Japan moves forward with consumption tax on cross-border supply of digital services

by Masao Yoshimura

A Japanese government proposal to impose consumption tax on the supply of digital services by foreign providers was passed by the Lower House on March 13 as a part the government’s 2015 tax reform package. The bill will next be considered by Japan’s Upper House.

The government proposal would reform the place of supply rules of the consumption tax, which is equivalent to a value added tax, on supplies of cross-border digital services, switching from origin-based to destination-based sourcing rules.

Current Japanese consumption tax rules provide that supplies of digital products or telecommunications services provided by overseas suppliers to Japanese customers are not treated as supplied in Japan. As a result, customers can purchase telecommunications services overseas free of consumption tax.

Under the proposed rules, supplies of telecommunications services would be treated as supplied in Japan when the recipient is a Japanese resident, regardless of where the supplier is located. “Telecommunications services” are broadly defined as provision of services through an electronic communications network, including provision of copyrights by utilization of electric telecommunication line.

In the case of cross-border supplies of telecommunications services to domestic businesses, the receiving businesses would be subject to a reverse charge mechanism, which requires the recipients of the relevant services to pay the consumption tax on services received.

However, it is often not possible to determine if a Japanese recipient is a business or final consumer because, under Japan’s accounts-based VAT, domestic businesses are not required to be registered for input credits and don’t have VAT registration numbers.

The proposed law therefore deems supplies of telecommunications services as supplied to businesses or not based on the nature of the services or terms and conditions for the service providing contracts.

This scheme could result in some domestic businesses receiving telecommunications services that are deemed as supplied to consumers (e.g. e-books) from overseas suppliers and that are not subject to reverse charge. For now, these businesses cannot claim input tax credits for the consumption tax paid on the services received because the government seeks to prevent taxpayers from receiving an input tax credit without charging and collecting a corresponding consumption tax from overseas suppliers.

Instead, the proposed regime addresses this issue by allowing input tax credits if purchasers receive services from “registered overseas suppliers.” To qualify to apply for registration, overseas suppliers must locate their office or to appoint a fiscal representative in Japan.

If enacted, this amendment will take effect on October 1.

—  Masao Yoshimura is an Associate Professor of Tax Law at Hitotsubashi University’s Graduate School of International Corporate Strategy in Tokyo, Japan, where he focuses on corporate and international tax.