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TAX NEWS - FEBRuary 2010

Japan to clarify transfer pricing rules

Japan's ruling Democratic Party on December 22, 2009, released proposals for tax reform based on recommendations of the Tax Commission. Among the expected changes that could affect multinational companies are amendments to the antitax-haven rules, the group taxation rules, and the transfer pricing rules.

The details of discussions published by the Tax Commission included consideration of the adoption of a contemporaneous documentation requirement for transfer pricing purposes. However, the contemporaneous documentation requirement was excluded from the Tax Commission's final proposals for Tax Reform 2010. Instead, the Tax Commission clarified the current situation, whereby the Japanese tax authorities are allowed to make adjustments based on their own logic, and including the use of secret comparables (detailed comparable data not presented to taxpayers upon audit).

The Tax Commission's proposal will be drafted into legislation/enforcement order that is expected to be released by April 1, 2010. It is expected that the legislation/enforcement order would require taxpayers to have documentation in connection with the calculation of transfer pricing and details of the intercompany transactions in question. As mentioned above, the intent of the reform is not to adopt a contemporaneous documentation requirement, which is a post-transaction test, but to require taxpayers to determine their transfer pricing based on certain policies with rationale.

Therefore, a preparation of a contemporaneous documentation alone would not keep the Japanese tax authorities from using secret comparables. Conversely, even if taxpayers are not equipped with contemporaneous documentation, they could be liberated from the threat of secret comparables if they conduct intercompany transactions based on predetermined detailed policies with rationale that are reflected in their intercompany agreements and other related documents.

The Japanese tax authorities also intend to revise their transfer pricing circular and list the major items to be examined upon audit to see if an arm's length pricing negotiation took place between taxpayers and their foreign affiliates.
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