Managing tax disputes in Japan
Masahiko Kobayashi, of Deloitte Tohmatsu Tax, explains why keeping on top of tax compliance requirements is especially important for Japanese taxpayers trying to avoid disputes, and outlines the pros and cons of appeal options in Japan.
International Tax Review (ITR): What advice would you give to companies about how to reduce the risk of becoming involved in a dispute with the Japanese tax authorities?
Masahiko Kobayashi (MK) (pictured below): First and foremost, companies must ensure they are adequately managing their tax compliance obligations. Companies should employ at least one professional who is well versed with Japanese accounting and tax practices to ensure the company fully complies with local tax rules.
However, it may be difficult to recruit suitable candidates in Japan with sufficient knowledge about accounting and tax law, and who can communicate fluently in English. Outsourcing tax compliance activities may be necessary.
When planning to engage in sizeable transactions which could give rise to tax issues, it is advisable to seek the opinion of tax advisers experienced in Japanese transactions.
To obtain certainty in relation to a certain transaction, taxpayers can submit an inquiry letter to the national tax agency (NTA) to obtain an opinion about the tax treatment. The inquiry cannot be made on a hypothetical basis and should be made before filing the relevant tax return. The opinion will not be issued until after the tax filing deadline of the relevant period.
The NTA also recommends that multinationals seeking to avoid transfer pricing disputes apply for advance pricing agreements (APA).
Unilateral and bilateral APAs are available. A unilateral APA is a procedure between the taxpayer and the NTA and is suitable for cases where the risk of a large adjustment is only in Japan. A bilateral APA is an arrangement involving treaty partners, and is the most effective solution for mitigating the risk of transfer pricing disputes.
The NTA conducts periodic audits to assess the tax affairs of companies in Japan so appropriate management of the audit process is important.
It is not uncommon for multinationals, whose group accounting functions have been globally centralised, to have all their accounting records kept at a central location.
At the time of a tax audit, failure to present those records in a timely manner could result in an unfavourable disposition by the NTA, for instance, denial of the blue return status, which entitles Japanese taxpayers to benefits such as the carry forward of losses in exchange for enhanced reporting to the tax authority.
Loss of the blue return status can have implications such as being denied carryover of non-operating losses.
During audit, answers provided to the tax auditors’ questions should be simple and accurate. Inaccurate responses could lead to misinterpretation by the tax auditors so advance preparation is important. Conducting a mock audit in advance is an effective way to prepare and identify potential weaknesses.
ITR: What options do Japanese taxpayers have to resolve disputes with the tax authorities other than litigation?
MK: Taxpayers with objections against an NTA assessment can file an administrative appeal in the first instance.
The administrative appeal process consists of the request for a reinvestigation, addressed to the head of the tax office that made the assessment, and the request for a reconsideration, addressed to the National Tax Tribunal Office (tribunal) to review the assessment.
Usually, decisions by the tribunal are more taxpayer-favourable than decisions by the request for reinvestigation. If a taxpayer has a blue return status, the first stage can be skipped and request for a reconsideration can be made directly to the tribunal.
Request for reinvestigation
· No fee;
· Relatively quick conclusion;
· If assessment made based on an apparent misunderstanding or erroneous application of law, tax office may use the process to correct the error.
· Difficult for NTA to deny assessment unless new evidence / information discovered allowing previous assessment to be overturned.
Request for reconsideration
· No fee;
· Tribunal review generally provides more independent view than reinvestigation;
· Tax authorities do not have a right to file a lawsuit even if they disagree with the conclusion of the tribunal.
· Tribunal not fully independent from tax department as more than half the tribunal judges come from the department and some may return there;
· Head of the National Tax Tribunal is assigned by the NTA Commissioner.
If an assessment was made based on a tax examiner’s fundamental misunderstanding of the facts, the taxpayer can expect the original assessment to be partly or fully denied by the tribunal during reconsideration.
In response to criticism that the tribunal was not independent from the NTA, the tribunal is undertaking some reform, including employing external professionals – such as foreign lawyers and accountants – as tribunal judges.
The success rate for taxpayers challenging an assessment through a reconsideration has been gradually increasing and is higher than cases which go to litigation.
If the case concerns a disposition contrary to a tax treaty, mutual agreement procedures (MAP) are an option to resolve the dispute. It is possible to file an MAP request and appeal the assessment. Usually the appeals process is suspended to allow the MAP procedures to proceed first.
ITR: Are you seeing any trends in the types of dispute cases which the Japanese tax authorities are taking up, and those where they are succeeding in the courts?
MK: The NTA’s recent areas of focus include:
· Transfer pricing, particularly relating to shifting of sales functions performed by Japanese subsidiaries from a buy-sell function to a service under a commissionaire structure. Though NTA lost a litigation case involving a famous software company, this remains an area of focus.
· Non-payment of royalties / remuneration for services by foreign subsidiaries to the Japanese company, particularly in cases where foreign subsidiaries recorded high operating margins. No court decisions have been made so far, though NTA has lost in some tribunal cases.
· The tax status of foreign based partnerships: transparent entity or company. Decisions at district court level have been varied.
· The existence of permanent establishments (PE) in respect of companies in the electronic commerce industry. A large multinational which only performed warehousing and transportation functions in Japan was recently found to have a PE in Japan and the case is under MAP consideration.
ITR: What do you think multinationals in Japan can expect from the NTA in future?
MK: The NTA appears to place more emphasis on taxpayers’ compliance efforts.
It publicly announced that if a company is evaluated as achieving a high compliance level, the NTA would make the interval between audits longer than usual. This implies the NTA is focusing its resources on pursuing more serious tax avoidance schemes or tax fraud cases.
Secondly, due to fundamental change to the tax audit procedures, with tax auditors requested to comply with procedures prescribed by tax law, field tax audits will be more focused on ensuring information provided by taxpayers meets prescriptive standards.
For example, auditors have frequently denied deductions of input consumption tax where a taxpayer has failed to keep receipts of the expense as required. Taxpayers will need to ensure a more rigorous level of compliance going forward.
Transfer pricing will continue to be a big focus. In 2011 the list of documents which will be requested during transfer pricing audits were prescribed into tax law, and failure to prepare such documents, although not resulting in a penalty, may trigger transfer pricing adjustments by the NTA through reference to secret comparable companies.
Although there are no contemporaneous transfer pricing documentation requirements, preparation of such documentation is effectively obligatory for foreign-based groups doing business in Japan to avoid presumptive taxation using secret comparables.
As for alternative dispute resolution options, the law governing the administrative appellate procedures, which covers all administrative appellate processes, is expected to be fundamentally changed in a couple of years.