(This is the 3rd article of this seminar series composed of 11 articles)
(Part 3) Transfer Pricing Examinations, Advance Pricing Agreements, and Documentation
1. Arm’s-Length Prices for Past, Future, and Current Business Years
There are broadly three situations in which corporations need to deal with transfer pricing taxation: (1) Taxation of Transfer Pricing, (2) Advance Pricing Agreements (APAs), and (3) Contemporaneous Documentation. For certain controlled transactions, (1) Taxation of Transfer Pricing is when the tax authority conducts an examination and imposes tax on a corporation according to the results, and the corporation is required to prepare the documents to calculate the arm’s-length price for the past business year. A corporation can request (2) an APA to obtain advance confirmation from the tax authority on the arm’s-length price in controlled transactions for future business years, and the corporation is required to prepare the documents to calculate the arm’s-length price when requesting the APA. A corporation performs (3) Contemporaneous Documentation when it prepares its own income tax return, and the corporation is required to prepare the documents to calculate the arm’s-length price for the current business year.
2. Transfer Pricing Taxation (Arm’s-Length Price for the Past Business Year)
The tax authority, in accordance with transfer pricing regulations, imposes tax on a corporation based on the assumption that the corporation has conducted controlled transactions with its foreign affiliate at the arm’s-length price, which is calculated based on one of various calculation methods.
[Business years ended before March 31, 2017]
The tax authority examines the transfer pricing and calculates the appropriate range of arm’s-length prices for the controlled transactions in question during the past business year. This is done by assessing the corporation’s and the foreign affiliate’s voluntarily submitted accounting documents, as well as publicly available information on other corporations in similar businesses. The tax authority imposes tax on the corporation when the actual transaction price in the controlled transactions deviates from the range that is calculated during the examination.
[Business years starting after April 1, 2017]
The tax authority examines the transfer pricing and calculates the appropriate range of the arm’s-length prices for the controlled transactions in question during the past business year. This is done by assessing the documents that are considered necessary to calculate the arm’s-length price (local files) or the documents equivalent to the local files that the tax authority requests the corporation to submit, as well as publicly available information on other corporations in similar businesses. The tax authority imposes tax on the corporation when the actual price in the controlled transactions deviates from the range that is calculated during the examination.
3. Advance Pricing Agreements on Transfer Pricing (Transfer Prices for Future Business Years)
In an Advance Pricing Agreement, a corporation prepares documents equivalent to the local files, sets the (permissible) range of the operating margin as the arm’s-length price for the controlled transactions to be conducted in future business years, and requests the tax authority to review the documents. The tax authority, if necessary, asks the corporation to make revisions, and finally confirms the contents.
The benefit of the APA is that the tax authority will not impose a transfer pricing tax on the controlled transactions if the tested party’s operating margins in the business years subject to the APA fall within the range confirmed in the APA.
APAs are available in other developed countries and are now an established part of the tax system, although they are stipulated not in the tax law but in the Administrative Guidelines.
4. Contemporaneous Documentation of Transfer Pricing Taxation (Transfer Pricing for the Current Business Year)
A corporation is required to prepare or obtain, and store, local files on controlled transactions before the submission deadline of the income tax return for the current business year, if: (1) the total amount of the controlled transactions in the previous business year was five billion yen or more, or (2) the total amount of the transactions of intangibles in the previous business year was 300 million yen or more. Examples of local files can be found on the website of the National Tax Agency (please refer to Part 2 of this seminar series). Even though the total amount of the controlled transactions is lower than the requirements mentioned above, a corporation can be required to submit documents equivalent to the local files before a specific day (designated by the tax examiner and within 60 days), if the examiner makes such a request during a tax examination.
(Note) “Controlled transactions” refers to the sale or purchase of assets, the provision of services, or other transactions conducted by corporations with related foreign parties.
(Note) “Transactions of intangibles” refers to the transfer or lending of intangible assets, such as patent rights, utility model rights, or other intangible assets.
(The next article in this “Transfer Pricing Seminar Series for Medium-sized Corporations in Japan” will be published next month.)
For further inquiries, please contact us at Japan@HLS-Global.jp.
Transfer Pricing Seminar Series Articles:
- (Part 1) Working Seminar for Medium-sized Corporations Unfamiliar with Transfer Pricing
- (Part 2) Overview of Transfer Pricing Taxation
- (Part 3) Transfer Pricing Examinations, Advance Pricing Agreements, and Documentation
- (Part 4) Transfer Pricing Methods to determine the Arm’s Length Price
- (Part 5) Traditional Transaction Methods
- (Part 6) Transactional Net Margin Method: TNMM
- (Part 7) Profit Split Method
- (Part 8) Considerations to prepare the Local File
- (Part 9) Considerations When Preparing Local Files
- (Part 10) Selection of the comparable companies and calculation of the profitability range
- (Part 11) Transfer Pricing Policy and Transfer Pricing Documentations
