The Japanese tax authorities have reorganized the international tax audit teams, effective July 2020. This reorganization allows a single audit team to examine both domestic and international tax issues (including transfer pricing and permanent establishments) simultaneously.
Taxpayers should be aware of this change and adapt their response to tax audits accordingly. In particular, taxpayers should ensure that their personnel managing a tax audit are aware of the potential for transfer pricing or international tax questions to arise from the start of a tax audit and be prepared to obtain the necessary support to respond.
Transfer pricing has been a prominent focus for the tax authorities, and there has been a rising number of transfer pricing assessments in recent years. Specifically, cases have increased from 169 in 2016 to 257 in 2018. As a result, this may be a key issue during a tax audit.
Change in tax authority structure
On 20 December 2019, Japan’s National Tax Agency (NTA) released a document showing the reorganization planned for the administrative year beginning July 2020.
Under the heading “Responding to internationalization,” the document sets out the divisions/audit teams within the regional tax bureaus (RTBs) which deal with international taxation.
Transfer Pricing Divisions in regional tax bureaus have been replaced by International Examination Management Divisions (a provisional title referred to as IEMD herein). IEMDs are located in the larger RTBs of Tokyo, Osaka and Nagoya, and have a much broader audit scope than just transfer pricing.
Another outcome of this restructuring is that domestic corporate tax audit teams are also now able to audit transfer pricing issues, whereas previously only transfer pricing divisions were able to audit such issues.
Effect on audit approach
The IEMD and domestic corporate tax audit teams will be able to audit a wide range of issues, including transfer pricing and international tax matters such as permanent establishments or application of the principal purpose test concurrently (a “simultaneous audit”).
Previously, an examiner would have had to bring in different teams to address each issue separately.
This new approach reflects the NTA’s desire to respond effectively to complicated tax issues (TP taxation or PE taxation, tax avoidance schemes, etc.), by concentrating audit authority in the hands of a single team.
Implications for taxpayers
Previously, as transfer pricing issues were examined separately from domestic tax issues, it was easier for the local tax or finance team to know when questions should be addressed to colleagues in international tax or transfer pricing departments, who are usually located overseas.
Now, under simultaneous audits, local corporate tax personnel managing a corporate tax audit are likely to be asked questions on transfer pricing and international tax matters.
Transfer pricing audits can be intrusive with NTA issuing many requests for documents and information. Questions can often be open ended and abstract. Therefore, it is important to understand the rationale for a request to be able to be efficient and responsive in a manner that does not increase audit risk.
Accordingly, taxpayers should consider the following in preparing for a tax audit:
For additional information with respect to this Alert, please contact the following: