The Journal The Authority on Global Business in Japan

With the policy debate on tax progressing as a component of integrated social security reform, and against the backdrop of efforts by the Financial Services Agency (FSA) to promote customer-oriented business conduct, the American Chamber of Commerce in Japan (ACCJ) urges the Japanese government to ensure an open and transparent dialogue that provides meaningful opportunities for key stakeholders—including foreign businesses—to comment. The ACCJ’s voice on this topic is gaining traction, since the following viewpoint was published in Japanese in March by the industry publication Insurance.

The ACCJ calls on the government of Japan (GOJ) to take measures to ensure that Japan’s consumption tax regime is aligned with the best interests of Japanese consumers. The regime should also be consistent with global best practices identified by international institutions—including the Organisation for Economic Co-operation and Development (OECD), the International Monetary Fund (IMF), and the European Commission—and implemented in countries such as the United Kingdom, Germany, and South Korea.

In particular, the ACCJ calls on the GOJ to revise the consumption tax law and rela­ted regulations to ensure neutrality in the treatment of the sale of insurance products through sales agents, thereby addressing disproportionate tax accumulation.

Ensuring such neutrality and addressing tax accumulation issues would provide consumers significant savings and greater choice of distribution channels in acquiring adequate and appropriate insurance pro­tection. It would also be a positive outcome for the GOJ by encouraging consumers to purchase protection that is consistent with the decision to exempt financial services from the consumption tax while main­taining control and limiting any fiscal impact. Such a move would also align Japan’s consumption tax policy for insu­rance products with global standards enjoyed by insurers and consumers in most other developed countries.

To this end, the ACCJ has outlined the following concrete measures that the GOJ can take to come into alignment with global best practices and enhance consumer choice.

Insurance companies in Japan have tradi­tionally operated their sales functions through an internal team of mainly salaried employees.

However, agency distribution, in the form of both inhouse career agencies and independent sales agencies, is becoming increasingly popular in Japan, as it provides consumers with greater convenience and choice.

In many cases, agencies sell insurance products of various com­panies. This allows consumers to compare products more easily and receive advice from the agent as to the best product for their individual needs. Further, as agent compensation is performance-based, com­panies have been able to keep costs down, passing these savings on to consumers.

Under Japan’s consumption tax regime, however, commissions paid to agents are subject to consumption tax, while the fixed sala­ries of inhouse sales staff are not. As financial services are exempt from consumption tax, it is impossible for companies to pass the consumption tax imposed on agent commissions directly on to the consumer or end user as the inten­ded payor of consumption tax according to global best practice.

As a result, the difference in consumption tax treatment can dis­courages insurance com­panies from pursuing sales agency distribution strategies due to the significant amount of additional non-recoverable expense. The administration of Japanese Prime Minister Shinzo Abe is com­mitted to raising the consumption tax rate from eight to 10 percent in October, which will further increase the burden on insurance companies.

Numerous recent policy decisions demonstrate that the GOJ positively encou­rages broader and clearer consu­mer choice. The ACCJ welcomes these moves and unequivocally supports the GOJ in these efforts. Ensuring that Japanese consumers have access to adequate, appropriate, and cost-effective life insurance protection—including both long-term healthcare and retirement savings—as well as general insurance protection is clearly in the best interest of the GOJ and society.

However, as shown in the accom­panying tables, the way in which Japan’s consumption tax rules treat commissions from insurance sales is an outlier among most developed countries. It also runs counter to the GOJ’s efforts to promote greater consumer choice.

This outlier situation is demonstrated by the essential mismatch inherent in the consumption tax treatment of insurance, compared with other industries.

According to global best practice identified by the OECD and IMF, the basic principle of the consumption tax is that it should be a neutral tax. That is, the consumption tax should be structured so that its application has no impact on how companies choose to structure their operations, including choice of inputs, distribution methods, etc.

It also should not have an adverse effect on a company’s competi­tiveness or create undue compliance burdens. To this end, con­sumption taxes should be borne by the end user, not by taxable businesses. Japan’s current consumption tax policy does not uphold the neutrality principle, as many financial services companies—including insurance companies—accrue significant amounts of unrecoverable consumption tax. This reduces their competitive position and distorts the financial services market.

Work led by the OECD’s Committee on Fiscal Affairs (CFA) has revealed that the current international consumption taxes environment—especially with respect to trade in services and intangibles—is creating obstacles to business activity, hindering economic growth, and distorting competition. This conclusion also rings true for Japan. The current application of consumption tax is inconsistent in key areas that directly impact Tokyo’s compe­titiveness as a global financial center.

The neutrality principle is important because it facilitates smooth market functioning by ensuring that companies are allowed to make efficient, customer-focused choices in response to market forces, not to potential tax impacts.

Ultimately, if the neutrality principle of consumption tax is not applied, companies are forced to adjust in ways that could impact consumer choice and convenience, for example through higher prices and fewer services. Considering the planned 2019 consumption tax increase, ensuring neutrality in the treatment of insurance products sales through sales agents is criti­cal from the viewpoint of consumer protection.

When the GOJ introduced the con­sumption tax, it decided to exempt financial services products in line with practices in nearly every other OECD country. It did this because of the in­herent difficulty in assessing the tax base, and because financial services are largely for the purpose of saving and not consumption. That intent is subverted, however, by applying the consumption tax to commissions, which then must be borne by companies or passed on to consumers.

Japan is one of very few countries that applies a value-added tax in this manner. The cascading of consumption taxes through the chain of production of exempt services, as in the case of Japanese consumption tax on insurance sales agents’ commissions, is generally recognized in other countries as creating market inefficiencies. And, in the case of insurance, it is typically addressed by exemption for intermediaries or, in certain countries, recovery of input tax for insurance companies.

For example, Table 2 shows the treatment of commission payments to sales agents for life insurance globally.

As can be seen, of the major nations detailed, only consumers in Singapore and Chile suffer the same disadvantage as those in Japan in their purchase of life insurance products.

The anomalies highlighted in relation to life insurance are equally applicable to general insurers, as can be seen in Table 3.

With the exception of Japan and Russia, commissions paid to sales agents match the treatment of the insurance products they are selling in every indirect tax regime we identify in Table 3. The effect of this is that either:

  • No indirect tax applies to the commissions
  • Any indirect tax on the commissions is recoverable because general insurance is taxable

In Japan, insurance companies already suffer unrecoverable indirect tax on a number of their operating expenses. One of the largest, if not the largest, is in respect to claims costs. These include:

  • Replacement parts/goods
    (e.g. auto­­motive replacement parts, replacement vehicles with respect to auto insurance)
  • Property
    (e.g. repair and construction
    of real property with respect to real property insurance)
  • Claims handling/adjustment fees
    (e.g. claims adjusters, private investigators, lawyers’ fees required to assess and settle claims. Generally, these services are outsourced to third-party providers and are therefore taxable.)
  • Effect of increased costs

As the consumption tax rate rises, these additional tax costs will need to be transferred to the consumer through premium increases. Material changes in insurance product pricing require FSA approval, and a timely change in pricing is rarely possible.

Even if the industry can obtain the necessary FSA approvals to increase product pricing to account for the increa­­sed consumption tax rates, the end result will inevitably be higher prices for insurance products for Japanese consumers. This would be inconsistent with the sound policy goal of ensuring Japanese consumers have access to adequate, appropriate, and cost-effective insurance protection.

Therefore, to continue to encourage citizens to safeguard their own futures, and to create a globally competitive insurance market in Japan, the ACCJ urges the GOJ to bring its policies and practices in line with global best practice and to neutralize the consumption tax treatment of payments to sales agents.

Based on global precedent, there are a number of options the GOJ can adopt to enhance consumer choice and bring Japan in line with global best practice. Here are three.

A. Make insurance premiums zero-rated taxable supplies

The imbalance created by the con­sumption tax treatment of pay­ments to sales agents arises because premiums for life and general insurance are treated as non-taxable supplies for consumption tax purposes. If premiums were treated as taxable supplies, but taxed at a zero-rate, this should eliminate the distortion. Advantages of this approach include:

  • No negative impact on consumers, as no consumption tax would apply to insurance premiums
  • The ability of insurance companies to recover the input consumption tax on all payments—including those to sales agents—removing the disadvantage and allowing for improved consumer choice

B. Include commissions paid to sales agents as exempt supplies

Similar to the treatment in the European Union and South Korea, one option would be to include commissions paid to sales agents as exempt supplies as “insurance-related services.” In addition to the ad­van­tages of the above option, this option would align Japan’s consumption tax treatment with that of all other developed nations—except Russia—in terms of sales agency commissions for insurance.

C. Allow for certain statutory recoverability

Similar to the rules for life insurance in Australia, another option would be to allow companies to recover a certain percentage of their consumption tax cost on commissions to sales agents. In Australia, to maintain neu­trality, the rate is set at 75 percent. Although this method is advantageous from the perspective of achieving neutrality, both the gov­ernment and insurance companies may incur increased administrative costs.

Of the three options identified, this one allows for a portion of the consumption tax levied on com­missions to be recovered, and would offer the GOJ and Japanese consumers benefits such as:

  • Providing tax neutrality that permits optimal distribution of insurance policies to consumers
  • Addressing issues around tax accu­mulation by not “passing on” the issue of non-creditability to the sales agencies and brokers
  • Providing the GOJ with a policy tool to control both the cost to the GOJ and the international competitiveness of Japan’s insurance industry

The ACCJ hopes that these recom­mended measures will help the GOJ align Japan’s approach to consumption tax with global best practices, boosting economic competitiveness and enhancing consumer choice.