When you operate a business in Japan, which is better, corporate or sole proprietor from the point of view of taxation

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Tax for company and individual in Japan

When you start business in Japan, you will deliberate whether to manage your business by company or sole proprietor (Kojin Jigyo).

So, in this page I will compare these situation from the point of view of taxation.

I will take up this family as sample.
Mr Husband
Ms wife
Their child Mr child :  16 years old.
Their child Ms child :  17 years old.
Annual Sales amount of his business is 30,000,000 yen
Expense 22,000,000 yen (other than salary )
Mr Husband is a lawyer in Japan.

When Mr Husband’s business is going well, he  will consider whether to incorporate or not.
Because he knows the huge merit of managing business under the name of company, especially as for taxation.

As for employment income deduction (Kyuyo shotoku kojo 給与所得控除)

Income tax(tax for individual) or corporation tax (tax for company ) is calculated as below.

1 )Sales  -  Expense = Profit

2) Profit  × Tax rate =   Tax amount

In the case of corporate,  Mr Husband is presumed to be a representative director.

In the case of sole proprietor (Kojin jigyo), in order to make sales, he spends money to  advertise his business, rent his office . The amount is assumed to be 22,000,000 yen. So, his profit is 8,000,000 yen.

30 million yen – 22 million yen = 8 million yen (profit before salary)

In the case he incorporates a company and he receives salary from his company, the amount of his salary is assumed to be 8,000,000 yen. He spends some money to buy suits, shoes, learn necessary knowledge.
In the case of salaried employee (Kyuyo shotoku sha 給与所得者), he can not deduct this actual expense from his profit of 8,000,000 yen. But, certain rate is enacted in law to presume his expense to calculate his income tax.
This is termed ” Kyuyo shotoku kojo = 給与所得控除 “.

(https://www.nta.go.jp/taxanswer/shotoku/1410.htm website of national tax agency )
employment income deduction

In the case of 8,000,000 yen, employment income deduction (again, you can not use employment income deduction) will be

8,000,000 yen × 10%+1,200,000 yen = 2,000,000 yen (employment income deduction).

Now, I calculate tax amount of both cases.
Assumed Mr Husband incorporates a company and he receives all profit  from his company as salary, the amount of his salary is 8,000,000 yen.
So, profit of his company is 0 yen.

And his taxable income is 8,000,000 yen –  2,000,000 yen (employment income deduction) = 6,000,000 yen (his taxable income if he has a company).

Thus, by incorporating a company, he can reduce 2,000,000 yen from his taxable income ( 課税所得=-kazei shotoku)


When his taxable income ( without incorporation of company) is 8,000,000 yen, his income tax is

8,000,000 yen × 23% – 636,000 yen = 1,204,000 yen (income tax without a company).
(In the case of sole proprietor, there is not employment income deduction )

When he incorporates a company, his salary is 8,000,000 yen.

( 8,000,000 yen – 2,000,000 yen ) × 20% – 427,500 yen(deduction. please refer to below table) =772,500 yen (income tax in the case he incorporates a company)
——-  ①

1,204,000 yen (income tax in the case he does not incorporate a company)- 772,500 yen (income tax in the case he incorporates a company)= 431,500 yen (So, by incorporating a company of his law firm, he can reduce tax amount of 431,500 yen).

( Tax rate differs depending on taxable income. When the amount of taxable income becomes higher, tax rate becomes higher. ( Progressive taxation. )
( It is termed “Ruishin kazei seido =  累進課税制度 “)

You can find income tax rate at below table. “税率” means tax rate.

Please refer to website of National tax agency  https://www.nta.go.jp/taxanswer/shotoku/2260.htm)

rate of income tax

.

Regarding break up of taxable income

As I wrote above, when the amount of taxable income becomes higher, tax rate becomes higher ( Progressive taxation = Ruishin kazei= 累進課税).

So, it is better to receive 8,000,000 of salary by several persons than by one person.
For example, if Mr Husband ( president of company ) receives salary  of 8,000,000 yen, his income tax is 772,500 yen. ——————-  ①

But,  when Mr Husband is director and Ms Wife is employee of the company, and they receive salary of 4,000,000 yen each.

Mr Husband’s income tax is
( 4,000,000 – 1,340,000(employment income deduction) ) × 10% – 97,500 yen(deduction ) = 168,500 yen.

Ms Wife’s income tax is
( 4,000,000 – 1,340,000 (employment income deduction) ) × 10% – 97,500 yen(deduction ) = 168,500 yen.

168,500 yen × 2 persons = 337,000 yen.

772,500 yen – 337,000 yen = 435,500 yen.

So, by breaking up the income, this household can reduce  amount tax by 435,500 yen.

And compared with sole proprietor,  this household can reduce  tax of 867,000 yen per a year.

( In the case of sole proprietor, Mr Husband can pay salary to Ms Wife and can reduce taxable income. But, there is limit of Mr Wife’s salary.  )

Deduction from Income

Income tax (所得税,shotoku zei), resident’s tax is not calculated by profit × tax rate.

Before you multiply by tax rate, you can deduct some amount from your profit.

This amount is called Deduction from Income ( 所得控除,shotoku kojo ).

There are some kind of Deduction from Income.  When Mr Husband sustains his wife, 2 children, Mr Husband can use spousal deduction and dependents deduction.

These amount is in general 380,000 yen each. So, when Mr husband’s salary is 8,000,000 yen, income tax is
( 8,000,000 yen – 2,000,000 yen – 380,000 yen – 380,000 yen – 380,000 yen  ) × 20% – 427,500 yen(deduction ) = 544,500 yen.

Amount of dependents deduction

Amount of dependents deduction

 (https://www.nta.go.jp/taxanswer/shotoku/1180.htm Quoted from Japan National Tax agency = Kokuzei cho = 国税庁)

So, Mr Husband can apply spousal deduction and dependents deduction for 2 children, he can reduce tax amount.
(380,000 yen  + 380,000 yen + 380,000 yen  ) × 20%  = 228,000 yen.

If Mr Husband of sole proprietor pays salary for his wife and his children, he can not use spousal deduction and dependents deduction for 2 children.

But, in the case of incorporate, you can use this method.  When Mr Husband  pays salary to his wife and 2 children (Of course, his wife and 2 children have to work for the company actually in some ways. )

As long as the amount of wife’s and children’s salary each is below 1,030,000 yen per a year, Mr Husband can apply spousal deduction and dependents deduction.

Deduction for Retirement Income

When you resign from the company and receive money as retirement allowance (Taishoku kin 退職金), you can adopt “Deduction for Retirement Income”.
For example, when Mr. husband receives salary of 20,000,000 yen, income tax will be
20,000,000 yen - 2,450,000 yen (Deduction from Income) - 380,000 yen (spousal deduction) yen – 380,000 yen ( dependents deduction ) – 380,000 yen ( dependents deduction ) × 40% – 2,796,000 yen = 3,768,000 yen.

On the other hand when Mr. husband has worked at the company for 25 years and received retirement allowance of 20,000,000 yen, the amount of deduction for retirement income will be

8 million yen + 700,000 yen × ( 25 -20 )= 8 million yen + 3,500,000 yen = 11,500,000 yen. 😆

deduction for retirement income
(https://www.nta.go.jp/taxanswer/shotoku/1420.htm   National tax agency )

So, the amount of income tax will be
= ( 20,000,000 yen  -  11,500,000 yen ) ×1/2 = 4,250,000 yen.
4,250,000 yen ×20%-427,500 yen = 422,500 yen. 😆 

So, the difference between the amount of income tax of salary and retirement income is
3,768,000 yen – 422,500 yen = 3,345,500 yen. 🙂 

But, in the case of sole proprietor, Mr. Husband can not apply deduction for retirement income. Because, it is not admitted that Mr. Husband pays retirement allowance to himself. And Mr. Husband can not apply deduction for retirement income for his wife and children even if he pays money ( wages for family employees of blue return taxpayer ) for them.

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