Taxing authority and tax law
Tax authority: National Tax Agency (NTA)
Tax law:
- Special Taxation Measures Law (STML) Article 66-4 — Special Provisions for Taxation of Transactions with Foreign Related Persons
- STML Article 68-88 — Special Taxation Measures of Transactions between Consolidated Corporations and Foreign Related Persons
Relevant regulations and rulings
- STML-Enforcement Order 39-12
- STML Enforcement Regulations Article 22-10
- STML-Circulars 66-4-(1)-1 to 66-4-(8)-2
- Commissioner’s Directive on the Establishment of Instructions for the Administration of Transfer Pricing Matters (Administrative Guidelines)
- Commissioner’s Directive on the Establishment of Instructions for the Administration of Transfer Pricing Matters for Consolidated Corporations (Administrative Guidelines for Consolidated Corporations)
- Commissioner’s Directive on Mutual Agreement Procedures
OECD guidelines treatment
The NTA refers to the OECD guidelines for direction, and the Japanese transfer pricing Administrative Guidelines contain the following statement: “In light of the importance of a common understanding regarding transfer pricing by each country’s tax authorities for the resolution of international double taxation that arises due to taxation pursuant to the transfer pricing tax system, appropriate administration shall be carried out by referring to the OECD Transfer Pricing Guidelines to the extent necessary in examinations and in reviews of requests for APA’s.”Administrative Guidelines, Para. 1-2(3)
However, under audit tax examiners often point out that Japan is not bound by the OECD guidelines and that they will follow their interpretation of Japanese tax laws and regulations even where there may be a disagreement over whether their approach is consistent with the OECD guidelines. On the other hand, the most recent US–Japan tax treaty explanation refers extensively to the OECD guidelines and suggests greater harmonization in the future.
Priorities/pricing methods
In general, transaction-based methods are preferred over profit-based methods. The tax authorities require that the CUP, Resale Price, and Cost Plus methods be used whenever possible, only allowing the use of other methods (e.g., Profit Split and Transactional Net Margin Method) after the first three have been discounted. The TNMM is available for fiscal years starting on or after 1 April 2004. Note that there are some cases in which the Residual Profit Split Method, which is accepted by the Japanese tax authorities as one type of the Profit Split Method mentioned above, is applied.
Transfer pricing penalties
Transfer pricing assessments are subject to the same penalties that apply to general corporate tax assessments. There are two types of penalties:
- Underpayment penalty tax - computed as either 10% of the additional assessed taxes (up to JPY500,000) or 15% of the additional tax, depending on the amount of underpayment
- Delinquency tax (interest) - begins from 4% per year plus the official discount rate and increases after a certain period to 14.6% per year
There is no separate penalty for failure to prepare and maintain transfer pricing documentation.
Penalty relief
There are no specific provisions for reductions in underpayment penalties.
However, the 2007 tax reforms allowed for the provision of a grace period for the payment of assessed taxes — including penalty taxes — for taxpayers submitting an application for mutual agreement procedures. The taxpayer must submit a separate application to be entitled to the grace period, which is defined as the period starting on the initial payment due date of assessed taxes and ending on the day one month after the day following the day on which the “correction” based on the mutual agreement has been made (or the day on which a notification was issued that an agreement could not be reached). Any delinquency taxes accrued during the grace period will be exempted. However, under STML Article 66-4-2(2) (which grants a postponement of tax payment), the tax authority requires the taxpayer to provide security equivalent to the amount of the tax payment (i.e., collateral). This new transfer pricing rule will be applicable for applications for a grace period made on or after 1 April 2007.
Documentation requirements
The 2010 tax reform effective 1 April of this year clarified expectations around documentation, by amending the STML to state that “documents stated in the ministerial ordinance…should be provided without delay” when requested in the course of an examination. The ministerial ordinance in question (STML Enforcement Regulations Art. 22-10) was in turn amended to include a detailed list of documents to be submitted. The previous version of the STML had required that “documents or accounting books” be rendered, without specifying what types of documents and books were required. The substance of the new list in the ministerial ordinance is largely identical to a list previously disclosed in the Administrative Guidelines (an advisory document), but the promotion to the ministerial ordinance, coupled with the citation in the STML, gives this list the force of regulation.
The list of documents is now formally linked to existing language in the STML providing that failure to provide appropriate materials in a timely manner upon request can trigger the tax examiner’s authority to collect transactional data from comparable firms to use as “secret comparables” for the taxpayer. That is, the comparables are not disclosed to the taxpayer because the transactional data of the companies are confidential. Alternatively, an examiner can resort to “presumptive taxation”, presuming an arm’s length price with reference to profit ratios of other corporations in the industry which carry out similar activities.
Documentation deadlines
The taxpayer is required to provide the tax authority with documentation (i.e., information and records) relevant to the establishment of the arm’s length price in a timely manner upon request. There is no exact deadline specified.
Statute of limitations on transfer pricing assessments
The statute of limitations on transfer pricing assessments is six years from the deadline for filing tax returns for a fiscal year (STML Article 66-4(16)).
A corporation must maintain corporate tax records for seven years from the fiscal year end (Corporation Tax Law Art. 126 and 150-2; Corporation Tax Law Enforcement Regulation, Article 59 and 67).
Return disclosures/related-party disclosures
The taxpayer must file Schedule 17-4 (previously Schedule 17-3), Detailed Statement Concerning Foreign Affiliated Persons and Related Party Transactions for fiscal years beginning on or after 1 April 2003. Schedule 17-4 requires that taxpayers disclose the transfer pricing methods applied in calculating the arm’s length prices of the foreign related-party transactions. This requirement implies that taxpayers are expected to identify the appropriate transfer pricing methods for their related-party transactions and be able to demonstrate the appropriateness of those methods. Therefore, this rule can be interpreted as a de facto transfer pricing documentation requirement as taxpayers are expected to maintain documents in support of any tax return disclosure.
Effective 30 April 2008, Schedule 17-4 requires taxpayers to disclose the following three additional information items:
- The number of employees of the foreign related party
- The amount of retained earnings of the foreign related party for the preceding year
- Any APA agreed between the taxpayer and the foreign Competent Authority
Audit risk/transfer pricing scrutiny
The NTA and the major Regional Tax Bureaus together employ about 200 dedicated transfer pricing specialists to actively enforce Japan’s transfer pricing rules. Audit risk is generally medium-high for large taxpayers with significant related-party transactions. The risk is increased for taxpayers who meet any of the following criteria:
- In industries targeted by the NTA
- With low profits or losses in Japan
- High profits in foreign affiliates as disclosed on Schedule 17-4 (relative to profits reported in Japan)
- With fluctuating profitability
- Who have significant transactions with tax havens
- In industries with high margins. The NTA is likely to seek to apply comparables, including secret comparables available only to the NTA
APA opportunity
Unilateral and bilateral APAs are available, though the NTA prefers bilateral. APA guidelines are included in the Administrative Guidelines.
The NTA has recently shown a willingness to accept profit-based methods, such as the TNMM.
The NTA amended the filing deadline for APA applications on 22 October 2008. Previous guidance required that the APA application be filed by the tax return filing deadline of the first year to be covered by the APA. The new NTA guidance sets the APA filing deadline as the day preceding the first day of the first fiscal year to be covered by the proposed APA.
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