pringles had been ruled a food stuff by a lower court but the Court of Appeals ruled they are actually a crisp and not a foodstuff therefore subject to the standard VAT rate and not the 0% rate.
Also in 2009, the Australian Taxation Office issued a ruling on the treatment of Pizza Rolls, which provided guidance on when a Pizza Roll is taxable and when it is zero-rated.
This kind of litigation could be more common in Japan when a reduced rate is introduced but the larger business process change will be a shift to requiring invoices with the Consumption Tax amounts noted and calculating the consumption liability on a transaction basis rather than an aggregate.
The Consumption Tax is a Value Added Tax but it uses a Subtraction Method for calculating the Net VAT. In contrast, almost all other countries use a Tax Credit Mechanism. In the subtraction method, you calculate the total VAT due based on the sales less purchases then apply the tax rate.
In Japan, the requirements for claiming an input tax deduction:
- Books that record the taxable purchase transaction
- statements of delivery, bills, etc or documents issued by custom authorities indicating the taxable purchases and the respective price
What is not required is the total amount of VAT to be paid. The tax is calculated by subtracting the tax amount on the taxable input from the tax amount on the taxable output.
The tax credit mechanism instead adds up the tax collected on sales and subtracts it from the total tax paid on purchases from every firm. Since the actual tax collected and paid are the basis for the calculation the tax has to be stated on the invoices.
Multiple rates make the subtraction method impossible and you have to calculate the VAT on each transaction. So when Japan introduces a reduced rate, invoices with the tax amount will become the norm but the transition will be complex and could take years to complete.