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Part III. Consumption Tax

1) Present Situations and Problems of Consumption Tax - for the formation of stable main tax -
    Consumption tax was introduced in 1988. Since then, revenues from consumption tax have continued to be stable, accounting for some 20% of national revenues. Thus, consumption tax has been fixed into the taxation system as one of the main taxes in Japan. Meanwhile, some people have an abiding distrust of the current tax system. Consumption tax is expected to play a greater role along with the advancement of falling birthrate, aging population, and globalization. Thus, it is urgent to gain trust in the consumption tax system and to revise the tax rate. It is often pointed out that consumption tax imposes regressive tax burden. This problem must be discussed and judged not only within the consumption tax system but also from the standpoints of the overall economy, including the tax system and the government's expenditures.
2) Directions of Reforms in the Future
(1) Basic policies - the need to gain trust in the tax from general public and to enhance the roles of consumption tax -
    Consumption tax plays a quite important role in a society with a falling birthrate and aging population. Consumption tax is neutral to economic activities and does not ask excessive burden on working generations. In addition, the consumption tax system contributes to ensuring fairness among different generations, promoting a vital socioeconomy, and ensuring stable tax revenues.
    Since growing social security expenditures and financial structure reforms are anticipated, the rate of consumption tax needs to be raised and its roles need to be enhanced. To theses ends, thorough administrative reforms must be continued. Moreover, a number of measures must be taken in order to gain people's trust in the consumption tax system and review the taxation into a highly transparent and fair tax system.
    From the standpoints mentioned above, the revision will be made on special treatment and the number of filing and tax payment times for the SMEs (small and medium size businesses). In addition, concerted efforts should be made to avoid delinquency of consumption tax payment and efforts should be made to collect the unpaid consumption tax. The competent administrative authorities should also urge vendors/suppliers to adopt total price indication system (including of tax and price of goods and services) for convenience of consumers.
(2) Reforms for Improved Reliability and Transparency - Fundamental review of preferential treatments for SMEs -
a. Preferential Systems for Small- and Medium-Businesses
    Preferential systems for small- and medium-business operators have been instituted in order to simplify and relieve their clerical burden. Nearly 13 years have passed since the systems were introduced. In order to gain people's trust in the tax system and improve the transparency of the tax system, urgent and thorough efforts should be exerted for the examination and revision of the preferential systems.
A. Tax Exempt Threshold
    Tax-exempt threshold for consumption tax (the amount of taxable sale must be ?30 million or less) has been left unchanged since the preferential system was introduced. At present, more than 60% of business operators fall into exempt enterprises. This has raised the suspicion of many consumers that the amount equivalent to the consumption tax paid by consumers may not be paid to the national treasury. This seems one of the major factors that many consumers distrust consumption tax.
    Therefore, the present level tax exemption threshold should be scaled down drastically in consideration of different clerical capacities of individual business operators and corporations.
    Under the present tax exemption threshold system, since many exempt enterprises have transactions with other business operators, credit for consumption tax amount on input from exempt enterprises has been granted. As a result, transparency of the consumption tax system is damaged. Therefore, the tax exemption limit system for business operators should be scaled down drastically to cover this damage before examining the introduction of an invoice system, which is described later in this report.
B. Simplified Tax System of Consumption Tax
    The simplified tax system (translator's note: Vendors/suppliers with taxable sales of less than Y200 million during the base period can elect to use ''deemed input ratios'' designated in accordance to the types of businesses) has been revised in the past, and its application has been on the decrease. However, the consumption tax system has taken root in society. Business operators seem to have become familiar with tax payment deskwork. It is also pointed out that in order to pay less tax, an increasing number of small- and medium-business operators with deskwork capability have been applying for the simplified tax system after calculating the amount of their tax that they are supposed to pay. Therefore, the simplified tax system should be revised drastically, including the discontinuance.
b. Self-Assessment and Payment System
    Considering that the characteristics of the consumption tax are similar to that of deposit by consumers, the frequency of the consumption tax self-assessment and payment system has been revised in the past in order to solve the problem that consumption tax paid to business operators is used for their fund operations. When considering this characteristic of consumption tax, the number of self-assessment and payment times should be increased. When the number of self-assessment and payment times are examined, clerical burden of taxpayers, tax administration cost and delayed payment of consumption tax must also be taken into consideration.
c. Total Price Indication System (method of displaying prices for consumers)
    More positive efforts should be made to discuss displaying the total price, including consumption tax, of commodities for the convenience of consumers (total price indication system). As is seen in many European nations, the total price indication system should be promoted by relevant government agencies in consumer protection administration as soon as possible.
d. Invoice System
    Adoption of an ''invoice system'' will become a subject for examination in order to improve taxpayers' trust in the consumption tax system. The invoice system requires that business operators should keep copies of (tax) invoice for crediting consumption tax on input. However, the (ordinary) bill keeping system under the present consumption tax system has no particular problem in crediting appropriate amount of input tax under the single tax rate and the narrow nontaxable scope. In the future when multiple tax rates are introduced, adoption of the (tax) invoice system should be examined more specifically, including the scope of reduced tax rates.
(3) Tax Rate Structure of the Consumption Tax
    A single tax rate is most desirable for consumption tax from the standpoints of simplified taxation and neutral position to economic activities. If the consumption tax rate should be raised to a double-digit percentage in the future in Japan as in European countries, consumption tax on foods etc., should be lowered in order to relieve regressive characteristics of consumption tax burden on income. In this case, however, the scope where such lowered consumption tax is applicable should be limited to minimum by considering socioeconomic costs, including clerical burden of vendors/suppliers concerned.
    Expansion of the scope of exempt transactions and adoption of zero-rating are not desirable because these measures will severely spoil the characteristic of consumption tax that consumption should bear fair tax as broad as possible.
(4) Local Consumption Tax
    Local consumption tax was legislated by tax reform for FY 1994 and has been enforced since FY 1997 mainly for the purposes of promoting decentralization and upgrading local welfare. Revenue from local consumption tax is less maldistributed among local government through clearing and now plays an important role as a stable main local tax. Along with falling birthrate and aging population, local consumption tax will have to play a greater role to serve welfare, education, and other social needs in local administration. Thus, local consumption tax must be upgraded and consolidated in the future.

Part IV. Property Taxation and other taxation

1) Inheritance Tax and Gift Tax
(1) Basic Policies for Reform - Meeting structural changes of socioeconomy and appropriate tax burden -
    Conditions surrounding inheritance tax have been changing greatly due to the following factors:

    Under this circumstance, contribution of a broader scope of appropriate burden to the society would be required.
    In such a case, on the one hand, the maximum tax rate must be lowered from the standpoint of appropriate tax burden; on the other hand, the degree of present progressive tax rates structure should be kept.
    Japan's gift tax is based on single calendar year taxation. Gift tax burden is set to relatively higher level from the standpoint of preventing potential inheritors from avoiding inheritance tax payment. Transfer of assets to inheritors through inheritance tends to take place in their latter part of life because of the long-living ancestor. Therefore, ensuring the neutrality of taxation effect on the timing of asset transfer is becoming important.
    If assets owned by ancestors (financial assets and real assets including houses) are transferred to their inheritors at the time earlier than the actual death of the ancestors, the transferred assets may be used more usefully by younger generations and thus, it is hoped to contribute to vitalization of the socioeconomy. From these standpoints, how to adjust inheritance tax and gift tax (smooth transfer of assets from parents to their children while they are living) should be examined.
    Special treatment related to succession of business contributes to smooth inheritance of SMEs. However, excessive incentives for business inheritance after succession could lose the balance with new formations of the business and new business deployment. Thus, special measures on business inheritance should be carefully examined.
    In this case, since the period that an inheritor works with the ancestor for the business tends to become quite long, it is important to promote smooth transfer of business during life and to consider the inheritor's contribution to the formation of the ancestor's assets.
(2) Directions of Inheritance Tax Reform
a. Tax Base
    Basic exemption should be lowered from the standpoint of Basic Policies for reform (above) and plunged land prices. In the adjustment of inheritance tax and gift tax, relation with basic exemption for gift tax should be reexamined for revision.
    Non-taxation measure for death benefit (of life insurance) and retirement deduction at death should be scaled down or discontinued by taking the improved public social security system into consideration from the standpoints of simplified taxation and keeping neutral to asset selection.
    Special treatments related to business succession, including the special treatment for small-scale houses, should be examined by taking dropping of land prices for a long period into consideration. The examination should include possible reorganization of the present special treatments into a special treatment for entire business assets in the future.
b. Tax Rate Structure
    The maximum tax rate of inheritance tax (50%) is much higher than that of income tax. It is considerably high compared with maximum tax rates of other countries too. Thus, it is appropriate to lower the maximum tax rate of inheritance tax.
    However, the degree of present progressive taxation should be maintained by considering ''Basic Policies for reform'' and considerable relief of burden of rich asset holders due to the lowering maximum tax rate on inheritance tax.
    Tax rate brackets should be gradual, depending on the amount of inheritance, since sharp changes in tax rates are inappropriate because inheritance is extraordinary and accidental.
(3) Directions of Gift Tax in the Future
a. Integration of Inheritance Tax and Gift Tax (move from gift taxation on annual gifts to gift taxation on accumulated gift basis)
    In the advancement of the aging society, social request for gift during life has been deep-seated. From this standpoint, possible integration of gift tax with inheritance tax should be examined, including accumulative taxation (see the appendix).
    Methods for accumulative taxation are mainly divided into lifetime accumulative taxation and fixed period accumulative taxation. In the both methods, the taxpayer and tax administration are need to keep record of assets concerned for long time. Therefore, in order to ensure appropriate enforcement, if taxation of gifts on accumulative basis is to be introduced, tax compliance measures to record, identify, match information for a long time of period need to be introduced. This will include introduction of automated/computerized systems in tax administration, examination of shift of burden of proof and the extension of period of limitation of tax audit, and introduction of TINs.
    Until the above-mentioned management systems are prepared, neither types accumulative taxations can be enforced comprehensively. Due consideration should be given to the degree of need for allowing gift from parents to their children while they are living, and the situation of assets by the Japanese people, and the possible mechanisms for the accumulative taxations must be examined. Along with further discussion for this, introduction of a preliminary measure for gift tax should be examined from the standpoint of respecting the position of keeping neutral to choosing the time of asset transfer to the next generation.
    In examining the possible integration of inheritance tax and gift tax and the preliminary measure, sufficient compliance measures should be taken to eliminate the possibilities that rich asset holders may be triggered to plan tax avoidance and that taxation administration may omit proper taxation due to difficulties in taxation execution because managing gifted assets will last for a long period of time.
b. Treatment of Gift to a Third Party
    Tax treatment of gift to a third party who is not a legal inheritor is also being discussed. In this case, the gift could be treated as income of the third party by examining the real condition of the gift. Such income taxation will contribute to preventing inheritance tax avoidance.
2) Property Tax (local tax)
(1) Present Situations and Challenges of Property Tax
    Taxable bases of property tax are fixed property (immovable property) and equipment which exist in any municipalities. Since the allocation of tax basis of property tax is less impartial, it is an appropriate main tax for local municipalities. Thus, revenues from this tax must be stabilized.
(2) Directions of Reform in the Future
    It is appropriate that the assessment standard that aims at 70% of public announcement prices of land is maintained from the standpoints of nationwide assessment equation and appropriateness.
    Equalization of burden levels has been making progress since FY 1997 to some extent although a lot of unleveled areas are still found in many parts of the country. Thus, additional measures to promote equalization and appropriateness of burden level must be taken by observing trends in revision of assessments, situation of burden levels, and fiscal conditions of local governments.
3) Taxation of Land and Housing
    The land tax system has been revised according to changes in land prices. Most of the taxation measures strengthened and introduced in the bubble economy period were discontinued or abolished and returned to the level before the bubbled economy.
    At present, land prices are bi-polarized and individualized. Thus, land prices must be analyzed not only from the standpoint of adjustment period after the bubble economy but also from the standpoints of trends in local economies and changes of industrial structure. Under the structural changes, the entire land policies are required for revision, including the positioning of the basic policy of the Basic Law of Land.
    In line with the revision of land policies, the land tax system needs examination by considering changes in land prices and the fact that the taxation base for the income of land transfer has been eroded greatly.
    From special policy purpose, various tax reduction measures have been instituted for an owner-occupied home at the levels of acquiring, holding and transferring of the home. However, the rate of owner occupied house has reached a certain high level. With advancement of falling birthrate and aging population, demand for homes is expected to decease. On the other hand, demand for leased houses and changing homes will increase. Thus, housing policies centering on promoting acquisition of one's own homes must be re-examined. Under these changing circumstances, tax reduction measures, such as deduction for home loans, should be re-examined.
4) Taxation of Financial Assets
    Taxation at income from financial assets will come to play a greater role in the future. This is because earned income is expected to decrease relatively while the stock economy (progressively increasing financial assets) and aging population continue to grow and the birthrate continues to fall. In the meantime the shift from deposit savings to investment by the households are being promoted.
    Under the circumstances mentioned above, the current financial tax system should be reexamined in aiming to ensure the neutral position among financial products, to keep fair taxation at income in other than financial areas, and to promote simplified taxation. In line with the examination, due attention should be paid to the characteristics of diverse and complicated financial assets, globalization and computerization of the financial market, geographically mobile nature of the asset, and relations of taxation at entities (collective investment schemes). In this case, the taxpayer identification number system and other income measures for monitoring income should also be discussed for consolidation.
    In addition, the idea of ''dual income tax'' and the unification of tax on financial assets should be examined in considering relations to transferring to comprehensive income taxation and the balance of taxations of capital income and labor income. (see the appendix).

Part V. Others

1) Liquor Tax and Tobacco Tax
    Like many other countries, Japan has been taxing liquors and tobaccos as special articles of taste at tax rates higher than on other goods. Thus, liquor tax and tobacco tax have played an important role in the Japanese tax system. When taking the severe financial conditions of the government into consideration, appropriate tax burden levels should be continued in the future by considering their production and consumption levels of liquor and tobacco.
(1) Liquor Tax
    From the standpoints of ensuring the neutral and fair position in tax system, the present classification of liquors (10 types) should be simplified to narrow gaps of tax burdens among different types of liquors. In particular, liquors in the classifications that are inconsistent with the basic principle of the ''same burden on the same type of liquors'' should be re-classified in order to balance burdens among liquors.
(2) Tobacco Tax
    The US and many other European nations have raised tobacco tax in recent years.
    By considering the rate of tax to the retail price of tobacco, consumer trends, trends in other nations and fiscal conditions of the government, raising the tax rate of tobacco should be examined.
2) Earmarked Revenues and Energy-Related Taxes
    Gasoline excise and oil tax are earmarked for certain purposes. Earmarked revenues are used when the benefit and burden of specific public service are closely related and when the financial source of the service must be ensured. Although earmarked revenues are useful in ensuring the source of finance systematically, the mechanism could lead to an inappropriate distribution of financial resources, contributing to a congealed budget structure. Thus, the mechanism of applying earmarked revenues must be constantly examined.
    The basic mechanism of the earmarked road revenues, including their expenditures, should be examined by considering the original purpose and historical background of the system. Specifically, it should be examined whether such earmarked revenues should need to be maintained for road construction and whether the earmarked revenues have not contributed to the congealed budget system. The Tax Commission is of the opinion that the earmarked road revenues should be reexamined for revision, including re-classification into general account revenues, although some of the members of the committee are of the opinion that the revenues should be maintained as they are.
    Concerning Japan's energy-related taxes including the earmarked road revenues, the entire tax burden on automobiles is not so high in Japan seeing from international levels. Thus, lowering tax burden on automobiles is inappropriate considering social costs of automobiles and for environmental preservation. It is also pointed out that the present automobile-related tax items are too many and complicated. Discussions should be continued on an appropriate tax system relating to automobiles.
3) Response to Environmental Issues
    The Guidelines for Promoting Measures against Global Warming was reviewed in March 2002 for the purpose of attaining Japan's goals set forth in the Kyoto Protocol. This broad outline also states that ''continuous and comprehensive examinations should be made on tax, charge, and other economic methods by comparing with other methods.'' It is advisable that the government should work on environmental issues based on people's understanding and support because the issues will eventually ask people to bear financial burdens in the form of tax. In this case, the tax system should have concrete positioning in environmental policies of the national and local governments based on the Polluter-Pays Principle (PPP). In addition, relations with existing energy related taxes should be examined for revision.
4) International Taxation
    Along with the development of globalization, and computerization, tracing diverse corporate activities becomes increasingly difficult. An increasing number of corporations have been trying to reduce taxable income with intention in the form of arbitrage transactions where international differences of tax systems and their gaps are used. In international taxation, outflow of income from the nation virtually means to lose the taxation right. Therefore, the taxation system relating to activities beyond the national boundary should be revised in order to ensure Japan's taxation right on cross-border activities. In addition, enforcing appropriate international taxation must be carried out from the standpoint of keeping the fair and neutral position to domestic and cross-border economic activities.
    More specifically, in response to diverse formations of overseas-affiliated corporations in Japan, taxation at diverse business entities and Japanese branches of foreign corporations should be examined for revision. Meanwhile, in anticipation of activities of Japanese corporations beyond the national border, examinations should be continued on consolidation of foreign subsidiaries and rationalization of the foreign tax credit system. In addition, from the standpoint of ensuring appropriate tax enforcement that meets globalization, it is important to improve access to overseas information sources through exchanges of information with competent tax authorities of foreign governments based on tax treaties and other treaties with those governments. For a precondition of such access, legal systems concerned should be introduced so that the competent authorities of the Japanese government can provide information requested by a foreign government with which Japan has concluded a tax treaty (see appendix).
    Electronic commerce is global by nature and thus its problems cannot be dealt with unilaterally. Through discussions at OECD, an internationally concerted action in this area should be examined and through which, foreseeability of business should be improved and appropriate taxation should be ensured.
5) Tax autonomy of local governments
    From the standpoint of decentralization, it is desirable for local governments to try to set up their financial sources by utilizing self-determined taxation right. In this case, however, issues relating to taxpayers and base of taxation should be discussed well according to principles of taxation, including fair and neutral taxation. In other words, local governments have to face local taxpayers to implement their taxation measures at their burden and responsibility.

Part VI. Infrastructure Building to Ensure Taxpayer Trust

    In working on the reform of the entire tax systems, it is essential to gain trust of taxpayers in the tax system and tax administration in order to institute a desirable tax system. To this end, tax administration needs to arrange the environment so that taxpayers can carry out self-assessment and tax payment with no difficulty and to consolidate the tax administration system for fair and appropriate taxation. Therefore, to materialize these standpoints, following systems and measures need to be advanced:
1) Taxpayer Identification Numbers (TINs)
    Globalization, informatization, and computerization have been prevailing in worldwide economic transactions in recent years. Under this situation, the environments around the taxpayer identification number system are drastically changing. A growing number of Japanese people have also begun to think that the introduction of the system would be inevitable.
    In the past, a variety of discussions have been made on the taxpayer identification number system, including the significance of the system, concrete application of the system and privacy protection. Thus, it is urgent to start examination and formulate a concrete scheme for introduction.
2) Withholding and Year-End Adjustment of Income Tax
    Income tax is based on taxpayers' self-assessment, and their voluntary filing of returns and payment. And tax withholding and year-end adjustment are carried out on payments of tax on employment income. Since tax amount, including exemptions/deductions as special taxation measures, is adjusted at the end of the year, ordinary employment income earners need no filing an income tax return.
    Tax withholding and year-end adjustment should basically be maintained in the future in order to ensure appropriate and reliable taxation and provide the simplified and to provide taxpayers with convenient tax payment system. However, it is also important for employment income earners to file an income tax return by themselves because this will enhance the awareness of bearing common social costs. Thus, examination should be continued on promoting environments for simplified filing system (including electric filing of returns), while paying sufficient consideration to tax administration.
3) Publication of High-Paying Taxpayers
    The present public notification system exists in income tax, corporation tax and inheritance tax. It has been playing the role of checking taxpayers with the public since 1950 when introduced for the first time. The public notification system of income tax was modified into the tax amount notification system in 1983 partly for the purpose of honoring high-income taxpayers. The system has been occasionally utilized for a purpose other than the original purposes, posing a concern about possible disturbance of privacy. Meanwhile, it is undesirable that the modification of the system leads to lowered reliability of the self-assessment and payment system. Thus, discussions should be made on the existing public notification system, including introduction of an alternative system, by paying attention to the significance that high-income taxpayers should be honored by society.
4) Others