At a time of globalisation, with the development of international business, internal transactions between international subsidiaries/subsidiaries of global organizations have become more common.
The values of these transactions are commonly referred to as transfer prices. Transfer pricing transactions are usually a transfer of profits from a country where high taxes apply to a country where lower taxes apply, including intangible assets which are difficult to assess.
The OECD report on BEPS (Base Erosion and Profit Shifting) and the resulting guidelines are an attempt to resolve these problems. Japan, in recent fiscal reforms, intended to align its provisions with the guidelines contained in the OECD Final Report resulting from the draft BEPS Guidelines.
These reforms also implement OECD guidelines on hard-to-Value Intangibles (HTVI) and on profit transfer arrangements.
The reform of tax law in Japan contains several changes, including:
- • clarification of the definition of intangible assets,
- • the adoption of the DCF (Discounted Cash Flow) as a method for estimating transfer prices,
- • extension of the limitation period from six to seven years,
- • formalise the use of the interquartile interval.
We will examine each of these areas below.
Definition of intangible assets
Immaterial assets are inherently unclear. That's what makes their valuation harder. Material assets such as real estate and machinery and financial assets such as cash and shares are relatively easy to estimate. The OECD Transfer Pricing Guidelines explain that an intangible asset is something that is not a physical or financial asset that can be owned or controlled for commercial use.
Examples include: intellectual property (e.g. patents), rights arising from commercial and government licences, company value, brands and trademarks.
Discounted Cash Flow Method (DCF)
The discounted cash flow method is not new in Japan. It has been used since more than 40 years. The change is that Japanese law formalized its application.
As a general rule, the discounted cash flow method provides the current valuation based on the discounted future value resulting from the expected future cash flow in case the companies are unable to provide the necessary information to determine the transfer price at market conditions (prices at which they are unable to provide the necessary information to determine the transfer price at market conditions).
two unconnected companies would conclude transactions. The Japanese National Tax Agency (NTA) can use the discounted cash flow method to estimate the tax by calculating the market price. The method is not only available to the National Tax Agency, taxpayers can also use it.
Legislation introduces a formal authorisation to use it as a way of measuring intangible assets. This solution is previously unusual in Japanese law.
Extension of the limitation period
The period during which the National Tax Agency can legally correct tax decisions has been extended from six to seven years. This gives more time to see the impact of an asset's operation, allowing a more precise determination of whether the market price is commercially reasonable.
Formalising the use of the interquartile interval
Japanese law thanks to tax reforms will formalise the solution that is already in use. The interquarter interval is a correction system which can be used to modify the transaction price in the absence of accurate data.
More detailed information
While Japanese legislators are ready to make changes to Japanese tax law, we are still waiting for more detailed information explaining how new regulations will look in practice. Given that the new rules will apply from April 2020, We expect their explanation to occur in 2019
source: Masatoshi Ito, Transfer pricing – overview of Japanese tax reforms , Russell Bedford Business World, September 2019