Japan releases guidance on transfer pricing documentation requirements

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1 7 June 2016 Global Tax Alert News from Transfer Pricing Japan releases guidance on transfer pricing documentation requirements EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary Japan s 2016 tax reform was enacted on 29 March 2016 and at the end of April 2016, the National Tax Agency posted guidance on its website to help clarify the documentation requirements within Japan. This Tax Alert updates a previous EY Global Tax Alert released in January 2016 regarding the implementation of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Action 13 into the Japanese transfer pricing regulations. The most significant update was the clarification on the contents of the Local File and on the deadlines for submission in the case of an audit. Detailed discussion Local File The Local File requirements largely follow current transfer pricing (TP) documentation requirements in Japan. The requirements call for greater information than is contained within the OECD Action 13 Final Report, 1 including the requirement for a local market analysis and counterparty segmented profit and loss accounts.

2 2 Global Tax Alert Transfer Pricing Japanese companies that have transactions with a foreign related party (applied per foreign entity) exceeding JPY5 billion in the preceding fiscal year 2 or intangible transactions exceeding JPY300 million (also applied per foreign entity) must prepare a Local File by the time of the tax return. 3 The documentation does not need to be submitted but it must be ready in the event of request during an audit. The deadline for submission will be set by the auditor at a maximum of 45 days for those companies that have to meet the contemporaneous requirement. For other companies, the deadline set by the auditor may be up to a maximum of 60 days. In addition to the documents required for the Local File (contemporaneous or otherwise), the auditor can request other important documents relevant in setting the transfer pricing, and can set a deadline, maximum of 60 days, for their submission. In the event that the requirements are not met, the tax authorities may use presumptive taxation and may make inquiries of and inspect third parties conducting the same/ similar business (secret comparables). Country-by-country report (CbC report) and Master File The content requirements of the CbC report and Master File are in line with the OECD Action 13 Final Report. The penalty for failure to submit the CbC report or the Master File by the respective deadline is up to a maximum of JPY300,000. This penalty can be levied on the representative, proxy or responsible employee, and additionally on the company itself. Starting for fiscal years beginning on or after 1 April 2016, Japanese companies with JPY100 billion group revenue for the preceding fiscal year 4 are required to prepare the CbC report. The CbC report will need to be provided in Japan if it was originally filed in a country that cannot provide the CbC report to the Japanese tax authorities. Possible reasons include the absence of a Qualifying Competent Authority Agreement (QCAA), absence of other measures to share the information or a Systemic Failure whereby the automatic exchange of information has been suspended even if there is a QCAA. The deadline to submit is within one year following the fiscal year-end of the parent company and the reporting language is English. Multinational enterprises with operations in Japan and that have JPY100 billion revenue or more for the preceding fiscal year 5 need to submit a Master File within one year following the fiscal year-end of the parent company. The Master File requirement applies to the ultimate parent for fiscal years beginning on or after 1 April The reporting language is Japanese or English. Companies need to take care as to whether the Japanese requirements will be earlier or later than other tax jurisdictions they operate within because of the introduction being from April, as opposed to many countries where the timing of implementation may be based on the calendar year end. Endnotes 1. Transfer Pricing Documentation and Country by Country Reporting, Action Final Report, released by the OECD. 2. Current year if no prior year activity. 3. Japanese or English language. 4. Current year if no prior year activity. 5. Current year if no prior year activity.

3 Global Tax Alert Transfer Pricing 3 Background: Under the 2016 revision to Article of Special Provisions for Taxation of Transaction with Foreign Related Persons, the Japanese local file documentation requirements expanded significantly. The table below compares the OECD guideline requirements and the updated requirements of Japanese law. OECD Local File documentation requirements Japanese Local File documentation requirements in comparison with OECD Local File requirements Local entity A description of the management structure of the local entity, a local organisation chart, and a description of the individuals to whom local management reports and the country(ies) in which such individuals maintain their principal offices. A detailed description of the business and business strategy pursued by the local entity including an indication whether the local entity has been involved in or affected by business restructurings or intangibles transfers in the present or immediately past year and an explanation of those aspects of such transactions affecting the local entity. Key competitors. Japanese requirements include a description of the business activities, policies and organisational structure of both the local entity and the foreign related party based on EY s past experience, this should be considered to include all the items in the OECD guidelines. The Japanese requirements are similar and the requirement to explain the business restructuring or movement of intangibles should be included within the functional analysis (see below for more details). Not explicitly within the Japanese requirements, however, this could be relevant to the market analysis as required per Article (i) (g). This requirement is that the Local File should include a section on the effects of the specific characteristics of the market on the pricing and profits and losses of the foreign related party transactions. Controlled transactions For each material category of controlled transactions in which the entity is involved, provide the following information: A description of the material controlled transactions (e.g. procurement of manufacturing services, purchase of goods, provision of services, loans, financial and performance guarantees, licences of intangibles, etc.) and the context in which such transactions take place. The amount of intra-group payments and receipts for each category of controlled transactions involving the local entity (i.e. payments and receipts for products, services, royalties, interest, etc.) broken down by tax jurisdiction of the foreign payor or recipient. An identification of associated enterprises involved in each category of controlled transactions, and the relationship amongst them. Copies of all material intercompany agreements concluded by the local entity. A detailed comparability and functional analysis of the taxpayer and relevant associated enterprises with respect to each documented category of controlled transactions, including any changes compared to prior years. Japanese requirements are for documents that describe the assets and services pertaining to the foreign related transactions. This should be considered to include all items suggested by the OECD guidelines. Japanese law also requires documents that show the existence or non-existence of transactions that are closely related to the foreign related transactions, as well as their content and nature. Japanese requirements are similar and it is also necessary to provide documents showing the price setting and negotiation process between the parties to the transactions which led to agreement on intra-group payments and receipts, and the profits and losses accruing to both parties in the foreign related transaction, as well as the process which led to the calculation of these profits and losses. This is not explicitly stated, however this would be expected within the description of assets and services pertaining to the foreign related transactions in Article 22:10 (i) (a). In addition, the information will also be disclosed in an attachment to the tax return (17-4). Japanese requirements request the agreements or documents that set out the contents of the agreements. The Japanese requirements also include the need for a detailed comparability and functional analysis. In addition, in the event that the corporation underwent a business restructuring (a merger, divestiture, transfer of business, transfer of important business assets, or changes to the business structure for any other reason) which resulted in any change to the functions carried out or risks borne by the Japanese corporation or the foreign related party in the foreign related transaction, Japanese law requires an explanation of the business restructuring and the resultant changes in functions carried out and risks borne. This is more specific and detailed than the OECD requirement to include changes for prior years.

4 4 Global Tax Alert Transfer Pricing An indication of the most appropriate transfer pricing method with regard to the category of transaction and the reasons for selecting that method. An indication of which associated enterprise is selected as the tested party, if applicable, and an explanation of the reasons for this selection. A summary of the important assumptions made in applying the transfer pricing methodology. If relevant, an explanation of the reasons for performing a multiyear analysis. A list and description of selected comparable uncontrolled transactions (internal or external), if any, and information on relevant financial indicators for independent enterprises relied on in the transfer pricing analysis, including a description of the comparable search methodology and the source of such information. A description of any comparability adjustments performed, and an indication of whether adjustments have been made to the results of the tested party, the comparable uncontrolled transactions, or both. A description of the reasons for concluding that relevant transactions were priced on an arm s length basis based on the application of the selected transfer pricing method. A summary of financial information used in applying the transfer pricing methodology. A copy of existing unilateral and bilateral/multilateral APAs and other tax rulings to which the local tax jurisdiction is not a party and which are related to controlled transactions described above. Annual local entity financial accounts for the fiscal year concerned. If audited statements exist they should be supplied and if not, existing unaudited statements should be supplied. Information and allocation schedules showing how the financial data used in applying the transfer pricing method may be tied to the annual financial statements. Summary schedules of relevant financial data for comparables used in the analysis and the sources from which that data was obtained. Controlled transactions (continued...) Similarly, Japanese guidelines require the company to state the method chosen and the reasons for that choice, and also requires any other documents the corporation created to calculate the arm s length price. This item is included within the Japanese requirements, as a requirement to document critical assumptions used in determining the pricing method. The starting point for Japan is single-year analysis. As per the Commissioner s Directive on the Operation of Transfer Pricing (Administrative Guidelines), there needs to be a logical reason for the use of a multiple year analysis, including the reason for the choice of the number of years. Japanese requirements are less explicit, calling only for [d]ocuments that describe the items considered in choosing comparable transactions...and the details (including financial information) of the comparable transactions. Japanese Local File requirements also include documents that show the existence or non-existence of transactions that are closely related to the foreign related transactions, as well as their content and nature. Overall, these requirements should be considered to include all the points included in the OECD guidelines. Japanese regulations also include this requirement to describe adjustments made to the tested party or comparables. This is included in the Japanese requirements under documents which describe the method used to calculate the arm s length price for amounts paid both to and by the Japanese corporation, or if transactional profit split methods were employed, in the documents describing the calculation under these methods of the amount of respective profit belonging to the corporation and the foreign related party. This is not explicitly stated, however, this would be included as part of the segmented P/L statement prescribed by (i) (f) Article 22:10 (i) (f), which requires documents that show the details of the profits and losses of the corporation described in Article 66-4, paragraph 6 of the Law and the foreign related party pertaining to the foreign related transactions, and documents showing the process that led to calculation of those profits and losses. Japanese regulations have broadly the same requirement, though are more specific because they refer to pricing that has been verified by the competent authority of the other country. Financial information The local entity financial statements are included within the tax return. This is not included explicitly but in practice would be required as part of the segmented P/L statement prescribed by (i) (f). Financial information on comparable transactions required, this should include the information specified by the OECD guidelines.

5 Global Tax Alert Transfer Pricing 5 For additional information with respect to this Alert, please contact the following: Ernst & Young Tax Co., Tokyo Ichiro Suto ichiro.suto@jp.ey.com Karl Gruendel karl.gruendel@jp.ey.com Tatsuhide Kanenari tatsuhide.kanenari@jp.ey.com Keith Thomas keith.thomas@jp.ey.com

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