Transfer pricing trends in Japan

1 Background 

In the recent years, international trades have thrived as multinational enterprises keep navigating their business operations in an ever-expanding globalized world. In the international taxation field, taxing jurisdiction worldwide are paying closed attention to the transfer pricing issue. As a measure to prevent the shift of income (profit) abroad through the transactions between the enterprises and their foreign affiliated entities, transfer pricing taxation have been introduced and/or developed over these years.

Japan is a country which introduced transfer pricing taxation rather early, about 25 years ago in 1986.

Japan’s transfer pricing taxation applies whenever there is a difference between the price realized from the cross-border transaction between affiliated entities and the price (also called arm’s length price) realized from the transaction between the enterprise and a non-affiliated third party. 

Transfer pricing taxation applies to both Japanese entities and foreign entities that have Japanese sourced income. 

2 Overview 

Japan’s transfer pricing taxation applies to sale, purchase, finance and asset (including intangible asset) transactions performed between a Japanese company and its foreign affiliate entities. Thus it can be said that almost all kinds of international transactions made between affiliated entities are subject to transfer pricing taxation. 

There are various transfer pricing methods stipulated in Japan’s transfer pricing rules such as Comparable Uncontrolled Price Method, Resale Price Method, Cost Plus method, Transactional Net Margin Method, and Profit Split Method etc. Among such methods, an entity can choose the most appropriate one to set up arm’s length price. 

According to the Act on Special Measures concerning Taxation, tax authority will reevaluate the transfer price when such price evaluated by the enterprise is judged to be not an arm’s length price. If such situation occurs, the enterprise will likely be required to pay additional tax assessed by the tax authority, tax arrears and penalty for late payment. It is advisable that the enterprises shall be very careful with the transfer price setting and comparability process, documentation and justification of pricing policies. 

3 Addressing risk inherent with transfer pricing in Japan 

1. Documentation 

Japanese law does not impose documentation requirements or penalties. Whenever there is a request of transfer pricing examination by the tax authority, the enterprise is required to provide the tax authority with transfer pricing documents. The examination starts with the tax officer’s scrutiny of the enterprise’s transfer pricing documents, then interview on the contents of the documents and finally request of additional documents if necessary. If the enterprise can’t make available the documentation of arm’s-length pricing to the tax authority when required, it is very likely that the tax authority may seek a transfer pricing adjustment for the transactions and result in application of the so-called “presumptive taxation” rule which usually ends up unfavorable to the examined enterprise. It is strongly recommended that multinational enterprises maintain proper documentation for the whole group company which can reasonably demonstrate that the results of transactions with foreign affiliated entities have been determined for tax purposes according to transfer pricing rules. 

2. Advance Pricing Agreement Program 

Japan has an unilateral Advance Pricing Agreement Program which is designed to resolve actual or potential transfer pricing disputes in a principled, cooperative manner, as an alternative to the traditional adversarial process. Under this program, the National Tax Agency agrees not to seek a transfer pricing adjustment for a covered transaction if the enterprise consults with the competent tax authority about the transaction in advance and files its tax return for a covered year consistent with the agreed transfer pricing method. In addition, Japan also has bilateral advance pricing agreements with other countries. Advance Pricing Agreement program is a very useful arrangement that is popularly applied by many enterprises involving transfer pricing worldwide. 

Recently, a protocol amending the US-Japan tax treaty was signed whereby an arbitration panel is formed by a third party helping both Japan and US authorities in determining transfer price.

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