Transfer Pricing Seminar for Medium-sized corporations in Japan

(This is the 5th article of this seminar series composed of 11 articles)

(Part 5) Traditional Transaction Methods

Traditional transaction methods are stipulated in Article 66-4 Paragraph (2) Item (i) a-c of the Act on Special Measures Concerning Taxation. In this article, we will explain Case1-3 in the Reference Case Studies on the Application of Transfer Pricing Taxation. Please refer to the original document for the full information, as the contents of that document are partially omitted in this article.

  1. Comparable Uncontrolled Price Method (CUP)

The Comparable Uncontrolled Price Method employs an equivalent transaction price set in circumstances where the seller and the buyer are not in a special relationship. The assets must be the same with or similar to those of the controlled transactions under circumstances similar to those found in the controlled transactions. If so, the transaction price can be deemed the arm’s-length price. This method is considered susceptible to differences in the properties, construction, functions, etc., of the assets.
In principle, transactions that involve products comparable to those in the controlled transactions are selected as the comparable transactions.

Case 1, “Use of the Comparable Uncontrolled Price Method,” in the Reference Case Studies explains the transactions described in the chart below. Transaction B between Company P and Company T is identified as a comparable transaction on the assumption that Product B is classified as a different product (i.e. has a different model number) from product A, but the two are similar in terms of properties, construction, functions, etc., and the two transactions are in the same position in the transactional chain and are substantially the same in volume. The transactions between Company P and Company S are referred to as internal comparable transactions, while Transaction B, between Company P and Company T, is identified as an external comparable transaction.

HLS transfer pricing blog flowchart(Source: Case 1 in “Reference Case Studies on Application of Transfer Pricing Taxation,” National Tax Agency)

2. Resale Price Method (RP)

The Resale Price Method calculates the arm’s-length price by deducting a routine gross profit from the price paid for resale by the buyer of inventory assets in a controlled transaction and compares it to the price in a sale to a party who is not in a special relationship with the company. This method is considered not susceptible to differences in properties, construction, etc., of the inventory assets but susceptible to differences in functions.

In principle, transactions that have similar profit margins (gross profit margins) as those in the controlled transactions are selected as comparable transactions.

Case 2, “Use of the Resale Price Method,” in the Reference Case Studies explains the transactions described in the chart below. The transactions in which Company T purchases Product B from a third party is identified as a comparable transaction on the assumption that Company T is a reseller of products imported from a third-party foreign manufacturer to third-party agents in Japan, and it does not engage in any other business. It also assumes that Product B has a close similarity to Product A in terms of its properties, construction, functions, etc. It further assumes that Company T is similar to Company S in terms of sales, position in the transactional chain, and in sales functions (i.e. similar advertising, sales promotion, after-sales service, etc.)

HLS transfer pricing blog flowchart(Source: Case 2 in “Reference Case Studies on Application of Transfer Pricing Taxation,” National Tax Agency)

3. Cost Plus Method (CP)

In the Cost Plus Method, the price calculated by adding a gross profit markup to the cost of the goods, including the purchase, manufacture, or any other activities carried out by the seller, is deemed to be the arm’s-length price in the controlled transactions. This method is considered not susceptible to differences in properties, construction, etc., but it is susceptible to differences in functions.

In principle, transactions that have similar profit margins (ratio of gross profit to cost of sales) as those of the controlled transactions are selected as comparable transactions.

Case 3, “Use of the Cost Plus Method,” in the Reference Case Studies explains the transactions described in the chart below. Transactions of Product B between Company P and Company T are identified as comparable transactions on the assumption that Product B is not the same as Product A but is similar in properties, construction, functions, etc., and the two transactions are substantially the same in volume. This method also assumes that the terms and conditions of the sales contracts (e.g. delivery terms, payment terms, product warranties, and conditions for returns) for the two transactions are the same, with the exception of the transaction price.

HLS transfer pricing blog flowchart(Source: Case 3 in “Reference Case Studies on Application of Transfer Pricing Taxation,” National Tax Agency)

(The next article in the “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:

Features Articles

Stay up to date on a variety of topics including Japan market entry, global tax and accounting, transfer pricing, and much more. Our featured articles are updated regularly and include the latest insights on global business.