Cosmos International Management Co., Ltd.

News (December 24, 2010)

Tax reform proposal for 2011 fiscal year -international taxation- change to the Best Method Framework for transfer pricing

On December 16, 2010, Japanese ruling party announced its tax reform proposal for the 2011 fiscal year. The overview of the reform regarding the international taxation is as follow.

(1) Revision of transfer pricing taxation

As we covered several times in the library of this website, the revision of the OECD transfer pricing guidelines has been proceeding, and Japanfs transfer pricing regulations, which follow the OECD guidelines, will be revised as follows.

Change of priority regarding application of transfer pricing methods
Under the current tax law, the three transaction-based methods (comparable uncontrolled price (CUP) method, resale price method, and cost plus method) are preferably applied. The proposed reform will abolish this priority order and give the option to choose the most appropriate method for calculating the armfs length price depending on the cases. And accordingly, the comparable profit split method, contribution profit split method and residual profit split method, which are currently recognized by the OECD guidelines as the sub-classified profit split methods, will be clearly defined.@(will be applicable from taxpayersf business years after Oct. 1, 2011)

The change to the so called gbest method ruleh is the significant revision of the core part of transfer pricing taxation. On the other hand, in reality, transfer pricing methods other than three transaction-based methods have already been applied in many cases. Hence, in effect, the proposed revision seems to be the adjustment of the rules following the reality. However, the OECD guidelines, with which Japanese transfer pricing regulations comply, remains the position of soft preference for the application of three transaction-based methods, which are regarded as more direct methods, so all methods still may not be recognized with total equality. It should be noted whether that aspect of the OECD guidelines will be reflected on the final revision and if so, how.

Clarification of armfs length range
The proposed revision clarifies that transfer pricing taxes would not be imposed when prices for transactions with foreign affiliates are within armfs length ranges and that when armfs length prices are outside the ranges, the average price of comparable transactions or other arms length pricing calculations that use rational prices according to sample allocation can be accepted.

Clarification of using secret comparables
To secure the taxpayerfs predictability, the proposed reform will clarify specific cases when secret comparables are applied (the information about the comparable transactions obtained by tax authorityfs inspection and/or information request from non-related parties who conducts similar transactions). The proposed reform will also make sure that when applying secret comparables, explanation for the contents of the secret comparables within the extent of confidentiality obligation should be made.

Additionally, necessary revisions with regard to enforcements accompanied with the revision of OECD guidelines would be made. Also, application procedures for arbitration following the adoption of the arbitration system in the Tax Treaty (already signed in the agreements with Netherlands and Hong Kong) will be issued.

(2)Revision of Foreign Tax Credit

For purposes of streamlining the foreign tax credit system, following amendments has been proposed:

Reduction of the threshold ghigh corporate tax rateh excluded from a foreign tax credit
Japan currently does not allow a foreign tax credit for the portion of exceeding a threshold of high foreign corporate tax rate compared to Japan, since not crediting that portion may not cause double taxation. This threshold rate will be reduced from current 50% to 35%, in accordance with the reduction of Japanfs corporate tax rate.

Exclusion of untaxed foreign source income from foreign source income
100% of untaxed foreign source income from foreign source income for purposes of calculating the foreign tax credit limitation is excluded. (currently two-third of untaxed foreign source income are excluded).
(will be implemented with interim measure)

Abolishment of special case of 90% limitation for foreign source income
Regarding calculation methods of foreign source income for the basis of computing foreign tax credit limitation, special case of 90% limitation (worldwide income ~ 90%) will be abolished.

In addition, where the applicable tax rates vary depending on agreements with local taxing authorities (e.g. corporate tax in British Isle of Guernsey), any taxes in excess of the amount computed using the lowest applicable rate will be excluded as foreign corporate tax or foreign income for purpose of applying foreign tax credit or the anti-tax haven rules.

Further, for purposes of computing the foreign tax credit limitation, income of a corporation which may be taxed in a foreign country in accordance with the treaty between Japan and that foreign country shall generally be deemed to be treated as foreign source income. (even if the same income are deemed as domestic source income under the Japanese domestic tax rules)

(3)Revision of Anti-Tax Haven ("CFC") Rules

  • The proposed reform will clarify, for regional headquarters companies with mainly operating as investment holding, that the exemption conditions other than Business Purposes Test (Substance Test, Administration and Control Test, Local Country Test or Unrelated Party Test) will be judged based on the headquarters activities.

    This seems to clarify the rules set in the tax reform FY2010, in which regional headquarters companies that meet certain requirements (100% owned by domestic corporations, manage two or more operating affiliate corporations) can be exempted from the application of the anti-tax haven rules.
  • For purposes of computing the effective corporate tax rate for CFC purposes, the proposed reform will abolish shareholding requirements in order to exclude foreign dividends generated from locations outside of the recipient foreign corporations from the untaxed foreign income. In addition, it will be clarified that when a foreign corporationfs taxable income is nil, the nominal tax rate of that foreign country will be applied for the judgment of the threshold rate (gtrigger rateh) of the anti-tax haven rules.
  • The proposed reform will clarify the computation methods regarding asset-based income and the current exception standards for the taxation of asset-based income in the anti-tax haven rules.


  • Special taxation measures : The extension and amplification for the un-taxation rules of the interests of transferred bonds and debentures applied for non-residents and for the special case of the taxation on interests regarding bond repurchase agreement in the financial institution.
  • Changes for the taxable capital gains related to beneficiary right of corporate bonds in the special purpose trust. (It will be applied for the gains from the transfer of beneficiary right, which is conducted after the enforcement date for a part of revision of the law regarding liquidation of asset.)


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