When to incorporate from being a sole proprietor: income and sales guidelines and calculating the tax-saving effect
For a sole proprietor or freelancer whose sales have been growing, "when to incorporate" is an important decision. Incorporation offers benefits such as saving on income tax, regaining consumption tax exemption, and widening the range of expenses, but maintenance costs and administrative work also increase. Understand the benchmark figures and decide at the right time.
The main benefits of incorporation
Lower income tax rate
Against an individual's top rate of 55% (income tax + residence tax), the effective tax rate for a small or medium-sized company is about 21–34%. By splitting income between director's remuneration and corporate profit, you can greatly reduce the tax burden[National Tax Agency No.5759 (in Japanese)].
Consumption tax exemption period (2 years)
A newly established company is, in principle, not a consumption-tax taxable business for two years after incorporation (capital under ¥10 million, etc.)[National Tax Agency No.6501 (in Japanese)]. However, note that once you register for the invoice system you become a taxable business even while otherwise exempt, so if your clients are mainly taxable businesses this two-year exemption benefit is hard to make use of (and the registration number cannot be carried over when you incorporate)[National Tax Agency — Invoice (in Japanese)].
Expensing director's remuneration
Director's remuneration paid to yourself becomes a deductible expense (loss) for the company. A sole proprietor cannot expense a salary paid to themselves, but after incorporation you can.
Applying the employment income deduction
Director's remuneration qualifies for the employment income deduction (up to ¥1.95 million). A sole proprietor has no employment income deduction, so this also leads to tax savings.
A wider range of expenses
You gain access to tax-saving techniques unavailable to individuals, such as deducting directors' retirement allowances and using corporate life insurance.
Guidelines for the timing to consider incorporation
When taxable income exceeds ¥7–8 million
Once your income tax rate rises above 23%, benefits start to appear compared with the effective corporate tax rate (about 21–34%).
When your personal sales exceed ¥10 million
If you incorporate at the point when you would become a consumption-tax taxable business, you may be able to obtain a fresh two-year exemption period as a company.
When annual income exceeds ¥10 million and the income tax rate reaches 33% or more
By retaining income in the company while optimizing director's remuneration, substantial tax savings become possible.
A tax-saving simulation of incorporation
Staying a sole proprietor
Income tax: approx. ¥3.02 million / Residence tax: approx. ¥1.24 million / National Health Insurance: approx. ¥1.06 million
Total: approx. ¥5.32 million
After incorporation (director's remuneration ¥6 million, corporate income ¥6 million)
Corporate tax etc.: approx. ¥1.7 million / Personal income and residence tax: approx. ¥900,000 / Social insurance premiums (personal share): approx. ¥500,000
Total: approx. ¥3.1 million
Drawbacks and costs of incorporation
Fixed costs increase: corporate residence tax (the per-capita levy) of at least ¥70,000 a year, tax accountant fees of ¥300,000–600,000 a year, mandatory enrollment in social insurance[Japan Pension Service (in Japanese)], and incorporation costs (¥200,000–300,000 for a kabushiki kaisha, ¥60,000–100,000 for a godo kaisha).
Kabushiki kaisha (stock company) vs. godo kaisha (LLC)
Kabushiki kaisha (stock company)
- High social credibility
- Advantageous for listing and raising funds
- Incorporation cost: about ¥200,000–300,000
- Director terms and financial-statement public notice are required
Godo kaisha (LLC)
- Incorporation cost: about ¥60,000–100,000
- No financial-statement public notice, no director terms
- Also used by Amazon, Apple, Seiyu, and others
- Lower name recognition
One approach is to start as a godo kaisha while your sales are small, then change to a kabushiki kaisha once you grow.
Summary
FAQ
What income level is the guideline for incorporating?
It is generally said that once taxable income exceeds roughly ¥8 million, incorporation tends to become favorable thanks to the effective corporate tax rate (about 23–34% for a small or medium-sized company) and the employment income deduction on director's remuneration. Make a comprehensive judgment that also includes social insurance and maintenance costs.
If I incorporate after sales exceed ¥10 million, is consumption tax exempt for two years?
In principle a newly established company is exempt for two years, but once you register for the invoice system you become a taxable business even while otherwise exempt. If your clients are mainly taxable businesses, the benefit of the two-year exemption becomes small.
How much does incorporation cost?
There are incorporation costs (about ¥60,000–100,000 for a godo kaisha, ¥200,000–300,000 for a kabushiki kaisha), the per-capita levy of corporate residence tax (from about ¥70,000 a year even at a loss), tax accountant fees, and the company's share of social insurance premiums.
Which is better, a kabushiki kaisha or a godo kaisha?
If you prioritize credibility and fundraising, a kabushiki kaisha; if you want to keep incorporation and operating costs down, a godo kaisha is one option. You can also start small and later reorganize into a kabushiki kaisha.
Reference links (sources)
This article is based on materials from the following public bodies (neutral, primary sources). Tax rates and requirements are subject to revision, so please check the latest details and seek professional advice before deciding.
- National Tax Agency No.5759 — Special corporate tax rate for small and medium-sized enterprises (in Japanese)
- National Tax Agency No.6501 — Exemption from the obligation to pay consumption tax (in Japanese)
- National Tax Agency — Invoice system: page for newly established businesses (in Japanese)
- Japan Pension Service — Application of social insurance to corporate establishments (in Japanese)
* This article is general information, not tax advice. For decisions on incorporation, please consult a tax accountant or other professional.