Taxes in Japan for Small Businesses: Sole Proprietor vs. Corporation

Hi, my name is Taisei Koshida, and I am a certified public accountant and licensed tax accountant in Japan.

If you start or run a small business in Japan, the taxes you pay depend partly on whether you operate as a sole proprietor or through a corporation.

A sole proprietor mainly deals with individual income tax, inhabitant tax, individual business tax, and consumption tax. A corporation has a different structure involving corporate tax, corporate inhabitant tax, corporate business tax, and consumption tax.

This article gives foreign entrepreneurs and small business owners a practical overview of the main taxes they need to understand and the basic differences between operating as a sole proprietor and a corporation in Japan.

1. What Taxes Do Small Businesses Pay in Japan?

There is no single “business tax” that covers everything in Japan.

Several different taxes apply, and the tax structure changes depending on whether you operate as an individual or through a corporation.

For a sole proprietor, the main taxes are:

• Individual income tax
• Inhabitant tax
• Individual business tax, if applicable
• Consumption tax, if applicable

For a corporation, the main taxes are:

• Corporate tax
• Corporate inhabitant tax
• Corporate business tax
• Consumption tax, if applicable

The amount of tax is not determined by sales alone. Business profit, deductions, the type of business, whether you operate as an individual or a corporation, and your consumption tax status all affect the final tax burden.

For a broader overview of starting and running a business in Japan, see Starting & Running a Business in Japan: Tax and Accounting Guide for Foreign Business Owners.

2. Taxes for Sole Proprietors in Japan

If you operate a business in your own name without establishing a corporation, the profit from the business is generally taxed as your individual income.

Individual Income Tax

Japan has a progressive individual income tax system.

For ordinary income subject to aggregate taxation, the national income tax rates range from 5% to 45%.

Reaching the highest tax bracket does not mean that all of your income is taxed at 45%. Different rates apply to different portions of your taxable income.

In practice, business income is calculated by deducting necessary business expenses from business revenue. Income deductions are then taken into account in calculating taxable income.

This is why proper bookkeeping and expense records are directly connected to the calculation of income tax for a sole proprietor.

For a practical explanation of what sales, expenses, bank records, receipts, and other information should be kept, see Bookkeeping in Japan: What Records Foreign Business Owners Actually Need.

Inhabitant Tax

In addition to national income tax, individuals are subject to inhabitant tax.

The income-based portion of individual inhabitant tax is generally around 10% in total. A per-capita amount also applies.

Inhabitant tax is generally calculated based on the previous year’s income.

This means that if you start a business or your income increases substantially, you also need to keep the following year’s inhabitant tax payment in mind.

Individual Business Tax

Individual business tax is a local tax imposed on certain types of business activities.

For a full year of business, there is generally an annual business owner deduction of JPY 2.9 million.

The tax rate generally ranges from 3% to 5%, depending on the type of business.

Not every sole proprietor is subject to individual business tax. Whether it applies depends on the type of business you operate.

Consumption Tax

Consumption tax is separate from individual income tax.

As a general rule, a business is exempt from consumption tax if taxable sales during the base period are JPY 10 million or less.

There are exceptions. A business can become subject to consumption tax because of the specified-period rules, certain payroll conditions, a voluntary election to become a taxable business, or registration as a qualified invoice issuer.

The basic starting point is therefore the JPY 10 million taxable-sales rule for the base period, followed by a check of whether any exceptions apply.

For more details, see An Easy Explanation of Consumption Tax for Doing Business in Japan.

For tax filing by self-employed individuals, see Japanese Tax Return Guide for Foreign Sole Proprietors and Self-Employed Individuals.

3. Taxes for Corporations in Japan

If you establish a Japanese corporation, such as a Kabushiki Kaisha (KK) or Godo Kaisha (GK), the company becomes a separate taxpayer from its owner.

The company earns the business profit, and corporate taxes are imposed on that profit.

Corporate Tax

A Japanese corporation pays national corporate tax on its taxable income.

For certain small and medium-sized companies, different tax rates apply to different portions of taxable income, so the corporate tax rate is not simply one flat rate.

Corporate Inhabitant Tax and Corporate Business Tax

In addition to national corporate tax, a corporation is also subject to corporate inhabitant tax and corporate business tax.

The combined effective corporate tax rate is approximately 30%.

Corporate inhabitant tax also includes a per-capita component. This means that even a small corporation with a tax loss does not necessarily have zero corporate-related tax payments.

Consumption Tax for Corporations

Corporations are also subject to consumption tax.

As with sole proprietors, JPY 10 million of taxable sales during the base period is one of the basic thresholds.

A newly established corporation normally has no base period for its first business year, so it can be exempt from consumption tax under the general rule.

However, exceptions apply based on factors such as capital, the rules for newly established or specified newly established corporations, the specified-period test, and registration as a qualified invoice issuer.

Therefore, it is not correct to assume that every new company is automatically exempt from consumption tax for its first two years.

For more information, see An Easy Explanation of Consumption Tax for Doing Business in Japan.

4. Sole Proprietor vs. Corporation: How Is the Tax Structure Different?

The biggest difference is who earns the business profit.

For a sole proprietorship, the individual earns the business profit. That profit becomes the individual’s income and is subject to individual income tax, inhabitant tax, and other applicable taxes.

For a corporation, the company earns the business profit. Corporate taxes are imposed on the company’s taxable income.

If the company pays director’s remuneration to its owner or director, that remuneration becomes salary income for the individual.

Director’s remuneration that satisfies the applicable requirements is generally deductible by the corporation and taxable as salary income for the individual.

For this reason, simply comparing the individual income tax rate with the corporate tax rate does not give a complete picture.

5. Does Incorporating Automatically Reduce Your Taxes?

No. Incorporating does not automatically mean that your total tax burden becomes lower.

As the profit of a sole proprietor increases, the progressive individual income tax rates make incorporation worth considering.

As a practical rule of thumb, when annual business profit exceeds around JPY 7 million, it is worth considering incorporation.

This does not mean that incorporation automatically becomes more advantageous once profit exceeds JPY 7 million.

The calculation involves factors such as:

• Business profit
• Director’s remuneration
• Individual income tax and inhabitant tax
• Corporate tax, corporate inhabitant tax, and corporate business tax
• Social insurance costs
• Consumption tax
• The cost of maintaining and administering a company

Social insurance costs are particularly important.

Even if incorporation reduces taxes, the total cost may not decrease very much once social insurance is included.

Tax is also not the only reason to incorporate. Relationships with business partners, credibility, financing, employees, liability, visa matters, and future business plans can also affect the decision.

JPY 7 million of annual business profit is therefore a useful point to start considering incorporation, not a fixed threshold for deciding to incorporate.

6. Consumption Tax Needs to Be Considered Separately

When comparing a sole proprietorship with a corporation, it is not enough to look only at individual income tax and corporate tax.

Consumption tax has its own rules.

Consumption tax liability is determined by factors such as taxable sales during the base period, the specified period, rules for newly established corporations, and registration as a qualified invoice issuer.

As a business grows and sales increase, consumption tax can also become an important cash-flow issue.

For example, if the consumption tax collected from customers is treated as ordinary business cash and spent, the business may face a cash shortage when the consumption tax return is filed and the tax becomes payable.

Consumption tax liability and future payments therefore need to be considered separately from income tax and corporate tax.

For more details, see An Easy Explanation of Consumption Tax for Doing Business in Japan.

7. What Happens When a Sole Proprietor Incorporates?

When a sole proprietor establishes a corporation and transfers the business to it, the individual and the corporation are separate taxpayers.

It is not simply the same business operating under a new name.

Assets and liabilities used in the sole proprietorship need to be considered, along with contracts, bank accounts, invoices, and the timing of the transfer to the corporation.

For consumption tax purposes, the individual sole proprietor and the newly established corporation are also treated as separate business entities.

Incorporation therefore involves not only establishing the legal entity but also properly switching the accounting and tax treatment from the individual to the corporation.

For practical guidance on organizing accounting records after incorporation, see Bookkeeping in Japan: What Records Foreign Business Owners Actually Need.

8. FAQs About Taxes for Small Businesses in Japan

Is a Sole Proprietor Always Taxed Less Than a Corporation?

No.

When business profit is relatively small, remaining a sole proprietor can be simpler once the costs of establishing and maintaining a corporation are considered.

As profit increases, however, the progressive individual income tax rates make incorporation worth considering.

As a practical benchmark, annual business profit of around JPY 7 million is a reasonable point to start considering incorporation.

Taxes, director’s remuneration, social insurance, consumption tax, and the cost of maintaining the company all need to be considered.

Do I Pay 45% Income Tax If My Income Reaches the Highest Tax Bracket?

No.

Japan has a progressive income tax system.

Even if your taxable income reaches the highest bracket, the 45% rate does not apply to all of your taxable income. It applies only to the portion that falls within that tax bracket.

Does Every Sole Proprietor Pay Individual Business Tax?

No.

Individual business tax applies to certain types of businesses.

There is also generally a JPY 2.9 million annual business owner deduction for a full year of business.

The type of business and the amount of income therefore need to be checked.

Is a New Company Exempt From Consumption Tax for Its First Two Years?

Not necessarily.

A newly established corporation has no base period at the beginning, so it can be exempt from consumption tax under the general rule.

However, a company can become taxable because of its capital, the rules for newly established or specified newly established corporations, the specified-period test, or registration as a qualified invoice issuer.

A new corporation should therefore not assume that it will automatically be exempt from consumption tax for its first two years.

When Should I Consider Changing From a Sole Proprietor to a Corporation?

Annual business profit of around JPY 7 million is a practical point to start considering incorporation.

JPY 7 million is not an automatic threshold.

Business profit, director’s remuneration, individual income tax and inhabitant tax, corporate taxes, social insurance, consumption tax, and the cost of maintaining a corporation all affect the result.

Non-tax factors such as business partners, financing, employees, visa matters, and future business plans can also affect the decision.

9. Accounting and Tax Support for Small Businesses in Japan

Koshida Accounting and Tax Office provides accounting and tax services in English for foreign entrepreneurs, sole proprietors, and small companies in Japan.

Services include bookkeeping, Japanese tax returns, corporate tax returns, consumption tax, and other accounting and tax matters in Japan.

For sole proprietors, support can cover everything from reviewing accounting records to preparing the annual Japanese tax return.

For corporations, support includes ongoing accounting and preparation of corporate tax returns.

When considering incorporation, organizing the expected business profit, director’s remuneration, taxes, social insurance, and company maintenance costs makes the differences between the two structures much clearer.

For a broader guide to starting and running a business in Japan, see Starting & Running a Business in Japan: Tax and Accounting Guide for Foreign Business Owners.

Need accounting or tax support for your business in Japan?
Contact Koshida Accounting and Tax Office to discuss your accounting and tax situation.