Transfer pricing – overview of Japanese tax reform

September 2019

As business has become more globalised, internal transactions between international subsidiaries of global organisations has become commonplace. The value at which these transactions take place is known as the transfer price. Often these transactions exist simply to move profits from high-tax to low-tax jurisdictions and involve intangible assets that are difficult to value. The OECD’s Base Erosion sand Profit Shifting (BEPS) report, and the guidelines arising from it, attempt to deal with this issue. 

Japan has recently introduced its own tax reforms with the intention of bringing its treatment of transfer pricing in line with the guidelines contained in the OECD final report arising from the BEPS project. The reforms also implement the OECD guidance on hard-to-value intangibles (HTVI) and its views on the shifting of profits. 
The reforms contain several changes, including:  
1. clarifying the definition of intangible assets 
2. adopting discounted cash flow (DCF) as a method of transfer pricing 
3. extending the statute of limitations from six to seven years 
4. formalising the use of an interquartile range 
In this article we take a high-level look at each of these areas.  
Defining intangible assets 
Intangible assets by their nature are vague and esoteric. This is what makes them difficult to value. Physical assets such as property and machinery, and financial assets such as cash and equities, are relatively easy to value. The OECD’s transfer pricing guidelines clarifies an intangible asset as …something that is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities… Examples include: 

  • intellectual property such as patents 
  • rights under commercial and government licenses 
  • goodwill
  • brands and trademarks. 

Using the discounted cash flow method 

The DCF method is not new to Japan, it has been in use for more than 40 years. What has changed, is that Japanese law has now formalised its use. At its heart, DCF gives a current valuation based on a discounted future value derived from assumed future cash flows.  

Where companies fail to supply the necessary documentation for establishing an arm’s length transfer price (the price at which two unconnected companies would realistically transact), Japan’s National Tax Agency (NTA) can use the DCF method to estimate tax by calculating an arm’s length price. 
The DCF method isn’t only available to the NTA, it exists for taxpayers to use also. Legislating for its use has the effect of formally permitting its use as a way of valuing intangible assets, something that didn’t exist previously in Japanese law. 
Extending the statute of limitations 
The period in which the NTA can legitimately correct tax decisions has extended from six to seven years. This gives the NTA more time to see the effect of an asset in action enabling it to more accurately determine whether an arm’s length price is commercially reasonable. 
Formalising the use of interquartile range 
Again, Japanese law is formalising something that is already in use. The interquartile range is a system of adjustment that can be used to modify a transaction price where a lack of accurate and quantitative data exists. 
More detail expected 
While the legislation is in place to make these changes happen, we still await some of the finer detail explaining how it will work in practice. Given the new rules will apply to businesses from April 2020, we expect to see this later in 2019.  

About the author 
Masatoshi Ito 
Tokyo, Japan 
Masatoshi is a partner of Shinsei International Tax Co., the Tokyo member firm of Russell Bedford. He was a national tax expert for the Tokyo Regional Taxation Bureau (TRTB) before moving to the National Tax Agency (NTA) of Japan for 26 years.

He worked in the field of transfer pricing for 11 years, which involved the handling of Mutual Agreement Procedures, Advance Pricing Arrangement, court cases, and tax reform.

He teaches a variety of seminars such as business research at Mizuho Research Institute Ltd and has written a book called “How to prepare Transfer Pricing
Documentation”, published by Chuo Keizai-sha in December 2018.  

Author: Masatoshi Ito, Shinsei International Tax Co., Tokyo, Japan

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