In general, transactions of goods and services carried out in Japan are subject to consumption tax. When customers purchase goods, they pay the total amount – which includes the consumption tax – to a business (e.g. a physical store or ecommerce mall). The business owner then pays the consumption tax they have collected to the government on behalf of the customer.

In other words, although the consumption tax is a tax charged to the customer, business owners are responsible for paying the collected tax to the government. A business owner who is liable for tax is known as a taxable business owner.

There are some transactions however that are not subject to consumption tax. In Japan, these transactions fall into three categories: tax-free (fukazei), non-taxable (hikazei), and tax-exempt (menzei) transactions. In this article, we’ll explain the differences between these types of transactions, what each term means, and why it is necessary to make a distinction between them.

What’s in this article?

• The difference between tax-free, non-taxable, and tax-exempt
  
• Why it’s important to distinguish between these types of transactions
  
• FAQs about transactions that are not subject to consumption tax
  
• Understanding the applicable tax categories and accounting procedures
  

The difference between tax-free, non-taxable, and tax-exempt

As explained above, consumption tax is usually applied to most products and services in Japan, but there are some transactions that are not subject to consumption tax.

There are three main types of transactions that are not subject to consumption tax: tax-free (fukazei), non-taxable (hikazei), and tax-exempt (menzei).

What is a tax-free (fukazei) transaction?

Tax-free (fukazei) transactions include the following:

• Transactions that take place outside Japan
  
• Transactions that are not for business purposes
  
• Transactions carried out without compensation
  
• Transactions that do not constitute transfers, lending, or provisions of services as defined by Japan’s National Tax Agency (NTA)
  

Because these transactions do not meet the requirements for taxation and therefore are not subject to tax, consumption tax is not applied. An example of a tax-free transaction is a donation. Donations are transactions that are not subject to consumption tax because they are given without an expectation of anything in return – i.e. no one is seeking compensation.

There are specific examples of tax-free transactions listed by the NTA. They include the following:

• Foreign transactions
  
• Salaries and wages
  
• Dividends on investments
  
• Donations and relief money
  
• Compensation for damages
  

What is a non-taxable (hikazei) transaction?

Non-taxable (hikazei) transactions are transactions that meet the requirements for taxation but are not taxed. This is either because the transactions are considered unsuitable for the collection of consumption tax by the NTA or because the transactions are subject to certain social policy considerations.

Compared to both the tax-free and tax-exempt categories, non-taxable transactions are more common. As a result, it’s more likely you’ll need to perform this category’s associated accounting procedures. It can sometimes be difficult to judge whether a transaction is taxable or non-taxable (fukazei), so it’s important to understand the difference.

Deeming whether a transaction is non-taxable can be complicated. If you need help, try referring to the non-taxable (hikazei) transactions guide provided by the NTA. Examples of non-taxable transactions include:

• Transfers or loans of land
  
• Transfers of postage stamps and revenue stamps
  
• Transfers of securities and gift certificates
  
• Social insurance medical expenses
  
• Nursing care service expenses
  
• Expenses related to midwifery
  
• Tuition fees as stipulated by the School Education Act
  

What is a tax-exempt (menzei) transaction?

Tax-exempt (menzei), as the name suggests, means the customer is free from paying tax. This transaction category specifically refers to goods and services intended for export; customers are not required to pay consumption tax on these purchases. For example, non-residents who do not have a Japanese address – such as foreign tourists visiting Japan from overseas – are eligible for tax-exempt purchases. Since the tax exemption only applies to goods and services consumed outside Japan, people living in Japan are not eligible for this exemption.

It’s important to understand that tax-free transactions only apply to export transactions and other transactions involving products that are not used in Japan. Examples of tax-exempt transactions include:

• Export sales of goods
  
• Goods purchased by foreign tourists (non-residents) visiting Japan for the purpose of using them outside Japan
  
• Provisions of services to non-residents
  

Why it’s important to distinguish between these types of transactions

None of these transaction types include consumption tax, so you might be wondering why you need to distinguish between them.

Distinction between these categories is necessary because their classifications make it possible to correctly calculate the taxable sales ratio (i.e. the percentage of total sales that is taxable). The classification process can be complicated, and the amount of consumption tax paid might be incorrect if you do not calculate it properly. Be careful in your accounting when recording whether a transaction is subject to consumption tax to avoid making mistakes on your tax return.

FAQs about transactions that are not subject to consumption tax

What is the main difference between tax-free (fukazei) and non-taxable (hikazei) transactions?

Although tax-free (fukazei) and non-taxable (hikazei) transactions might seem similar at first glance, there is a big difference between the two in terms of whether they meet the requirements for consumption tax.

As explained above, a tax-free transaction is one that does not meet the requirements for consumption tax to be levied in the first place. A non-taxable transaction is one that meets the requirements for taxation but the tax authority deliberately does not tax it for a specific reason, including social policy or because the nature of the transaction is considered unsuitable for applying consumption tax.

What happens if you confuse tax-free (fukazei) and non-taxable (hikazei) transactions?

If you make a mistake in the classification of transactions, it could cause problems with your tax return. This is due to the way the taxable sales ratio is calculated.

In the taxable sales ratio, the denominator is the total sales amount (this includes the sum of taxable transactions, non-taxable (hikazei) transactions, and tax-exempt (menzei) transactions) and the numerator is the amount of taxable sales (the total amount of taxable transactions and tax-free (fukazei) transactions). As stated by the NTA, non-taxable transactions are included in the denominator when calculating the taxable sales ratio. However, tax-free transactions are not subject to consumption tax in the first place, so they are not included in either the numerator or denominator of the calculation formula.

If you handle the distinction between these two transaction types incorrectly, there can be errors in the amount of purchase tax credit, which will in turn affect the amount of consumption tax paid.

You can correct mistakes later, but you will have to go through the extra hassle of filing an amended return, and you might also have to pay additional tax or a surcharge. To avoid this, accounting staff should be aware of the difference between non-taxable and tax-free transactions when carrying out their duties.

What kind of businesses are tax-exempt?

A tax-exempt business is a business that is exempt from declaring and paying consumption tax. In principle, this includes individual proprietors with sales of less than ¥10 million. Newly established businesses with no sales history usually also fall into this category.

Note that since the introduction of Japan’s Qualified Invoice System, taxable businesses generally are unable to receive tax credit for transactions and purchases they make with tax-exempt businesses. Businesses should deepen their understanding of the Invoice System and take appropriate measures when conducting business-to-business (B2B) transactions.

Understanding the applicable tax categories and accounting procedures

Since October 2019, the standard consumption tax rate in Japan has been 10% for taxable goods and services (a reduced rate of 8% applies to some items).

There are also cases where consumption tax is irrelevant, such as the three types of transactions introduced in this article. These transactions are exempt from consumption tax, but the reasons for this differ.

It is important to understand the distinction between transactions that are subject to consumption tax and those that are not, as this will affect the preparation of appropriate accounting records, the issuing of invoices and receipts, and the filing of future tax returns.

Stripe has developed Stripe Tax, which includes a customisable, automatic consumption tax calculation function. It can automatically determine and reflect the 8% or 10% tax rate that varies depending on the product, and since the tax processing for consumption tax is centralised for all electronic transactions, it can improve and streamline back-office operations.