Compliance with the Anti-Monopoly Act in light of the Introduction of the Invoice System

I.Introduction – The Invoice System and Abuse of Superior Bargaining Position

On October 1, 2023, Japan will introduce the so-called invoice system (the “Invoice System”), a new regime to input tax credits for Japanese Consumption Taxes (“JCT”). Applications to register as a qualified invoice issuer under the Invoice System have been accepted since October 1, 2021.

The Invoice System will have a significant financial impact on both suppliers and purchasers of goods and services in Japan; illustrated by the following two examples.

First, the financial impact on purchasers. In this example, the purchaser, a taxable business person, purchases parts for JPY2.2 million (which includes JPY200,000 JCT) from each of ten tax-exempt suppliers, and after processing the parts, sells them as merchandise for JPY55 million (which includes JPY5 million JCT). Under the Invoice System, as purchases from tax-exempt suppliers are no longer eligible for input tax credits, the purchaser will lose the ability to claim JCT input tax credits for each of the ten purchases. This means that the purchaser can no longer obtain JPY200,000 JCT x 10 = JPY 2 million JCT input tax credits, which in effect reduces the purchaser’s income by JPY 2 million (see below table).

[Impact on Purchaser]

Second, the financial impact on suppliers. In this example, one of the tax-exempt suppliers in the above example purchases parts for JPY1.1 million (which includes JPY100,000 JCT) from a taxable business person. After the Invoice System is introduced, if the supplier becomes a taxable business person (and further registers as a qualified invoice issuer), the supplier will be obliged to pay the JPY 100,000 JCT amount that it receives as JCT to the Japanese tax authorities, which it is not obliged to pay under the current regime. This means that, in effect, the supplier’s income is reduced by JPY100,000 (see below table).

[Impact on Supplier]

Given these financial impacts, there is a risk of purchasers potentially breaching the Anti-Monopoly Act (specifically, the prohibitions against the abuse of a superior bargaining position) depending on how purchasers communicate and negotiate with their suppliers. For example, unilaterally requiring tax-exempt suppliers to change their status to a taxable business person (and further register as a qualified invoice issuer) or terminating transactions with tax-exempt suppliers if they do not change their status would likely violate the Anti-Monopoly Act. Purchasers should, therefore, carefully consider appropriate measures beforehand in light of the introduction of the Invoice System.

For example, some platform operators may be involved in continuous purchase transactions covering the same activities with many freelancers and gig workers who are presumed to be tax-exempt business persons. Given that such platform operators will no longer be able to obtain input tax credits for JCT imposed on such purchase transactions, the way that such purchase transactions with the freelancers and gig workers are structured should be reviewed. That said, if platform operators unilaterally require the freelancers and gig workers to become taxable business persons and register as qualified invoice issuers by October, 2023 as a prerequisite to continuing the purchase transactions on the basis that platform operators will no longer be able to obtain input tax credits, the platform operators may be at risk of abusing of a superior bargaining position under the Anti-Monopoly Act as the resulting financial impact on freelancers and gig workers could be significant. This is not unique to purchase transactions between platform operators and freelancers and gig workers but is an unavoidable issue, especially for purchasers placing a large number of purchase orders with tax-exempt business persons. Purchasers must carefully consider this issue in light of the cost structure of their businesses. As the Invoice System will commence on October 1, 2023, Purchasers have only a limited time to negotiate and reach agreement with their suppliers on this issue.

The following is an overview of the Invoice System and a concise explanation of some possible measures that can be taken to lessen its impact. Additionally, a summary has recently been issued of the second meeting of the Cabinet Secretariat’s Liaison Committee between the relevant government ministries and agencies on how to efficiently implement a reduced rate consumption tax system which was held on November 18, 2021. The summary includes a draft Q&A document explaining measures that can be taken for tax-exempt business persons and the Invoice-System in relation to, among other related matters, the risks of abuse of a superior bargaining position and related anti-competition issues. The summary can be accessed at https://www.cas.go.jp/jp/seisaku/keigen_kaigi/index.html (Japanese only).

II.Overview of the Invoice System

(i)The Invoice System

The JCT system is, in simple terms, a system where taxable business persons pay JCT equal to the difference between, on the one hand, the JCT levied on the sale and provision of their own goods and services (i.e., JCT on sales) and, on the other hand, the JCT paid on their purchases of materials and services connected to the sale and provision of their own goods and services (i.e., JCT on purchases). For example, in relation to parts purchased by Company A for JPY550,000 (which includes JPY50,000 JCT) and processed and sold by Company A as merchandise for JPY1,650,000 (which includes JPY150,000 JCT), the total JCT payable would only be JPY100,000, i.e., the difference between the JPY150,000 JCT on the sale (received by Company A as part of the sales price to the customer) and the JPY50,000 JCT on the purchase (paid by Company A as part of the purchase price to the supplier). The deduction of the JCT difference in these two transactions (i.e., JPY50,000) in calculating JCT payable is referred to as an input tax credit.

Under the Invoice System, taxable business persons (purchasers) will need to retain the invoices (i.e., qualified invoices) for their purchases issued by suppliers to obtain input tax credits.※5 Further, such invoices must contain the following specified details:※6

• name and registration number of the business person issuing the invoice (i.e., the qualified invoice issuer);
• the date and details of the applicable transaction; and
• total amount paid per tax rate, the applicable tax rate, and the amount of JCT, all of which are necessary for calculating JCT.

Accordingly, JCT on purchases from business persons not registered as qualified invoice issuers will no longer be deductible by purchasers as they are not registered and are not allowed to issue qualified invoices, subject to the transitional measures detailed in section (iii) below.

(ii)Qualified Invoice Issuer Registration

In general, to become registered as a qualified invoice issuer as of October 1, 2023 when the Invoice System will be introduced, the applicant must submit a registration application to the specified district tax director by March 31, 2023.※7※8 However, to become registered as a qualified invoice issuer, the applicant must first be registered as a taxable business person.※9 Therefore, any tax tax-exempt business persons must become taxable business persons before applying for registration as qualified invoice issuers.※10※11

(iii)“Tax Profit” Issues and Transitional Measures

Under the current law, input tax credits are also available for JCT imposed on purchases from tax-exempt business persons.※12 One reason for this is to avoid tax-exempt business persons from being excluded from transactions and competitively disadvantaged due to purchasers’ inability to obtain input tax credits for JCT imposed on purchases from tax-exempt business persons.※13 However, it should be noted that under the current law, tax-exempt suppliers are not obligated to pay the JCT portion of the sales price that they receive from purchasers, while purchasers are entitled to tax credits for JCT amounts paid to tax-exempt suppliers. The retention of the JCT amount received by tax-exempt business persons is referred to as “tax profit” (ekizei), and some observers criticize this as the government effectively extending financial assistance to tax-exempt businesses by way of such “tax profit.” The higher the consumption tax rate, the larger the “tax profit,” which leads to JCT tax revenue leakage from the national treasury. This has long been considered a national fiscal issue.※14※15

The status of a tax-exempt business person will continue in place after the Invoice System is introduced. In order to ensure that tax-exempt business persons not registered as qualified invoice issuers are not immediately excluded from transactions, transitional measures will be put in place. Under these transitional measures, purchases from tax-exempt business persons will be eligible for an input tax credit of 80% of the JCT for three years after the introduction of the Invoice System and up to 50% for the following three years as long as, among other conditions, the requirements for such input tax credits under the current law are met.※16 Eventually, input tax credits will not be available for purchases from tax-exempt business persons. Therefore, if more tax-exempt business persons become taxable business persons and register as qualified invoice issuers, transactions with tax-exempt business persons will likely decrease, thereby alleviating the “tax profit” issue.

(iv)Simplified Tax System

As mentioned above, in light of the future introduction of the Invoice System, tax-exempt business persons will need to consider whether to remain tax-exempt business persons or register as qualified invoice issuers after becoming taxable business persons. In addition, if they choose to register as qualified invoice issuers, they will also need to consider when so register. When considering these matters, they will need to take into account the risk of a decline in business and the potential financial impact of not becoming a qualified invoice issuer.

In this context, utilizing the so-called “simplified tax system” is worth consideration. The simplified tax system was established to ease the administrative burden on small and medium-sized businesses. Under the simplified tax system, the amount of input tax credit is obtained by multiplying the amount of JCT payable on taxable sales during the taxable period by the deemed purchase rate instead of the JCT payable on the monetary amount of actual purchases. This simplified tax system is available to taxable business persons with taxable sales of JPY50 million or less during the reference taxable period (i.e., the calendar year before the previous year for individuals and the fiscal year before the previous year for companies※17).

Therefore, although differing from the original purpose of the simplified tax system of reducing administrative burdens, it may be advantageous for tax-exempt business persons to use the simplified tax system if their deemed amount of input tax credit, which is calculated based on their deemed purchase rate, is expected to be higher than the input tax credit amount calculated based on the monetary amount of their actual purchases upon becoming taxable business persons (and further registering as a qualified invoice issuer).

Such previous tax exempt business person can potentially benefit from the difference in JCT by choosing the simplified tax system and thereby potentially alleviate the decrease in “tax profit” following their change from a tax-exempt business person to a taxable business person (and further registration as a qualified invoice issuer).※18※19 Therefore, tax-exempt business persons considering becoming taxable business persons (and further registration as qualified invoice issuers) following the introduction of the Invoice System should also consider whether to opt to use the simplified tax system.

The deemed purchase rates for each type of business under the simplified tax system are as set out below:※20

III.Requiring Suppliers to Register as Qualified Invoice Issuers and Anti-Monopoly Act Issues

Anti-monopoly issues and considerations from a purchaser’s perspective in setting the terms and conditions for transactions with suppliers after the introduction of the Invoice System, with a particular focus on tax-exempt suppliers, are discussed below.

(i)Risk of Abuse of Superior Bargaining Position

Registration by suppliers as qualified invoice issuers would obviously benefit purchasers as it will enable them to obtain tax credits as before. If suppliers are already taxable business persons, their tax burden will remain unchanged compared to before the introduction of the Invoice System, even if they register as a qualified invoice issuer under the Invoice System. However, tax-exempt suppliers will face significant adverse tax consequences, such as the loss or reduction of “tax profit” if they become taxable business persons and register as qualified invoice issuers under the Invoice System.

In these circumstances, purchasers who (i) require tax-exempt suppliers to register as qualified invoice issuers, implying that the purchasers would otherwise immediately terminate, or lower unit prices under, their agreements with the suppliers, or (ii) actually terminate or reduce unit prices under agreements with suppliers who do not register as qualified invoice issuers, are highly likely to breach the prohibitions against abuse of a superior bargaining position under the Anti-Monopoly Act as such behavior amounts to a unilateral setting of terms and conditions by a party in a superior bargaining position.

In addition, if any purchasers were to require a large number of tax-exempt suppliers to uniformly and hastily register as qualified invoice issuers, the financial impact on those suppliers would be significant, creating a risk that the Japan Fair Trade Commission could investigate the cases on a large scale as potential abuses of a superior bargaining position.※21※22

(ii)Would Removal of “Tax Profit” Negate Abuse of a Superior Bargaining Position?

Purchasers may like to believe that they would be justified in unilaterally forcing tax-exempt suppliers to disgorge the “tax profit” through negotiation with the suppliers on the grounds that the “tax profit” is just a side-benefit windfall which should be reduced or removed from a national fiscal viewpoint, and that input tax credits will be phased out for purchasers from tax-exempt suppliers after the introduction of the Invoice System. However, the “tax profit” is not unlawful and the status of “tax-exempt business persons” will remain even after the introduction of the Invoice System. Furthermore, purchasers enforcing disgorgement of the “tax profit” against suppliers would likely have a significant adverse effect on suppliers. Accordingly, it would be difficult for purchasers to justify any such unilateral action against tax-exempt suppliers and/or successfully rebut claims of abuse of a superior bargaining position by arguing that their actions reduced the “tax profit” – even though this appears to be one of the purposes of the Japanese government in introducing the Invoice System.

(iii)Balancing the Interests of Tax-exempt Suppliers and the Principle of Freedom of Contract

Freedom of contract is a fundamental principle of a capitalist economy. Purchasers should not be obliged to engage in business with tax-exempt suppliers on the same terms and conditions as before and after introduction of the Invoice System, even in the context of laws regulating abuse of a superior bargaining position. Continuing to engage in business with tax-exempt suppliers on the same terms and conditions as before introduction of the Invoice System would essentially result in higher unit prices for purchasers given the tax effect of phasing out input tax credits for purchasers after the introduction of the Invoice System, which could be critical to the profitability of purchasers.

Strengthening business relationships with suppliers who offer better terms and conditions and reducing or terminating business relationships with those who do not is a direct consequence of the principle of competition, and it is not per se unlawful to require tax-exempt business persons to register as qualified invoice issuers. Some tax-exempt suppliers even may seek to expand their business and strengthen their competiveness by becoming qualified invoice issuers in order to allow their purchasers to continue to receive input tax credits. As long as tax-exempt business persons properly analyze the advantages and disadvantages of registration as a qualified invoice issuer, overly restricting tax-exempt business persons from becoming qualified invoice issuers would impede competition, which would not facilitate the purpose of the Anti-Monopoly Act either. Therefore, purchasers should seek solutions acceptable to both themselves and suppliers under the Invoice System, while at the same time recognizing the circumstances and position of suppliers.

(iv)Sample Practical Measures

In asking tax-exempt business persons to register as qualified invoice issuers, it is critical that such requests are not made as unilateral requirements. To avoid claims of “unilateralism,” purchasers should (i) consider the circumstances of suppliers (especially those of tax-exempt business persons), (ii) give suppliers sufficient time to make a decision after they have understood the circumstances and position of the purchaser, and (iii) avoid pressuring suppliers to indicate their willingness to register as qualified invoice issuers.

There is no single approach to reaching a balanced and reasonable agreement to avoid abuse of a superior bargaining position. The number of suppliers, their characteristics (e.g., whether or not they are sole proprietors who conduct their business as a side business), the power balance between the supplier and purchaser, the extent of dependence of the supplier on the purchaser and other aspects of the supplier-purchaser relationship can vary widely. To this end, although these are only examples, purchasers could adopt the following practical measures:

• Purchasers could thoroughly explain the Invoice System to their current tax-exempt suppliers, including the transitional measures under the Consumption Tax Act, and inform them that the phasing out of the input tax credits for purchases from them will have a significant impact on purchasers.
• Subsequently, purchasers could ask their tax-exempt suppliers to consider registering as a qualified invoice issuer (after becoming a taxable business person) and give the suppliers sufficient time to do so while simultaneously showing the purchaser’s consideration and understanding of the difficulties that such registration entails for suppliers.
• If possible, a package of unit prices and terms and conditions could be proposed in order for suppliers and purchasers to share the financial burden, and incentives could be offered to those switching from tax-exempt to taxable status.
• In proposing these packages and incentives, the transitional measures could be also taken into account.

It will likely take some time to reach agreement through negotiations and discussions on these packages and incentives. If a purchaser takes appropriately timed step-by-step measures to reduce or terminate business with a supplier with whom it is difficult to reach agreement after a certain reasonable time period, the risk of claims of abuse of a superior bargaining position will be relatively low.

(v)Possibility of New legislation on Dealings with Start-ups and Freelancers

Coinciding with the previous increases in the JCT rate, the Act Concerning Special Measures for Correcting Practices Impeding Consumption Tax Pass-on, etc. with the Aim to Ensure Smooth and Proper Pass-on of Consumption Tax was passed as a temporary measure to protect both tax-exempt and taxable suppliers. Under this Act, it would constitute a “forced price reduction” if purchasers did not raise their purchase prices to cover the increase in JCT. However, no special measures are expected to be introduced to provide protection to suppliers in connection with the introduction of the Invoice System.

In March 2021, the Japan Fair Trade Commission issued the following guidelines jointly with other relevant ministries and agencies:

• Guidelines for Business Collaboration with Start-ups (issued by Japan Fair Trade Commission and Ministry of Economy, Trade and Industry); and
• Guidelines for Creating an Environment for Working as a Freelancer (issued by Cabinet Secretariat, Japan Fair Trade Commission, Small and Medium Enterprise Agency, and Ministry of Health, Labour and Welfare).

None of these Guidelines will change the existing requirements or prohibitions under the Subcontracting Act or the Anti-Monopoly Act. However, new legislation similar to the Subcontracting Act is being considered by the Japanese government in order to protect start-ups and freelancers. If such new legislation is introduced, purchasers should take such legislation into account when considering the approach to requesting suppliers to register as qualified invoice issuers.

IV.Conclusion

The Invoice System is likely to have significant financial impact on both purchasers and suppliers. Against this background, inappropriate acts by purchasers, such as unilaterally requiring tax-exempt suppliers to register as qualified invoice issuers or immediately terminating business with suppliers who do not register as qualified invoice issuers under the Invoice System, are highly likely to constitute abuse of a superior bargaining position under the Anti-Monopoly Act, as they amount to a unilateral setting of terms and conditions by a party in a superior bargaining position. Therefore, in preparation for the introduction of the Invoice System on October 1, 2023, when negotiating with their suppliers, purchasers should take a cautious approach over a reasonable period of time taking into consideration their suppliers’ circumstances in order to reach a mutually acceptable conclusion while tax-exempt suppliers should consider registering as qualified invoice issuers in order to continue, and even expand, their business with their customers.