Japan Tax Update. New consumption tax regime on X-border service transaction. Issue 99, April 2014

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1 Japan Tax Update New consumption tax regime on X-border service transaction Issue 99, April 2014 Proposed legislation for a new Japanese consumption tax (JCT) regime on cross-border service transactions ( X-Border s ) is currently being studied and is targeted for inclusion in the 2015 tax reform cycle. The envisaged system has significant business implications for multinationals in the digital economy and should be carefully monitored going forward. This Japan Tax Update provides a summary of the analysis and discussions on April 4, 2014 by the International Taxation Group of the Government Tax Commission. 1. The new JCT regime expected in the 2015 Tax Reform proposal On April 1, 2014, the Tax Hike Act related to social security reforms took effect, raising the applicable JCT rate from 5% to 8% for taxable transactions carried out on or after April 1, The Tax Hike Act also enables a further increase of the JCT rate to 10% on or after October 1, 2015, with the final decision to move forward anticipated by the end of Concurrently, the need to clarify and reform the taxation of the ever expanding global digital economy has been both an international priority (this is a key provision within the OECD s Base Erosion and Profit Shifting (BEPS) Report issued last year) and a subject of discussion in Japan, where X-Border s are not subject to JCT under existing rules. The 2014 Tax Reform Proposal published by the ruling LDP and the Komeito stated that they will target to include new legislation to address the issue in the 2015 Tax Reform. In an effort to address and harmonize the JCT rate increase with a new regime on X-Border s, the International Taxation Group ( ITG ) of the Government Tax Commission has been in discussions since November, 2013 to consider and finalize a proposal in conjunction with the 2015 tax reform cycle. In the third meeting of the ITG on April 4, 2014, a more detailed proposal on the new JCT regime was discussed and is analyzed herein.

2 2. Current JCT taxation of X-Border s out of date with international trend (1) Current Rules Japan s current JCT regime was established in 1989 before the rise of the digital economy and is a set of rules to tax goods and services transactions that occur in Japan. Underlying the rules is a principle (and assumption) that such flow of goods and services are carried out via the physical presence of tangible assets (i.e. assets and/or persons) in Japan, and that accordingly the trigger for JCT should also be tied to the physical presence of such assets in Japan. In the case of service transactions, where the service is provided by a non-resident physically outside of Japan, no JCT is triggered. In the case of the digital economy, the location of the service is not apparent. Consistent with the above principle, current rules prescribe that unless specified otherwise the location of the office of service provider will be treated as the place of service provision. Accordingly, for non-resident suppliers, provision of X-Border s is not subject to JCT. In contrast, domestic digital economy service providers are required to charge JCT on their services, creating a pricing disadvantage for such companies vis-à-vis their multinational competitors. (2) Rise in JCT rate widens the gap Effective for transactions occurring on or after April 1, 2014, the JCT rate has increased from 5% to 8%, with such rate anticipated to increase to 10% from October 1, The rate increase will naturally exacerbate the current unfair pricing competitiveness of domestic digital economy service suppliers. To address the circumstances, in July 2012 the Japanese government organized a study group (which has developed into the ITG) to assess and introduce new JCT rules in respect of the digital economy and X-Border s that (i) ensures the economic neutrality of service providers activities, regardless of residence, (ii) safeguards the proper taxation right of the Japanese government and (iii) results in fair and equitable tax administration. In fact, internationally the debate on taxation of the digital economy has existed since the late 1990 s, with the Office of Economic Cooperation and Development (OECD) issuing several proposals and reports 1 on the taxation mechanism in regard to online business-to-business (B to B) and business-to-consumer (B to C) transactions. Recently, the debate has intensified with taxation of the digital economy being included as a principle plank of the OECD s Base Erosion and Profit Shifting (BEPS)action plan; A draft discussion paper on this was released on March 24, (3) Reforming the rules In November of last year, the Japanese government via the ITG released its preliminary report on reforming the JCT rules, with the discussion focusing on four parts: (i) issues under the current JCT regime; (ii) actions taken by OECD and legislation in EU countries; (iii) review of the current rules for the location of service provision; and (iv) proposed new JCT taxation rules on X-Border transactions. The discussion was further taken up in the third ITG meeting on April 4, 2014, at which the new JCT rules were discussed in more detail. In particular, focus was given to refining the determination of the service location and the mechanism to tax and collect JCT on X-Border transactions. (a) Defining the service location Under the contemplated new rules, the location of the service will still determine the taxability of the transaction for JCT purposes. Where the service location is outside Japan, the transaction will not be not subject to JCT. In the third ITG meeting, it was discussed to review the current rules for service provision. 1 Electronic Commerce: Taxation Framework Conditions (1998), Taxation and Electronic Commerce Implementing the Ottawa Taxation Framework Conditions, (the 2001 Report ), Implementation of the Ottawa Taxation Framework Conditions (the 2003 Report ). 2 Action 1 (Tax Challenges of the Digital Economy) of the BEPS Action Plan PwC 2

3 Those services of which the location of service provision is not apparent Type of service Those services of which the location of service provision is apparent 1. International transportation, international communication, international postage service Rules to determine location of service Current The location where the service is provided The location of dispatch or destination 2. Insurance contracts The location of the office which concludes the insurance contract 3. Provision of information or services with respect to plant construction 4. Provision of information or other planning services 5. Other than (1) through (4) above The location where plant construction material plant is mainly procured The location of the office of service provider Proposed No change The location of service recipient (Destination Principle) Based on the proposal, the location of the service recipient will be deemed as the location of the services for items 4 and 5 above. Accordingly, these services when provided to an individual or business in Japan will be subject to JCT. In addition, it is proposed to clarify that the provision of digital contents are treated as provision of services. (b) Taxing X-Border s In terms of the mechanism to assess and collect JCT, the ITC in its April 4, 2014 meeting outlined different rules and mechanisms for B to C transactions versus B to B transactions, although noting that such is subject to further analysis and discussion. In regard to B to C transactions, the envisaged scope is limited mainly to digital services provided via the internet. However, in regard to B to B transactions, the envisaged scope is broader and may include online advertising distribution and legal advisory services by nonresident suppliers. More importantly, the ITC announced very different mechanisms to collect and remit JCT in the B to B and B to C models. PwC 3

4 B to C Transactions model individual consumers (e.g. digital books, online music distribution, etc.) both individual and business consumers (cloud services, etc.) without limitation under the relevant service contract. It is not clear from the trade conditions that the service is provided to business. Proposed JCT Taxation Tax filing/payment obligation on non-resident service supplier Non-resident service supplier is required to designate a tax agent in Japan. The ability to take input tax credit by a business customer (if existing in a B to C transaction) is currently under close scrutiny. Individual Consumer Tax Office Onshore Payment (JCT inclusive) Tax filing and payment Offshore Provider A B to B Transactions (Reverse Charge Mechanism) model Proposed JCT Taxation business customers (e.g. online advertisement distribution, legal advisory services, etc.) both individual and business consumers (cloud services, etc.) without limitation, but from the terms of the relevant service contract such service is intended for business customers. Reverse charge system (domestic service recipient may be obliged to collect and pay JCT) Non-resident service supplier is required to notify the business customer of the reverse transaction, while this notice will not affect the nature of the transaction (i.e., the transaction subject to the reverse charge system). Certain business customer is exempt from reporting the JCT of reversed charge transaction assuming that the same amount of reversed charge JCT will be claimed as input tax credit Business Customer Tax filing Tax Office Onshore Payment (JCT exclusive) Offshore Provider A *********************** PwC Thoughts and Observations As envisaged and summarized above, the contemplated JCT taxation of X-Border s has significant implications for multinationals operating in the digital economy and should be carefully monitored over the course of this year as the rules become refined and finalized. Among matters to consider include: PwC 4

5 [For offshore service providers] The ability of current business systems and processes to identify the location of an online customer, and how such will need to be adjusted for the new rules. The ability of current business systems and processes to identify the form of an online customer (individual consumer versus business), and how such will need to be adjusted for the new rules. JCT collection and remittance procedures and related tax and treasury implications Tax reporting obligations and procedures where multinationals are operating in partnership form (e.g. law firms) [For domestic service recipient businesses] Identify services procured from offshore providers and confirm whether reverse charge mechanism is applicable. If taxable sales ratio is not high, consider the impact of the additional consumption tax obligation and mitigation measures if any. For more information, please consult your tax representative or contact any of the following members listed below: Zeirishi-Hojin PricewaterhouseCoopers Kasumigaseki Bldg. 15F, 2-5, Kasumigaseki 3-chome, Chiyoda-ku, Tokyo Telephone: , Partner Yoko Kawasaki Akemi Kito Jack Bird Marc Lim Managing Director Yumiko Arai PwC Japan Tax (Zeirishi-Hojin PricewaterhouseCoopers), a PwC member firm, is one of the largest professional tax corporations in Japan with more than 500 people. In addition to tax compliance services our tax professionals are experienced in providing tax consulting advice in all aspects of domestic/international taxation including financial and real estate, transfer pricing, M&A, group reorganization, global tax planning, and the consolidated tax system to clients in various industries. PwC firms help organisations and individuals create the value they re looking for. We re a network of firms in 157 countries with more than 184,000 people who are committed to delivering quality in assurance, tax and advisory services. Tell us what matters to you and find out more by visiting us at This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors Zeirishi-Hojin PricewaterhouseCoopers. All rights reserved. PwC refers to Zeirishi-Hojin PricewaterhouseCoopers, a member firm in Japan, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. PwC 5