CFO Insights 2021 November

Due to recent events, the need for companies to go digital has increased dramatically. In response, the 2021 Japan tax reform included a number of items intended to promote digitalization and help companies ease the transition from their current working environments. One such item included in the tax reform package was certain fundamental revisions to the Electronic Record Retention Law (“ERRL”) and the preservation of transaction information sent/received electronically. Under the current document preservation rules, preservation in hard copy format is permitted as an alternative to preserving transaction data electronically. However, hard copy preservation will now be abolished for certain documents beginning 1 January 2022.

For many countries where electronic document storage is and has been the norm, rule changes requiring companies to store certain documents electronically may seem unusual. As such, it may be beneficial to first give a brief overview of the existing rules to provide more context for the changes and help companies better understand what is changing and why it is important to take the necessary steps to ensure compliance with the new rules.

Overview of Japan’s current record retention rules

Unlike many countries, documents in Japan must generally be stored in hard copy and retained for at least 10 years under the current record retention rules, unless the taxpayer meets certain conditions to store documents electronically.

In particular, electronically stored documents are required to meet certain authenticity requirements (e.g., timestamps, retaining revision/deletion history, preparing manuals, etc.) and certain visibility requirements (e.g., ensuring readability, meeting specified search function criteria, etc.). Additionally, except for electronic transaction records (i.e., transaction information such as purchase orders, invoices, etc. exchanged electronically), the taxpayer is required to submit an application to the local tax office and receive prior approval before it can begin storing documents electronically. As for electronic transaction records, approval is not required, but a company must satisfy certain prescribed conditions under the ERRL.

Storing documents electronically without complying with the requirements mentioned above may result in certain documents not being treated as sufficient for national tax purposes. In addition, failure to comply could also result in the taxpayer potentially losing blue form taxpayer status, which would cause the taxpayer to lose certain benefits such as the ability to carryforward net operating losses.
 

Changes to the existing rules under 2021 tax reform

As shown above, Japan’s existing electronic document storage rules were fairly complex and burdensome, requiring taxpayers to complete several steps before they could take advantage of electronic storage. As a result, the Japanese government, in an effort to promote digitalization and keep Japan’s rules competitive on a global scale, introduced extensive reform measures to its document storage rules as part of its 2021 tax reform package.

In particular, taxpayers no longer need to apply and receive approval from the tax office to begin storing documents electronically. Additionally, certain requirements related to the search function, authenticity, and timestamping were eased to encourage taxpayers to take advantage of the system.

However, the biggest change came in the form of taxpayers being no longer able to store certain electronic transaction records in hard copy starting 1 January 2022. After that date, all electronic transaction records must be stored electronically. Failure to do so may result in the revocation of approval for tax consolidation and/or blue form tax taxpayer status and may also result in certain documents not being treated as sufficient for national tax purposes.

Benefits of electronic storage

As mentioned above, storing documents electronically is commonplace in many jurisdictions, but for many companies in Japan, hard copy storage of documents is still the norm. Such companies still implementing hard copy storage systems, will be required to switch to digital storage for electronic transaction records beginning 1 January 2022 to avoid the potential ramifications discussed above. However, there may be additional benefits to switching to digital storage as well.

Electronic storage may allow companies to reduce costs, as well as risks and administrative burden. The table below demonstrates some of the benefits of maintaining documents electronically, including reducing tax costs/risk and the ability to support teleworking, which has become a necessity in the current pandemic environment.