Recent Trends of Tax Disputes in Japan Transfer Pricing Cases

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1 Recent Trends of Tax Disputes in Japan Transfer Pricing Cases Asia-Pacific Forum Tax Regulation: Law, Economics and the Role of Courts Vladivostok 20 September, 2013 Professor Dr. Hiroshi Oda University College London Nagashima, Ohno and Tsunematsu (Japan)

2 Introduction - BEPS OECD Addressing Base Erosion and Profit Shifting There is a growing perception that governments lose substantial corporate tax revenue because of planning aimed at shifting profits in ways that erode the taxable base to locations where they are subject to a more favourable tax treatment OECD Action Plan In the area of transfer pricing, the rules should be improved in order to put more emphasis on value creation in highly integrated groups, tackling the use of intangibles, risks, capital and other high-risk transactions to shift profits. *UK Starbucks case

3 1. Procedure for Settling Tax Disputes 1. Administrative Review Tax Tribunal special body within the National Tax Agency (based upon the idea of separation of decision-making and review of decisions) Intended as a body for a third party review of the decisions of the tax agency 2. Judicial Review first instance court *Recent reform in Russia opposite direction

4 2. Tax Tribunal Established 1970 by Amendment to the General Law on National Taxes and Administrative Appellate Law A fair third party body within the Tax Agency Head office and 12 regional offices The President of the Tax Tribunal renders a decision based upon the opinion of the Panel of three administrative law judges appointed from within the NTA Are they impartial? Recent changes outside experts employed as administrative judges (8 lawyers, 6 tax attorneys, 4 accountants)

5 3. Objection and Review Procedures Original decision Objection lodged with either the head of the tax office or the regional tax office (objection procedure can be bypassed: decisions of the regional head) Decision on the objection within one month Administrative Review by the Tax Tribunal Appeal to the district court

6 4. Objections Lodged Decreasing use of objections Low rate of objections accepted and the original decision revoked/rectified

7 5. Request for Review by the Tax Tribunal Cases of Review Request Increased Claim accepted and original decision the original decision revoked/rectified not too high

8 6. Judicial Review Judicial Review cases stable in small number (some celebrated cases, though) Success rate of the plaintiff (tax payer) varies

9 7. Supreme Court Judgment (1) Takefuji Case (Supreme Court Judgment, 18 February, 2011) Owner of a consumer credit company bestowed 160 billion yen worth shares via a Dutch entity to his son who is a resident of Hong Kong (At that time, bestowment to someone domiciled abroad was not subject to Japanese inheritance tax) The National Tax Agency determined this to be tax evasion and imposed 130 billion yen back taxes and penalty The case reached the court. The first instance court ruled in favour of the taxpayer. This was reversed by the second instance court, but the Supreme Court quashed this judgment and ruled in favour of the taxpayer. The contested issue was whether this person was domiciled in Japan or Hong Kong

10 7. Supreme Court Judgment (2) The Supreme Court ruled that domicile should be determined objectively (determination of where the person s centre of living is), even though subjectively, there is an intention of avoiding gift tax. Supplementary opinion: it is an apparent tax evasion scheme. However, under the constitutional requirement of statutory basis for taxation, tax law should not be easily applied in an expansive manner or by analogy. Subsequently, the Inheritance Tax Law was amended in order to close this loophole.

11 8. Transfer Pricing Legislation 1986 Introduction of the TPL based upon Arm s length principle (at the time of rapid globalisation of Japanese companies) 2001 Transfer Pricing Administration Guidelines (based upon the OECD Guidelines) Juridical persons are deemed to have effected transaction with foreign related parties at an arm s length price.

12 9. Methods of Determining Arm s Length Price 1. Comparable uncontrolled price (CUP) method 2. Resale price method 3. Cost plus method 4. Methods similar to the above and listed in the cabinet order 1) Profit split method 2) Transactional net margin method

13 10. Transfer Pricing cases NTA ordered payment of back taxes and penalties in 302 cases (in 93 cases, bilateral negotiation with the host country held) cases of under claim resulting from TP Total amount 68.7 billion yen (sharp increase from average 213 million in the previous year to 687 million such cases three times increase as compared to 2001 usually sorted out through objection procedure, but some Tax tribunal cases, e.g. Takeda 4 cases of judicial review so far.

14 11. Recent Cases 2013 Olympus Corporation 10.3 billion income transferred, according to the NTA, to a UK Subsidiary 2013 Hoya Corporation 20 billion yen income transferred Others include Yahoo (26.5 billion yen back tax), TDK, Mitsui Shipping

15 12. NGK Insulators case NGK Insulators NTA determined that this company failed to declare the income (transferred to overseas subsidiaries) up to 16 billion yen for the past five years (back taxes 13 billion yen) The company objected. Overseas subsidiaries in the US and Poland paid technical fees when producing car components. NTA argued that the pricing was low and thus the company transferred income to the subsidiaries. Case continues.

16 13. Successfully contested cases (1) Paid back taxes reimbursed in some cases: Shin-Etsu Chemical Corporation NTA ordered to pay 11 billion yen back taxes technical fees received from a US production subsidiary NTS determined that the company transferred 23.3 billion yen income to this subsidiary by setting the fee level low. The company paid back taxes, but applied for a bi-lateral talk between US and Japanese tax authorities. As a result of the talk, the transferred income was reduced to 3.9 billion yen paid tax was reimbursed to Shin-Etsu.

17 13. Successfully contested cases (2) Takeda Pharmaceutical Company Ltd. Takeda sold a pharmaceutical product to its JV with a US company allegedly at a price lower than arm s length price billion income transfer was at issue. Takeda resorted to the objection procedure. The case was also contested at the Tax Tribunal. On both instances, the decision of the NTA was reversed and 57.1 billion yen was reimbursed. 2013

18 14. Standard Practice Back Tax Payment Order by the NTA objection request for (but pay) bi-lateral negotiation between the Host Country and Japanese tax authorities Tax Tribunal if successful, reimbursement court

19 15. Cases contested in Court Four cases were contested in court in three cases, the NTA won, while in one case, the taxpayer won (Tokyo High Court, 30 October, 2008). No case reached the Supreme Court. The law is not clear as to which method of determination of the arm s length price should be applied. It is understood that the most reasonable method which corresponds to the type of transaction. In this case decided by the Tokyo High Court, the payment for service provided by an IT firm was at issue.

20 16. Other Cross-Border Issues Japan has finally signed the Convention on Mutual Administrative Assistance in Tax Matters this year. Active participation in the Base Erosion and Profit Shifting (BEPS) discussion at the OECD. Thin capitalisation rule revised/introduction of earning stripping rules