Side Business Income vs Miscellaneous Income in Japan

The short answer: the decision table

Sources: National Tax Agency, partial amendment (7 October 2022) to the Income Tax Basic Circular, 35-2 Examples of miscellaneous income from an activity[National Tax Agency]; results of the public comment procedure on the same draft amendment[e-Gov]

The text of the circular starts from the principle that the question is "whether the activity generating the income is carried on to a degree that amounts, in the ordinary sense of the term, to a business", and it adds the note that "where no books and records are retained, the income falls under miscellaneous income from an activity" (except where receipts exceed 3 million yen and there are facts establishing business income). The yardstick for "negligible receipts" set out in the results of the public comment procedure is 3 million yen or less in a normal year (roughly three years) and less than 10% of your main income.

The line by annual income: what 10% of your main job comes to

"Main income" means the gross amount of your salary (receipts), and "a normal year" means roughly three years. Being small only in the year you start is not a problem; three years running below 10% is what looks negligible. Conversely, the higher your main income, the higher the line, so an employee on 10 million yen a year is likely to be treated as having miscellaneous income unless the side business reaches 1 million yen, even with books in place.

Even below 10%, you can still have business income if you can show "facts establishing a business, with a profit-seeking purpose, consideration, continuity and repetition". In practice that means several clients, orders received every month, and advertising or sales activity carried on as a business. The burden of explaining this to the tax office falls on you, however, so near the line it is safer to file as miscellaneous income.

What actually differs between business income and miscellaneous income

This gap is why the public comments poured in over the 3-million-yen problem. Pushed into "miscellaneous income", you lose the benefits of the blue-form return, and in a year when investment in the side business puts you into a loss, you can no longer set that loss against your salary. Put the other way round, the biggest practical gain from treating a side business as business income is the blue-form special deduction, and that deduction rises to 750,000 yen from the 2027 tax year. For the blue-form requirements, see the difference between blue-form and white-form returns.

The notification of commencement of business and the blue-form return: file them if you want business income

1. File the notification of commencement of business (notification of the start or closure of a sole proprietorship) with the tax office. The deadline is one month from the start of the business, but there is no penalty for filing late. Filing it does not by itself make the income business income (the test is the substance plus the books), and you can file as business income without it, but it is customary to submit it together with the blue-form application. Nothing is reported to your employer if you file it as a company employee.
2. File the application for approval of a blue-form return by 15 March of the year for which you want the deduction (or within two months of starting up if you begin business that year). Without it you are on a white-form return and the 650,000 yen deduction is unavailable.
3. Keep books. Record entries under double-entry bookkeeping (accounting software can automate this) and retain invoices and receipts for seven years. That is what "retaining books and records" consists of, and it is required both for the business income test and for the blue-form return.
4. Check your employer's work rules. The notification and your taxes are not communicated to your employer, but your side-business income can come to light through the resident tax notice. For how to switch resident tax to self-payment, see filing a tax return for a side business.

If your side job is under an employment contract (a part-time job), the pay is employment income and none of this applies. For a side job paid as salary, check the problem of being covered by social insurance at two workplaces instead. Income from flea-market apps and points is covered in the tax treatment of point-earning and flea-market sales.

Points for those filing as miscellaneous income

• The 200,000 yen rule applies to income tax only. If your side-business income (receipts minus expenses) is 200,000 yen or less you need not file an income tax return, but you still have to file for resident tax.
• Expenses are deductible from miscellaneous income too. Your income is receipts minus necessary expenses. The obligation to keep books starts once receipts two years ago exceed 3 million yen, but keep your receipts anyway so that you can substantiate the expenses.
• Losses are simply lost. A loss on miscellaneous income cannot be set against your salary and cannot be carried forward to the following year. For a side business with heavy up-front spending on equipment or stock, it is better to meet the requirements for business income before you start.
• You can switch to business income later. From the year in which your receipts pass 10% and you start keeping books, you can file as business income. The blue-form application is due by 15 March of that year.

Summary

• If you keep bookkeeping records, side-business income of ¥3 million or less is still treated as business income in principle.
• If it is typically ¥3 million or less and under 10% of your main job's income, it counts as "minor" and is treated as miscellaneous income. For a ¥6 million annual income, the line is ¥600,000.
• If losses continue year after year with no effort to improve, it is treated as miscellaneous income for lacking a profit motive.
• Business income lets you use the blue-form special deduction and offset losses against other income; miscellaneous income allows neither.
• To treat it as business income, file a business opening notification and a blue-form approval application, and keep double-entry books.

Reference links (sources)

This article is based on the materials below. Because the classification turns on the individual facts, please consult the tax office or a tax accountant if you are close to the line.

• National Tax Agency, Income Tax Basic Circular (Article 35, miscellaneous income, 35-2 Examples of miscellaneous income from an activity)
• National Tax Agency, results of the public comment procedure on the draft partial amendment to the Income Tax Basic Circular (7 October 2022) (the approach to negligible receipts and to a profit-seeking purpose)
• National Tax Agency, No.1500 Miscellaneous income
• National Tax Agency, No.2070 The blue-form return system

Note: this article is general information. The tax figures are estimates and vary with your income and deductions.