Nothing is certain except death and taxes – Benjamin Franklin
Hi, my name is Taisei Koshida, a certified public accountant and tax accountant in Japan.
What is the worst-case outcome of a tax audit in Japan?
One of the most serious outcomes is that the tax authorities determine that a taxpayer intentionally disguised or concealed facts, rather than simply making an accounting or tax filing mistake. This can result in heavy additional tax (重加算税), which is substantially more serious than the additional tax generally imposed for an ordinary underreporting.
However, a simple accounting mistake and intentional concealment are not the same thing. In practice, this distinction can become an important issue during a Japanese tax audit.
In this article, I explain what acts of disguise and concealment mean, what can happen if the tax authorities make such a determination, and what taxpayers should consider if they disagree with it.
1. What Are Acts of Disguise and Concealment in a Japanese Tax Audit?
If a taxpayer intentionally conceals sales, records fictitious purchases or outsourcing expenses, or otherwise creates a false appearance to reduce taxable income, the tax authorities may regard the conduct as acts of disguise or concealment (仮装・隠蔽).
This is different from simply making a mistake in bookkeeping or a tax return.
The distinction is important because a finding of disguise or concealment can result in heavy additional tax (重加算税), rather than the additional tax generally imposed for ordinary underreporting.
2. What Happens If Disguise or Concealment Is Found?
The consequences are more serious than those of an ordinary tax filing error.
Heavy additional tax (重加算税) may generally be imposed at a rate of 35% in place of the additional tax for underreporting, or 40% in cases involving failure to file, depending on the circumstances. Higher rates may apply in certain repeated cases.
A finding of intentional disguise or concealment may also affect how the tax authorities view the taxpayer in future tax administration. In practice, a history of serious non-compliance can be relevant when the tax office assesses future tax audit risk.
This is why the distinction between an intentional act and a genuine mistake can be extremely important during a tax audit in Japan.
3. What If the Tax Officer Claims That You Concealed Income?
During a tax audit, there can be disagreement over whether an error was simply a mistake or an intentional act of disguise or concealment.
For example, unrecorded sales or missing purchase documents do not automatically mean that the taxpayer intentionally concealed income. The facts and circumstances behind the error matter.
If you genuinely believe that an error was unintentional, you should clearly explain how and why the mistake occurred and provide any documents or other evidence that support your explanation.
You do not need to agree with the tax officer simply because the officer takes a different view. If the distinction affects whether heavy additional tax applies, it is important to explain your position clearly and consistently.
4. Who Has the Burden of Proof for Disguise and Concealment?
The tax authorities bear the burden of establishing the facts necessary to impose heavy additional tax based on disguise or concealment.
Therefore, if you disagree with a tax officer’s assertion that your conduct constituted disguise or concealment, you do not have to accept that characterization simply because it was raised during the audit.
In practice, the facts surrounding the transaction, the taxpayer’s explanation, accounting records, emails, contracts, and other documents can become important in determining whether the conduct was intentional.
If you believe the tax officer’s conclusion is incorrect, it is important to distinguish clearly between what actually happened and what the officer is inferring from the circumstances.
5. FAQ: Heavy Additional Tax in Japanese Tax Audits
Does an accounting mistake automatically result in heavy additional tax?
No. An accounting or tax filing error does not automatically constitute disguise or concealment. Whether heavy additional tax applies depends on the facts and circumstances, including whether there was intentional conduct to disguise or conceal the true facts.
What should I do if I discover unrecorded sales before or during a tax audit?
First, identify why the sales were not recorded and preserve the documents that explain what happened. The existence of unrecorded sales and the question of whether they were intentionally concealed are separate issues.
Should I immediately agree to file an amended return if a tax officer proposes heavy additional tax?
You should first understand the factual and legal basis for the tax officer’s position. Filing an amended return can have important consequences, so if you disagree with the characterization of your conduct as disguise or concealment, you should consider the issue carefully before agreeing.
What documents can help show that an error was unintentional?
There is no single document that proves this in every case. Accounting records, invoices, bank records, contracts, emails, and records showing how the error occurred can all be relevant. Consistency between the taxpayer’s explanation and the available records is particularly important.
Proper record keeping is also important before a tax audit occurs. For more information, see:
Japan’s Electronic Record Keeping Law: A Practical Guide for Businesses
Is every large tax adjustment considered tax evasion?
No. The amount of an adjustment and whether the taxpayer intentionally disguised or concealed facts are different issues. A large correction does not by itself establish intentional concealment.
Related Articles on Tax Audits in Japan
If you would like to understand how a Japanese tax audit works in practice, I also recommend the following articles:
How Tax Audits Work in Japan: What Foreign Business Owners Should Expect
The Points in Tax Audits in Japan
How Often Does Japan Audit People Who Fail to File Tax Returns? Statistics and Practical Risks
What Businesses Had High Amounts of Unreported Income in Individual Income Tax Returns in Japan?
Accounting and Tax Support in Japan
Koshida Accounting and Tax Office provides accounting and tax services in Japan with English support.
We assist foreign individuals, entrepreneurs, and small business owners with accounting in Japan, tax filings, and Japanese tax audits. If you receive an inquiry or tax audit notice from the Japanese tax authorities, we can help you review the issues, prepare the necessary accounting and tax records, and communicate with the tax office.
We also provide taxation consulting in Japan for small businesses and support clients who need professional accounting and tax services in English.
Please feel free to contact us through our inquiry form.