Cosmos International Management Co., Ltd.

News (April 30, 2010)

Japan's 2010 tax reform includes transfer pricing revision

In Japan, the government-led committee reviews and revises tax laws every year. Regarding the latest tax reform for the Fiscal Year 2010, the reform proposal was announced on December 2009, and was approved by the Parliament on March 2010 to be effective from fiscal year 2010 (starting from April 2010). With regard to transfer pricing, the 2010 Tax Reform includes a few revisions, and the only major one is that transfer pricing documentation (gTP documentationh) in relation to deemed taxation has been clarified.

Japan, as opposed to most of major countries, still does not have formal TP documentation requirement. In other words, even though Japanese corporations do not prepare TP documentation by the tax filing date, tax authorities will not impose penalties for that reason.

However, the transfer pricing directive issued by the National Tax Agency (gNTAh) stipulates that tax authorities would investigate TP documentation during transfer pricing tax examinations. Moreover, the Act on Special Measures Concerning Taxation (gASMTh) Article 66-4, which is Japanfs most important and basic transfer pricing tax law, states in (7) that if taxpayers fail to submit the books and documents that are considered to be necessary for the calculation of the arm's length price, the tax authority may presume the amount of taxable income, thereby making reassessment; that is called gdeemed taxationh. The underlined gbooks and documentsh might be considered as TP documentation, but previously there was no definition. Thus taxpayers were not sure if they should really prepare TP documentation to avoid the deemed taxation by the NTA. Now, as the 2010 revision clarifies that the gbooks and documentsh are TP documentation, taxpayers must know they can avoid the very dangerous deemed taxation if they prepare TP documentation in advance of tax examination.

Even though the 2010 revision still cannot be interpreted as formal TP documentation requirement, it surely indicates the NTAfs stronger message that TP documentation is needed to avoid the deemed taxation.

Summary Translation of the Revised Clauses

ASMT Article 66-4 (7):
Where the relevant official of the National Tax Agency or the relevant official of the Tax Office or Regional Taxation Bureau having jurisdiction over a corporation's place for tax payment has requested the corporation to present or submit the books and documents that are considered to be necessary for the calculation of the arm's length price --- in each business year or copies of such books and documents ---, if the said corporation has failed to present or submit these books and documents or copies thereof without delay, the district director may presume the amount calculated by the method listed (*) --- to be the said arm's length price, and thereby make a reassessment --- with respect to the said corporation's amount of income or amount of loss for the relevant business year:

(*) In order for the district director to presume the taxable income, resale price method or cost plus method is applied, and only if the above two methods cannot be applied, TNMM and cost plus method will be applied.

(The revision)
ASMT Article 66-4 (6):
The underlined gthe books and documentsh has been changed to gthe documents as defined in the Ministry of Finance Enforcement Orderh.

(New addition)
Ordinance for Enforcement of the ASMT (gASMT Ordinanceh)
Article 22-10 (1):

The documents prescribed in ASMT Article 66-4 (6) as gdefined in the Ministry of Finance Enforcement Orderh are as below:

(i) Following documents describing contents of foreign-related transactions defined in ASMT Article 66-4 (1):

  1. Documents containing detail of assets and contents of services related to the subject foreign-related transactions;
  2. Documents regarding functions performed and risks born by the corporation subject to the ASMT Article 66-4 (6) and its foreign related party;
  3. Documents containing the detail of intangible fixed assets and other intangible assets that the corporation subject to the ASMT Article 66-4 (6) and its foreign related party used for the foreign-related transactions;
  4. Contracts of foreign-related transactions and documents for the contents of the contracts;

  5. Pricing policy for foreign-related transactions in which the corporation subject to the ASMT Article 66-4 (6) receives from and pay to its foreign-related party, and documents containing the details of price negotiations between the corporation and the foreign-related party;
  6. Documents containing the detail of profit and loss for the foreign-related transactions between the corporation subject to the ASMT Article 66-4 (6) and its foreign-related party;
  7. Documents regarding analyses of market in relation to foreign-related transactions such as sales and purchase of assets, provision of services etc. and any other matters regarding the market;
  8. Documents containing the details of the business policy of the corporation and its the foreign-related party with regard to the foreign-related transactions;
  9. Whether there are any other transactions closely connected with the foreign-related transactions, and if any, documents containing the details of such transactions.

(ii) Following documents used by the corporation subject to the ASMT Article 66-4 (6) for the calculation of armfs length prices with regard to foreign-related transactions:

  1. Documents containing the selected calculation method defined in the ASMT Article 66-4 (2) and the reasons for adoption of the calculation method, and any other document prepared by the corporation for calculating the armfs length prices;
  2. Documents containing the selection of comparable transactions adopted by the corporation and the details of the comparable transactions;
  3. If the corporation selected the calculation method prescribed in the ASMT Enforcement Order Article 39-12 (8) (i) (**), => documents for calculation of the amount belonging to both the corporation and its foreign-related party;
  4. If the corporation calculates armfs length prices regarding more than one transaction as a single transaction, => documents containing the reason for the calculation and details of each original transaction;
  5. If differences are adjusted with respect to comparable transactions, => Documents containing the reasons for adjustments and the adjusted methods.

(**) Profit split method

Conclusion and Implications

As already mentioned it may not be appropriate to interpret the revision as Japanfs adopting TP documentation requirement, because the revision (i) does not require taxpayers to prepare, (ii) does not impose any penalties in case of non-compliance, and (iii) does not set any specific deadline for the preparation.

However the revision, with the combination of revised law and added enforcement ordinance, has surely clarified the NTAfs stance that submitting TP documentation during the transfer pricing tax examination is necessary in order to avoid the deemed taxation that enables tax authorities to apply the methods in their favor. In addition, it is very difficult for taxpayers to newly make TP documentation after the tax examination starts and submit to tax authorities by the specified deadline; even though there is no definition about gwithout delayh and the deadline is set by each case.

Therefore, it is advisable for taxpayers with certain TP assessment risks to interpret the revision as virtual documentation requirement and prepare TP documentation in accordance with the ASMT Ordinance Article 22-10 (1) in advance. If taxpayers do not know whether they have certain TP assessment risks or not, they should conduct transfer pricing risk analysis and assess the risk.

The contents of TP documentation defined in the ASMT Ordinance Article 22-10 (1) are generally in line with the previous transfer pricing directive, but the documents defined in the Article 22-10 (1) (i) f. are the segmented profit / loss statements which had not been defined by the directive. As there are cases that segmenting foreign-related transactions from the whole numbers is difficult, especially risky taxpayers should prepare for the reasonable segmentation that can persuade tax examiners.

Further, taxpayers should be aware of the possibility that the tax circulars or directives related to this revision could be issued later this year. Finally, it is not clear at this moment as to whether the revision could lead to formal TP documentation requirement in Japan in the future, but the role of the documentation in transfer pricing practice will be more important anyway.


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