• Plans to tackle “regressive” consumption tax
• More firms may outsource compliance
• Policy credibility at stake
Japan’s consumption tax, introduced in 1989 as a levy on the supply of goods and services, is similar to the European value-added tax (VAT). Initially 3%, the rate was increased to the current 5% in 1995.
Although politically sensitive due to the burden it places on consumers, the tax is an important source of revenue for the Japanese government. It accounts for 20% to 25% of the total tax raised, which is greater than the contribution from corporation tax.
Discussions on consumption tax reform have been ongoing for several years, and in preparation for the recently confirmed rate increase, two changes were made in 2012.
First, the definition of “consumption taxpayers” (i.e. entities obliged to report their consumption tax liability to the tax authorities) was widened.
Next, rules concerning the computation of consumption tax liability amounts were amended.
Both changes were enacted in response to criticism that certain exemptions and deductions effectively allowed businesses to keep some of the consumption tax paid by their customers, rather than pass it on to the government.
The much-debated consumption tax hike that was confirmed in October by Prime Minister Shinzo Abe is scheduled to be introduced in two stages.
From 1 April, the rate will rise to 8%, and then on 1 October 2015, the rate is expected to increase to 10%. A decision on whether to proceed with the 2015 increase will be made after an assessment on the prevailing economic conditions.
The 8% rate will apply to all transactions from 1 April, unless certain transitional measures apply, in which case the current 5% rate will persist for specific transactions.
The consumption tax hike is part of a policy response to Japan’s ballooning public debt; the government debt now exceeds ¥1 quadrillion (nearly £6trn).
The increase in government borrowing is in large part due to the well-documented need to finance Japan’s mounting social security liabilities.
As the birth rate remains low, the number of working-age people is set to be fewer, and thus the expected revenue from individual income taxes will surely decline. Raising the consumption tax is one way to help fill the gap, as the tax is borne across all age groups.
From a bureaucrat’s perspective, the consumption tax is also a more stable source of revenue than income tax, as it is arguably less sensitive to the ebb and flow of economic conditions.
The government though must balance consumers’ wishes to keep taxes low with the need to retain the trust of the international financial world.
There are concerns that any erosion of confidence in Japan’s ability to manage its debt levels could cause government bond prices to fall and interest rates to rise.
In such a scenario, the increased cost of servicing debt could push borrowing requirements ever higher. To avoid such a vicious cycle, there was seemingly a rising sense that increasing the consumption tax rate was unavoidable.
In spite of the potential treasury benefits, support for a rate hike has understandably been more muted among consumers. A frequently voiced criticism is that consumption tax is a “regressive” tax—uniformly applied regardless of ability to pay, such that the burden is felt more acutely by lower income groups.
In response to this, the recently announced 2014 tax reform proposals indicate that the government will consider introducing a system of multiple consumption tax rates to mitigate the impact of the rate hike.
Details are still undecided, but the expectation is that the consumption tax rate on basic necessities such as food and certain household items will be reduced. However, such a system is unlikely to be introduced before the increase to 10% in October 2015.
Although likely to be welcomed by consumers, the introduction of multiple rates would make the consumption tax system more complicated and harder to administer, particularly for small and medium-sized businesses.
As complexity of the system increases, firms will need to review their business processes and their financial systems’ capability to deal with the changes.
For large organisations, this may entail a review of existing enterprise resource planning systems (e.g. SAP, Oracle), and a decision on whether to customise with additional functionality or integrate with a “bolt-on” application that specifically deals with consumption tax requirements.
For smaller firms that lack the resources to properly evaluate and deal with the changes, the new rules may shape a decision on whether to begin outsourcing bookkeeping and tax compliance functions.
As finance departments are increasingly being asked to contribute more to their organisations using fewer resources, the challenge of understanding and evaluating options in regards to consumption tax changes is something that will need to be budgeted for, in terms of management time as well as money.
Even for those businesses for which consumption tax is a cost that is exclusively borne by customers, it will still be necessary to manage the cost of administering the increasingly complex tax system and ensuring the availability of appropriate data for compliance purposes.
Careful planning will therefore be required to ensure that, as future changes to consumption tax laws are clarified, businesses are prepared and able to efficiently meet their tax compliance obligations.