New documentation requirement: Up until 2010, Japanese transfer pricing regulations did not require detailed documentation on the taxpayer’s transfer pricing policy. However, the 2010 annual tax reform, which took effect on 1 April 2010, introduced certain documentation requirements. Before the amendment, it was only required that the taxpayer should produce “books and records that are necessary to compute the arm’s length price”. In the practical context of transfer pricing audits, it was often pointed out that it was unclear what specific documents that wording covered. That is, if the taxpayer fails to produce certain transfer pricing documentation to the Japanese tax authority without delay, upon being so requested in the course of a transfer pricing audit, the Japanese tax authority is entitled to issue a transfer pricing assessment using a presumed arm’s length price determined according to certain prescribed methodologies, including so-called “secret comparables”.
This means that, if the taxpayer wishes to avoid a transfer pricing assessment on the basis of presumption by the tax authority – or the use of secret comparables (which should be the case for all transfer pricing audits), the taxpayer must have the required documentation prepared and in good order, and be ready to submit it to the tax authority without delay upon a request made in the course of a transfer pricing audit. There is no threshold determining which taxpayers are subject to the requirements on the basis of turnover, corporate size, etc.
Disclosure by tax returns: In addition to the documentation requirement discussed above, all corporate taxpayers who engage in controlled transactions with foreign affiliates must attach to their corporate tax return a statement concerning foreign affiliates, referred to as Schedule 17(4). The statement requires disclosure of certain facts relating to the foreign affiliates and the controlled transactions, including the following:
- Corporate details:
- Corporate name;
- Principal business;
- Number of employees;
- Amount of stated capital;
- Classification / type of affiliated relationship;
- Shareholding ratio;
- Profit / loss status of the foreign affiliates for the latest fiscal year:
- Gross sales or turnover;
- Operating expenses (costs of goods sold, and sales, general and administrative expenses);
- Operating profits;
- Earnings before taxes;
- Retained earnings;
- Status of controlled transactions with foreign affiliates:
- Type of controlled transactions (sale and purchase of inventory, provision of services, royalties for use of tangible property, royalties for use of intangible property, interest on loans, or other transactions);
- Total amount received from or paid to the foreign affiliate, with respect to each type of the controlled transactions;
- Transfer pricing methodology adopted by the taxpayer, with respect to each type of the controlled transactions;
- Whether or not the taxpayer obtained an advance pricing arrangement (APA) with respect to the foreign affiliates.
The information to be disclosed on Schedule 17(4) is mere facts or numbers, and may not be very onerous to fill in. However, taxpayers should bear in mind that the information disclosed in Schedule 17(4) will be the basis for the Japanese tax authority to conduct a transfer pricing audit on the taxpayer. If there is any inconsistency between the information provided in Schedule 17(4) and the taxpayer’s position on transfer pricing in a tax audit (especially in relation to the transfer pricing methodology) this would be a problem. As such, taxpayers must be cautious in preparing Schedule 17(4) and must bear in mind the possibility of a future transfer pricing audit.