Japan: Transfer pricing proposals focus on hard-to-value intangibles

19 December 2018

The ruling coalition (the Liberal Democratic Party and the New Komeito) on 14 December 2018 agreed to an outline of tax reform proposals that include transfer pricing measures.

The proposals are only an outline indicative of the government’s plans for tax reform, and details are expected to be unveiled with the future release of bills, cabinet orders, and ministerial ordinances. Thus, the final version of the tax reform provisions could differ from these proposals.


Transfer pricing proposals

The transfer pricing rules would be amended to follow certain international guidance from the OECD including the final report under Actions 8 – 10 of the base erosion and profit shifting (BEPS) project; the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017; and the Guidance for Tax Administrations on the Application of the Approach to Hard-to-Value Intangibles (June 2018).

More specifically, the transfer pricing rules would be amended to refine the calculation method to determine an arm’s length price and to establish the method to make it possible for the Japanese tax authorities to verify the reasonableness of the transaction price for hard-to-value intangibles, taking into consideration outcomes that occur or are known after the subject transactions.


Definition of intangibles subject to transfer pricing rules

Intangibles subject to the transfer pricing rules would be defined as follows:

Among any assets owned by companies, assets other than physical assets or financial assets (cash, bank deposits, securities, etc.) which should be compensated for their commercial usage (sales, loans, etc.) between independent parties under ordinary terms and conditions.



Methods to reach arm’s length price

It is proposed to include the discounted cash flow (DCF) method as one of the transfer pricing methods because the OECD Transfer Pricing Guidelines describe the DCF method as being useful to reach an arm’s length price for intangibles when comparable transactions cannot be identified.

In connection with the DCF method’s introduction, the transaction price calculated using the DCF method based on the information available to the Japanese tax authorities at the time of the controlled transactions with foreign related parties would be treated as the arm’s length price for purposes of a presumptive tax assessment, that would be applicable when the required documents to determine the arm’s length price are not submitted in a timely manner.



Introduction of price adjustment measures to hard-to-value intangibles

The OECD Transfer Pricing Guidelines reflect the recommendations of the final report under BEPS Actions 8 – 10, such that tax administrations can consider ex-post outcomes as presumptive evidence about the appropriateness of the ex-ante pricing arrangement for purposes of price adjustments of hard-to-value intangible transactions due to information asymmetry between the taxpayer and tax administrations.

Hard-to-value intangibles would be defined as intangibles satisfying all of the following:

  • Unique and having significant value
  • Arm’s length pricing is calculated based on the income projection
  • Assumptions used in valuing the arm’s length price are uncertain

Accordingly, the following measures would be introduced for price adjustments:

  • Price adjustment measure: In situations when ex-post outcomes give a result different from the ex-ante pricing arrangement for the arm’s length pricing of hard-to-value intangible transactions, the Japanese tax authorities would be able to make a tax assessment based on the arm’s length price measured by the most appropriate method to reach an arm’s length price of hard-to-value intangible transactions taking into consideration ex-post outcomes and the probability of events to bring such discrepancy. This measures would not be applied as far as the ratio of the difference between the arm’s length price and the original transaction price is 20% or less.
  • Conditions for exemption: The price adjustment measure (described above) would not be applied, provided that the following documentation is submitted by the taxpayer within a certain period of time at the request of the Japanese tax authorities:
    • Documents for (1) details of the projections used in valuing the arm’s length prices of the hard-to-value intangible transactions; and (2) evidence that (a) the discrepancy between the projections and the ex-post outcomes is due to a disaster or other similar event that could not be foreseen at the time of the transactions, or (b) the arm’s length price was determined by taking into account the probability of events to bring the discrepancy appropriately at the time of the transactions
    • Evidence to prove that the ratio of the difference between the actual income and the projected income against the projected income is 20% or less in total for five years, starting from the beginning of the fiscal year in which the first income from an unrelated party was generated for the use of the hard-to-value intangible. The price adjustment measure would not be applied after the end of the five years if the evidence was submitted to the Japanese tax authorities.


Extension of statute of limitations under transfer pricing rules

The OECD’s Hard-to-Value Intangible Guidance requires some consideration of timing issues because a feature of such intangibles is taking time for their commercialization, and that the statute of limitations may not correspond with the tax audit cycle when the tax authorities can audit hard-to-value intangible transactions after the emergence of ex-post outcomes. To address these issues, adjustments to the statute of limitations are recommended.

Accordingly, the Japanese proposals would extend the statute of limitations under the transfer pricing rules from six years to seven years.


Adjustment methods for differences

The so-called “inter-quartile method” would be allowed for the adjustment of differences when the arm’s length price is calculated by reference to the profitability of uncontrolled comparable transactions in the event necessary adjustments cannot be made quantitatively.


Effective date

These transfer pricing rule changes are proposed to apply for fiscal years beginning on or after 1 April 2020 for corporation tax purposes and from 2021 for income or income tax purposes.


Read a December 2018 report [PDF 351 KB] prepared by the KPMG member firm in Japan


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