Japan: Latest Japanese Supreme Court judgment on input JCT credit for purchase of residential apartments for future resale

Under the partial JCT recovery method (also known as the itemised method), the Japanese consumption tax (JCT) paid on taxable purchases is recoverable as follows: (i) fully recoverable on purchases linked only to the purchaser's taxable transactions; (ii) not recoverable on purchases linked only to transactions other than taxable transactions; and (iii) partially recoverable on purchases linked to both taxable transactions and non-taxable transactions – in proportion to the taxable sales.

In this case, a real estate broker purchased residential apartments with tenants in situ and recovered JCT fully on such purchase because the apartments were purchased for future resale, which is a taxable transaction. Such treatment has been commonly seen and accepted in practice for a long time; however, the tax authorities have disallowed the "full" input JCT credit since 2005 on the grounds that the apartments are also leased for residential use, which is a non-taxable transaction, even if the leasing is inevitable before the resale and is not the broker's main business.

The Court took a strict interpretation of the concept "linked only to the taxable transactions" for a "full" input JCT recovery and accepted the tax authority's assessment regardless of the past practice.

Key takeaway

The amendment to the JCT Act in April 2020 clarified the conditions under which input JCT credit may be reclaimed on the acquisition of buildings; therefore, the issue on the recovery of input JCT on residential apartments became less disputed.

However, because the Court interpreted the concept "linked only to the taxable transaction" quite narrowly this time, taxpayers should be careful when recovering input JCT in full going forward.