“Necessary Expenses” (in Japanese ‘必要経費’ or ‘hitsuyou keihi’) are deductible for Japanese individual income tax purposes when calculating Japanese Real Estate Income, Business Income, Forestry Income and Sundry Income (in Japanese respectively ‘不動産所得’ or ‘fudousan shotoku’; ‘事業所得’ or ‘jigyou shotoku’; ‘山林所得’ or ‘shinrin shotoku’ and lastly ‘雑所得’ or ‘zasshotoku’).
This article examines the concept of Necessary Expenses with a focus on real estate. In addition to the general definition of Necessary Expenses it includes a list of items that are subject to statutory exclusion from being treated as Necessary Expenses and hence which are not tax deductible. Please see here for other articles on individual taxation including real estate tax.
Necessary Expenses – special cases
There are a number of different issues besides straightforward expense deduction to consider when looking at Necessary Expenses for Japanese individual tax purposes.
Such issues include the recognition of tax deductible statutory reserves, Necessary Expenses when ceasing a business and other special cases such as depreciation, transactions treated as non deductible capital rather than expenses, deductibility of losses on assets and similar. These will be looked at in future articles in more detail.
Basic definition of Necessary Expenses
Necessary Expenses deductible for Japanese income tax purposes against real estate income are defined in the Japanese Income Tax Law Article 37-1.
For reference the key parts of article 37 as they related to Real Estate Income are reproduced below in Japanese followed by their English translation.
“…Article 37 Necessary Expenses are, excluding items that are regulated separately, in relation to the calculation of the amount of Real Estate Income, Business Income or Sundry Income for the year, the costs of sales relating to the revenue for each class of income or other expenses needed directly in order to secure the amounts of revenue concerned and the selling expenses, general management expenses or other expenses of activity required in order to give rise to the income (with the exception of depreciation expenses, excluding amounts for a year where the obligation is not yet decided)…”
Prohibition on the deduction of accrued Necessary Expenses
The phrase in article 37 above “…excluding amounts for a year where the obligation is not yet decided….” (in Japanese “…その年において債務の確定しないものを除く…” effectively denies a deduction in the year concerned for amounts that are accrued for that year for accounting purposes but where the date on which the liability was determined did not fall in the year concerned.
For example, if a property manager worked on a property in the month of December but did not issue his invoice for the work concerned until January and his fees were not due until invoiced, his charges for December would not be deductible in that year even though an accrual for the expenses would be requird under normal accounting principles.
The same phrase in article 37 also prohibits the disallowance of reserves other than those specifically allowable under a separate provision of the Japanese tax code. Any such reserves would ultimately be deductible in the period which included the time the reserved liability finally became due.
Amounts not included in Necessary Expenses
As implied by the wording of article 37 above, a number of expenses are subject to separate regulation outside the rules of the article. Such other regulations include the allowance of certain special deductions for items such as bad debt reserves, retirement expense reserves, reserves for returned goods and similar.
Below is a brief list of some items that are specifically excluded from being treated as Necessary Expenses. Advice should always be taken from a qualified Japanese tax accountant when assessing whether or not an item is a tax deductible Necessary Expense.
Items that are specifically not deductible include the following:
Expenses related to household expenses, other than the following items
Where the main part of expenses related to a household are required for the execution of the activities giving rise to Real Estate Income, Business Income, Forestry Income or Sundry Income and when the amount that is necessary can clearly be distinguished [from other household expenses] then the corresponding expense amount.
For a person who has received consent to be a “blue form tax filer” then in addition to the amounts under (1) above amounts that are clearly required for activities giving rise to Real Estate Income, Business Income, Forestry Income or Sundry Income when based on a recording of the transactions concerned [note – the maintenance of appropriate accounting records in which such recordation would be made is a requirement for approval of “blue form” filing status.]
Interest on national taxes (in Japanese ‘利子税’ or ‘rishizei’, except to the extent that the interest concerned is attributable to the payment of taxes on the Real Estate Income, Business Income, Forestry Income or Sundry Income of the taxpayer), national late payment interest, penalties for under declaration of income and penalties on stamp duty payments (in Japanese’延滞税’ or ‘entaizei’ and ‘加算税’ or ‘kasanzei’ as they relate to national taxes and ‘過怠税’, a penalty paid for late stamp duty payments).
Individual local inhabitants taxes (in Japanese ‘都道府県民税’ and ‘市区町村民税’ or ‘todoudukenminzei’ and ‘shikuchousonminzei’)
Late tax payment interest, under tax declaration penalties, no tax filing penalties and heavy tax penalties relating to local taxes. (in Japanese ‘延滞税’ or ‘entaizei’; ‘過少申告加算金’ or ‘kashou shinkoku kasankin’; ‘不申告加算金’ or ‘fushinkoku kasankin’ and ‘重加算金’ or ‘heavy tax penalty’)
Fines, criminal penalties, administrative fines – including amounts overseas corresponding to the same ( in Japanese ‘罰金’, 科料’ 過料’ or ‘bakkin’, ‘karyou’ and ‘karyou’ respectively)
Compensation monies (or similar amounts) to the extent that they infringed the rights of other persons either intentionally or through gross negligence.
Payments or late fines in relation to certain ‘Emergency Measures to Maintain Citizen’s Life’ (in Japanese the ‘国民生活安定緊急措置法’ or ‘kokumin seikatsu antei kinkyuu sochi hou’).
Surcharges or late payments based on the laws concerning ‘Fair Transactions or Prohibition of Private Monopolies’, including amounts resembling these assessed overseas (in Japanese payments made under the ‘私的独占の禁止及び公正取引の確保に関する法律’ or ‘shiteki dokosen kinshi oyobi kousei torihiki no kakuho ni kansuru houritsu’).
Surcharges or late payments further to the ‘Financial Transactions and Products Law’ (in Japanese the ‘金融商品取引法’ or ‘kinyuu shouhin torihiki hou’).
The payment of bribes subject penalties or the provision of monies identified under article 18 of the Law Preventing Unfair Competition (in Japanese ‘不正競争防止法第１８条’or ‘fusei kyousou boushi hou dai 18 jou’).
Foreign taxes to the extent that an election has been made to claim a foreign tax credit.
Salaries (except to the extent allowed for a ‘blue form’ tax return filer), lease payments, interest on loans paid to family members who are dependents of the person carrying on the business that gives rise to Real Estate Income, Business Income or Forestry Income.
Specified loss arising to a person who is a member of certain defined partnerships and similar based on defined limited liability partnership contracts.
Comparison to corporate tax
Although not applicable to individual tax, readers may wish to refer to these articles on blue form tax filing, on Japanese tax interest and penalties and on the restriction of losses on certain nin’i kumiai partnerships to see how similar matters are addressed in a Japanese corporate tax context.