Japan’s Tax Code and foreign currency

Most foreign companies need to include transactions with non-Yen invoice currencies in their Japanese subsidiary company or office’s financial statements and yearend tax-returns. Many don’t know, and their Japanese tax accountant might not have told them, that Japan’s Tax Code includes statutory rules governing the foreign currency exchange rates and currency conversion methodology a Japanese company must use when entering forex transactions in its financial statements.

A typical end to end transaction with an overseas supplier denominated in a foreign currency is:

1. An invoice is received denominated in a non-Yen currency, such as USD or EUR.
2. A credit entry is made in the “買掛金 Accounts payable (CoGS, etc.)” journal, converted to JPY and balanced with debit entries in the relevant expense journals.
3. Some time later, an outbound international wire transfer of Yen, converted to the foreign currency, is made to pay the foreign currency invoice.
4. The JPY amount paid, excluding bank fees, is entered as a credit entry in the relevant “当座預金 Current account”, “普通預金 Savings”, or other cash journal.
5. The bank’s international wire transfer fees are entered as a debit in the “支払手数料 Payment fees” expense journal.
6. The original credit entry in the “買掛金 Accounts payable (CoGS, etc.)” journal is reversed with a debit entry of the same amount.
7. If the amount of Yen converted to the foreign currency at payment (as entered as a credit entry in the relevant “当座預金 Current account”, “普通預金 Savings”, or other cash journal) was less or more than the amount calculated for the original credit in the “買掛金 Accounts payable (CoGS, etc.)” journal, a foreign exchange gain or loss entry is made in the “雑収入 Miscellaneous income” journal or the “雑損失 Miscellaneous losses” journal to balance the general ledger.

The above creates obvious potential for exchange rate manipulation to decrease a Japanese company’s taxable income, which is why Japan’s Tax Code states very clear rules to ensure Japanese companies don’t randomly pick currency conversion rates or currency exchange methodologies intended to increase expenses or reduce income.

Article 61-8, Paragraph 1, “Conversion of Foreign Currency Transactions” of Japan’s Tax Code describes specific rules for converting foreign currency transactions to Yen:

1. The TTM (telegraphic transfer midrate) rule, in which all foreign currency conversions, whether involving buying or selling Yen, are made using a TTM rate.
2. The TTB / TTS (telegraphic transfer buy / telegraphic transfer sell) rule, in which all expenses are converted using a TTS rate and income converted using a TTB rate.

If a Japanese company uses -1- above, it must use it for all foreign currency conversions in that and future financial years. Similarly, if a company uses -2- above, it must use it for all such conversions in that and future financial years. This prevents a Japanese company from “exchange rate shopping” to artificially increase foreign denominated expenses or decrease foreign denominated income.

Article 61-8, Paragraph 1, “Conversion of Foreign Currency Transactions” of Japan’s Tax Code also specifies strict rules for determining the TTM, TTB, and TTS rates:

1. The rates should be those published by the Japan company’s main bank.
2. The rates must be one of:
   1. The closing TTM, TTB, or TTS rates on the transaction date (for accruals the date the invoice was issued, for payment the date payment occurred). If there was no market on the transaction date (such as on weekends and Japanese national holidays) the previous business day’s TTM, TTB, and TTS closing rates are used).
   2. The TTM, TTB, and TTS closing rates on the last day of the month or week immediately preceding the month or week within which the transaction date falls.
   3. The TTM, TTB, and TTS closing rates on the first day of the month or week within which the transaction date falls.
   4. The average TTM, TTB, and TTS closing rates for the week or month immediately preceding that in which the transaction date falls.

   As with the decision to use TTM or TTB/TTS rates, the rule for determining the TTM, TTB, and TTS closing rates must be consistent for all currency conversions.

As with most matters related to yearend accounting for your company’s Japanese subsidiary company or office, while following the above rules can’t guarantee avoiding a National Tax Agency audit, it will at least minimize the risk.